Incremental Analysis - MA

CHAPTER 20
Gabriela Hasbun/Redux
Incremental Analysis
Chapter Preview
An important purpose of management accounting is to provide managers with relevant infor-
mation for decision-making. Companies of all sorts must make product decisions. Oral-B
Laboratories opted to produce a new, higher-priced toothbrush. General Motors announced
the closure of its Oldsmobile Division. Quaker Oats decided to sell off a line of beverages, at a
price more than $1 billion less than it paid for that product line only a few years before.
This chapter explains management’s decision-making process and a decision-making
approach called incremental analysis. The use of incremental analysis is demonstrated in a
variety of situations.
companies in the world dominate the soap market (e.g., Proctor

Feature Story & Gamble, Clorox, and Unilever), starting a new soap
company seems like an outrageously bad idea. But that didn’t
Keeping It Clean dissuade Adam Lowry and Eric Ryan from giving it a try. The
When you think of new, fast-growing, San Francisco compa- long-time friends and former roommates combined their skills
nies, you probably think of fun products like smartphones, (Adam’s chemical engineering and Eric’s design and market-
social networks, and game apps. You don’t tend to think of ing) to start Method Products. Their goal: selling environ-
soap. In fact, given that some of the biggest, most powerful mentally friendly soaps that actually remove dirt.
20-1
20-2 CH A PT E R 20 Incremental Analysis
Within a year of its formation, the company had products they have to be far more careful about controlling costs and far
on the shelves at Target stores. Within 5 years, Method was more innovative in solving problems. Consider Method’s most
cited by numerous business publications as one of the fastest- recently developed laundry detergent. It is 8 times stronger
growing companies in the country. It was easy—right? Wrong. than normal detergent, so it can be sold in a substantially
Running a company is never easy, and given Method’s com- smaller package. This reduces both its packaging and shipping
mitment to sustainability, all of its business decisions are just costs. In fact, when the cost of the raw materials used for soap
a little more complex than usual. For example, the company production recently jumped by as much as 40%, Method actu-
wanted to use solar power to charge the batteries for the forklifts ally viewed it as an opportunity to grab market share. It deter-
used in its factories. No problem, just put solar panels on the mined that it could offset the cost increases in other places in its
buildings. But because Method outsources its manufacturing, supply chain, thus absorbing the cost much easier than its big
it doesn’t actually own factory buildings. In fact, the company competitors.
that does Method’s manufacturing doesn’t own the buildings In these and other instances, Adam and Eric identified
either. Solution—Method parked old semi-trailers next to the their alternative courses of action, determined what was
factories and installed solar panels on those. relevant to each choice and what wasn’t, and then carefully
Since Method insists on using natural products and sus- evaluated the incremental costs of each alternative. When you
tainable production practices, its production costs are higher are small and your competitors have some of the biggest
than companies that don’t adhere to these standards. Adam and marketing budgets in the world, you can’t afford to make very
Eric insist, however, that this actually benefits them because many mistakes.
Watch the Method Products video in WileyPLUS to learn more about incremental
Video
analysis in the real world.
Chapter Outline
LEARNING OBJECTIVES
LO 1 Describe management’s • Incremental analysis approach DO IT! 1 Incremental Analysis

decision-making process and • How incremental analysis works
incremental analysis.
• Qualitative factors
• Incremental analysis and ABC
• Types of incremental analysis
LO 2 Analyze the relevant costs in • Special price DO IT! 2 Special Orders

accepting an order at a special price. • Available capacity
LO 3 Analyze the relevant costs in a • Make-or-buy DO IT! 3 Make or Buy

make-or-buy decision. • Opportunity cost
LO 4 Analyze the relevant costs and • Single-product case DO IT! 4 Sell or Process Further
revenues in determining whether to • Multiple-product case
sell or process materials further.
LO 5 Analyze the relevant costs to be • Repair, retain, or replace equipment DO IT! 5 Repair or Replace
considered in repairing, retaining, • Sunk costs Equipment
or replacing equipment.
LO 6 Analyze the relevant costs in • Unprofitable segments DO IT! 6 Unprofitable Segments

deciding whether to eliminate an • Avoidable fixed costs
unprofitable segment or product.
• Effect of contribution margin
Go to the Review and Practice section at the end of the chapter for a review of key concepts
and practice applications with solutions.
Visit WileyPLUS with Orion for additional tutorials and practice opportunities.
Decision-Making and Incremental Analysis 20-3
Decision-Making and Incremental Analysis
LEARNING OBJECTIVE 1
Describe management’s decision-making process and incremental analysis.
Making decisions is an important management function. Management’s decision-making

process does not always follow a set pattern because decisions vary significantly in their scope,
urgency, and importance. It is possible, though, to identify some steps that are frequently
involved in the process. These steps are shown in Illustration 20.1.
ILLUSTRATION 20.1 Management’s decision-making process
Choice B Choice B
SALES
Choice A Choice A
Choice C Choice C
1. Identify the 2. Determine and evaluate 3. Make a decision 4. Review results

problem and assign possible courses of action of the decision
responsibility
Accounting’s contribution to the decision-making process occurs primarily in Steps 2

and 4—evaluating possible courses of action and reviewing results. In Step 2, for each
possible course of action, relevant revenue and cost data are provided. These show the expected
overall effect on net income. In Step 4, internal reports are prepared that review the actual
impact of the decision.
In making business decisions, management ordinarily considers both financial and non-
financial information. Financial information is related to revenues and costs and their effect on
the company’s overall profitability. Nonfinancial information relates to such factors as the effect
of the decision on employee turnover, the environment, or the overall image of the company in
the community. (These are considerations that we touched on in our Chapter 14 discussion of
corporate social responsibility.) Although nonfinancial information can be as important as finan-
cial information, we will focus primarily on financial information that is relevant to the decision.
Incremental Analysis Approach

Decisions involve a choice among alternative courses of action. Suppose you face the
personal financial decision of whether to purchase or lease a car. The financial data relate to
the cost of leasing versus the cost of purchasing. For example, leasing involves periodic lease
payments; purchasing requires “up-front” payment of the purchase price. In other words, the
financial information relevant to the decision are the data that vary in the future among the
possible alternatives. The process used to identify the financial data that change under alterna-
tive courses of action is called incremental analysis (see Alternative Terminology). In ALTERNATIVE
some cases, you will find that when you use incremental analysis, both costs and revenues TERMINOLOGY
vary. In other cases, only costs or revenues vary. Incremental analysis is also
Just as your decision to buy or lease a car affects your future financial situation, similar called differential analysis
decisions, on a larger scale, affect a company’s future. Incremental analysis identifies the because the analysis focuses
probable effects of those decisions on future earnings. Such analysis inevitably involves esti- on differences.
mates and uncertainty. Gathering data for incremental analyses may involve market analysts,
engineers, and accountants. In quantifying the data, the accountant must produce the most
reliable information available.
How Incremental Analysis Works

The basic approach in incremental analysis is shown in Illustration 20.2.
ILLUSTRATION 20.2 Basic approach in incremental analysis

Incremental Analysis
Home Insert Page Layout Formulas Data Review View
P18 fx
A B C D
Net Income
1 Alternative A Alternative B Increase (Decrease)
2 Revenues $125,000 $110,000 $ (15,000)
3 Costs 100,000 80,000 20,000
4 Net income $ 25,000 $ 30,000 $ 5,000
5
This example compares Alternative B with Alternative A. The net income column
shows the differences between the alternatives. In this case, incremental revenue will be
$15,000 less under Alternative B than under Alternative A. But a $20,000 incremental cost
savings will be realized.1 Thus, Alternative B will produce $5,000 more net income than
Alternative A.
In the following pages, you will encounter three important cost concepts used in
incremental analysis, as defined and discussed in Illustration 20.3.
ILLUSTRATION 20.3 Key cost concepts in incremental analysis
r3FMFWBOUDPTUBOESFWFOVFT In incremental analysis, the only

#1 #2
factors to be considered are those costs and revenues that differ
ALT ALT across alternatives. Those factors are called SFMFWBOUDPTUTBOE
SFWFOVFT. Costs and revenues that do not differ across alternatives
can be ignored when trying to choose between alternatives.
,
ock
Kn ck
o
Kn
TPPCBE r4VOLDPTUCosts that have already been incurred and will not
be changed or avoided by any present or future decisions are
referred to as TVOLDPTUT. For example, the amount you spent
in the past to purchase or repair a laptop should have no bearing
on your decision whether to buy a new laptop. 4VOLDPTUTBSF
OPUSFMFWBOUDPTUT
1
Although income taxes are sometimes important in incremental analysis, they are ignored in the chapter for
simplicity’s sake.
Decision-Making and Incremental Analysis 20-5
Incremental analysis sometimes involves changes that at first glance might seem contrary
to your intuition. For example, sometimes variable costs do not change under the alternative
courses of action. Also, sometimes fixed costs do change. For example, direct labor, normally
a variable cost, is not a relevant cost in deciding between the acquisition of two new factory
machines if each asset requires the same amount of direct labor. In contrast, rent expense,
normally a fixed cost, is a relevant cost in a decision whether to continue occupancy of a build-
ing or to purchase or lease a new building.
It is also important to understand that the approaches to incremental analysis dis-
cussed in this chapter do not take into consideration the time value of money. That is,
amounts to be paid or received in future years are not discounted for the cost of interest in this
chapter. Time value of money is addressed in Chapter 25 and Appendix G.
Service Company Insight American Express

That Letter from AmEx if they would give back their credit card. You could receive the $300
even if you hadn’t paid off your balance yet, as long as you agreed
Might Not Be a Bill
to give up your credit card. Apparently, these customers cost more
No doubt every one of you has than they are worth.
received an invitation from a
credit card company to open a Source: Aparajita Saha-Bubna and Lauren Pollock, “AmEx Offers Some
new account—some of you have Holders $300 to Pay and Leave,” Wall Street Journal Online (February 23,
probably received three in one 2009).
day. But how many of you have
received an offer of $300 to close
out your credit card account? What are the relevant costs that American Express would need
American Express decided to to know in order to determine to whom to make this offer?
Tina Spruce/iStockphoto offer some of its customers $300 (Go to WileyPLUS for this answer and additional questions.)
Qualitative Factors
In this chapter, we focus primarily on the quantitative factors that affect a decision—those
attributes that can be easily expressed in terms of numbers or dollars. However, many of the
decisions involving incremental analysis have important qualitative features. Though not easily
measured, they should not be ignored.
Consider, for example, the potential effects of the make-or-buy decision or of the decision
to eliminate a line of business on existing employees and the community in which the plant is
located. The cost savings that may be obtained from outsourcing or from eliminating a plant
should be weighed against these qualitative attributes. One example would be the cost of lost
morale that might result. Al “Chainsaw” Dunlap was a so-called “turnaround” artist who went
into many companies, identified inefficiencies (using incremental analysis techniques), and
tried to correct these problems to improve corporate profitability. Along the way, he laid off
thousands of employees at numerous companies. As head of Sunbeam, it was Al Dunlap who
lost his job because his Draconian approach failed to improve Sunbeam’s profitability. It was
reported that Sunbeam’s employees openly rejoiced for days after his departure. Clearly, quali-
tative factors can matter.
Relationship of Incremental Analysis

and Activity-Based Costing
In Chapter 17, we noted that many companies have shifted to activity-based costing to
allocate overhead costs to products. The primary reason for using activity-based costing is
that it results in a more accurate allocation of overhead. The concepts presented in this
chapter are completely consistent with the use of activity-based costing. In fact, activity-
based costing results in better identification of relevant costs and, therefore, better incremental
analysis.
Types of Incremental Analysis

A number of different types of decisions involve incremental analysis. The more common
types of decisions are whether to:
1. Accept an order at a special price.
2. Make or buy component parts or finished products.
3. Sell products or process them further.
4. Repair, retain, or replace equipment.
5. Eliminate an unprofitable business segment or product.
We consider each of these types of decisions in the following pages.
DO IT! 1 Incremental Analysis ACTION PLAN

• Past costs that cannot be
Owen T Corporation is comparing two different options. The company currently operates under
changed as a result of any
Option 1, with revenues of $80,000 per year, maintenance expenses of $5,000 per year, and operat-
present or future action are
ing expenses of $38,000 per year. Option 2 provides revenues of $80,000 per year, maintenance
sunk costs.
expenses of $12,000 per year, and operating expenses of $32,000 per year. Option 1 employs a piece
of equipment that was upgraded 2 years ago at a cost of $22,000. If Option 2 is chosen, it will free • Benefits lost by choosing
up resources that will increase revenues by $3,000. one option over another are
Complete the following table to show the change in income from choosing Option 2 versus opportunity costs.
Option 1. Designate any sunk costs with an “S.”
Net Income
Increase
Option 1 Option 2 (Decrease) Sunk (S)
Revenues
Maintenance expenses
Operating expenses
Equipment upgrade
Opportunity cost
Solution
Net Income
Increase
Revenues $80,000 $80,000 $ 0
Maintenance expenses 5,000 12,000 (7,000)
Operating expenses 38,000 32,000 6,000
Equipment upgrade 22,000 0 0 S
Opportunity cost 3,000 0 3,000
$ 2,000
Related exercise material: BE20.1, BE20.2, DO IT! 20.1, E20.1, and E20.18.
Special Orders
LEAR NING OBJECTIVE 2

Analyze the relevant costs in accepting an order at a special price.
Sometimes a company has an opportunity to obtain additional business if it is willing to make

a price concession to a specific customer. To illustrate, assume that Sunbelt Company produces
100,000 Smoothie blenders per month, which is 80% of plant capacity. Variable manufacturing
Special Orders 20-7
costs are $8 per unit. Fixed manufacturing costs are $400,000, or $4 per unit. The Smoothie
blenders are normally sold directly to retailers at $20 each. Sunbelt has an offer from
Kensington Co. (a foreign wholesaler) to purchase an additional 2,000 blenders at $11 per unit.
Acceptance of the offer would not affect normal sales of the product, and the additional units
can be manufactured without increasing plant capacity. What should management do?
If management makes its decision on the basis of the total cost per unit of $12 ($8 variable + HELPFUL HINT
$4 fixed), the order would be rejected because costs per unit ($12) exceed revenues per unit This is a good example of dif-
($11) by $1 per unit. However, since the units can be produced within existing plant capacity, ferent costs for different pur-
the special order will not increase fixed costs. Let’s identify the relevant data for the decision. poses. In the long run all costs
First, the variable manufacturing costs increase $16,000 ($8 × 2,000). Second, the expected are relevant, but for this deci-
revenue increases $22,000 ($11 × 2,000). Thus, as shown in Illustration 20.4, Sunbelt sion only costs that change are
increases its net income by $6,000 by accepting this special order (see Helpful Hint). relevant.
ILLUSTRATION 20.4 Incremental analysis—accepting an order at a special price

Incremental Analysis - Accepting an order at a special price
P18 fx
A B C D
Net Income
1 Reject Order Accept Order Increase (Decrease)
2 Revenues $0 $22,000 $ 22,000
3 Costs 0 16,000 (16,000)
4 Net income $0 $ 6,000 $ 6,000
5
Two points should be emphasized. First, we assume that sales of the product in other
markets would not be affected by this special order. If other sales were affected, then
Sunbelt would have to consider the change in profit due to lost sales in making the decision.
Second, if Sunbelt is operating at full capacity, it is likely that the special order would be
rejected. Under such circumstances, the company would have to expand plant capacity. In that
case, the special order would have to absorb these additional fixed manufacturing costs, as
well as the variable manufacturing costs.
DO IT! 2 Special Orders ACTION PLAN

• Identify all revenues that
Cobb Company incurs costs of $28 per unit ($18 variable and $10 fixed) to make a product that
would change as a result of
normally sells for $42. A foreign wholesaler offers to buy 5,000 units at $25 each. The special
accepting the order.
order results in additional shipping costs of $1 per unit. Compute the increase or decrease in net
income Cobb realizes by accepting the special order, assuming Cobb has excess operating capacity. • Identify all costs that
Should Cobb Company accept the special order? would change as a result
of accepting the order, and
net this amount against the
Solution change in revenues.
Net Income
Reject Accept Increase (Decrease)
Revenues $–0– $125,000* $125,000
Costs –0– 95,000** (95,000)
Net income $–0– $ 30,000 $ 30,000
*5,000 × $25
**(5,000 × $18) + (5,000 × $1)
The analysis indicates net income increases by $30,000; therefore, Cobb Company should accept
the special order.
Related exercise material: BE20.3, DO IT! 20.2, E20.2, E20.3, and E20.4.
Make or Buy

Analyze the relevant costs in a make-or-buy decision.
When a manufacturer assembles component parts in producing a finished product, manage-

ment must decide whether to make or buy the components. The decision to buy parts or ser-
vices is often referred to as outsourcing. For example, as discussed in the Feature Story, a
company such as Method Products may either make or buy the soaps used in its products.
Similarly, Hewlett-Packard Corporation may make or buy the electronic circuitry, cases,
and printer heads for its printers. Boeing recently sold some of its commercial aircraft
factories in an effort to cut production costs and focus on engineering and final assembly
rather than manufacturing. The decision to make or buy components should be made on the
basis of incremental analysis.
Baron Company makes motorcycles and scooters. Illustration 20.5 shows the annual
costs it incurs in producing 25,000 ignition switches for scooters.
ILLUSTRATION 20.5 Direct materials $ 50,000

Annual product cost data Direct labor 75,000
Variable manufacturing overhead 40,000
Fixed manufacturing overhead 60,000
Total manufacturing costs $225,000
Total cost per unit ($225,000 ÷ 25,000) $9.00
Instead of making its own switches, Baron Company might purchase the ignition switches
from Ignition, Inc. at a price of $8 per unit. What should management do?
At first glance, it appears that management should purchase the ignition switches for $8
rather than make them at a cost of $9. However, a review of operations indicates that if the
ignition switches are purchased from Ignition, Inc., all of Baron’s variable costs but only
$10,000 of its fixed manufacturing costs will be eliminated (avoided). Thus, $50,000 of the
fixed manufacturing costs remain if the ignition switches are purchased. The relevant costs for
incremental analysis, therefore, are as shown in Illustration 20.6.
ILLUSTRATION 20.6 Incremental analysis—make or buy

Incremental Analysis - Make or buy
P18 fx
A B C D
Net Income
1 Make Buy Increase (Decrease)
2 Direct materials $ 50,000 $ 0 $ 50,000
3 Direct labor 75,000 0 75,000
4 Variable manufacturing costs 40,000 0 40,000
5 Fixed manufacturing costs 60,000 50,000 10,000
6 Purchase price (25,000 × $8) 0 200,000 (200,000)
7 Total annual cost $225,000 $250,000 $ (25,000)
8
This analysis indicates that Baron Company incurs $25,000 of additional costs by buying
the ignition switches rather than making them. Therefore, Baron should continue to make the
ignition switches even though the total manufacturing cost is $1 higher per unit than the purchase
Make or Buy 20-9
price. The primary cause of this result is that, even if the company purchases the ignition
switches, it will still have fixed costs of $50,000 to absorb.
Opportunity Cost
The foregoing make-or-buy analysis is complete only if it is assumed that the productive ETHICS NOTE
capacity used to make the ignition switches cannot be converted to another purpose. If there
In the make-or-buy decision,
is an opportunity to use this productive capacity in some other manner, then this opportunity
it is important for manage-
cost must be considered. As indicated earlier, opportunity cost is the lost potential benefit that ment to take into account the
could have been obtained by following an alternative course of action (see Ethics Note). social impact of its choice.
To illustrate, assume that through buying the switches, Baron Company can use the For instance, buying may be
released productive capacity to generate additional income of $38,000 from producing a the most economically feasi-
different product. This lost income is an additional cost of continuing to make the switches in ble solution, but such action
the make-or-buy decision. This opportunity cost is therefore added to the “Make” column for could result in the closure of
comparison. As shown in Illustration 20.7, it is now advantageous to buy the ignition switches a manufacturing plant and
because the company’s income would increase by $13,000. laying off many good workers.
ILLUSTRATION 20.7 Incremental analysis—make or buy, with opportunity cost

Incremental Analysis - Make or buy with opportunity cost
P18 fx
A B C D
Net Income
1 Make Buy Increase (Decrease)
2 Total annual cost $225,000 $250,000 $(25,000)
3 Opportunity cost 38,000 0 38,000
4 Total cost $263,000 $250,000 $ 13,000
5
The qualitative factors in this decision include the possible loss of jobs for employees who
produce the ignition switches. In addition, management must assess the supplier’s ability to
satisfy the company’s quality control standards at the quoted price per unit on a timely basis.
Service Company Insight Amazon.com

Giving Away the Store? later, it was true that Amazon’s sales had grown considerably. It was
also estimated that its Prime customers buy two to three times as
In an earlier chapter, we dis- much as non-Prime customers. But, its shipping costs rose from 2.8%
cussed Amazon.com’s incred- of sales to 4% of sales, which is remarkably similar to the drop in its
ible growth. However, some gross margin from 24% to 22.3%. Amazon’s order fulfillment center
analysts have questioned uses 30,000 robots and more than 100 million square feet of space. It
whether some of the methods generates significant fees from merchants that sell on its site and rely
that Amazon uses to increase on its fulfillment services.
its sales make good business
sense. For example, a few Sources: Martin Peers, “Amazon’s Prime Numbers,” Wall Street Journal
years ago, Amazon initiated Online (February 3, 2011); and Evan Niu, “Ever Wonder How Amazon.com
a “Prime” free-shipping sub- Pays for All of That Free Shipping?” The Motley Fool (October 26, 2015).
iStockphoto
scription program. For a $99
fee per year, Amazon’s custom- What are the relevant revenues and costs that Amazon should
ers get free shipping on as many goods as they want to buy. At the consider relative to the decision whether to offer the Prime free-
time, CEO Jeff Bezos promised that the program would be costly in shipping subscription? (Go to WileyPLUS for this answer and
the short-term but benefit the company in the long-term. Six years additional questions.)
20-10 CH A PT ER 20 Incremental Analysis
DO IT! 3 Make or Buy ACTION PLAN

• Look for the costs that
Juanita Company must decide whether to make or buy some of its components for the appliances
change.
it produces. The costs of producing 166,000 electrical cords for its appliances are as follows.
• Ignore the costs that do not
Direct materials $90,000 Variable overhead $32,000 change.
Direct labor $20,000 Fixed overhead $24,000
• Use the format in the
Instead of making the electrical cords at an average cost per unit of $1.00 ($166,000 ÷ chapter for your answer.
166,000), the company has an opportunity to buy the cords at $0.90 per unit. If the company • Recognize that opportunity
purchases the cords, all variable costs and one-fourth of the fixed costs are eliminated. cost can make a difference.
a. Prepare an incremental analysis showing whether the company should make or buy the elec-
trical cords. b. Will your answer be different if the released productive capacity of the production
facility will generate additional income of $5,000?
Solution
a.
Net Income
Make Buy Increase (Decrease)
Direct materials $ 90,000 $ –0– $ 90,000
Direct labor 20,000 –0– 20,000
Variable manufacturing costs 32,000 –0– 32,000
Fixed manufacturing costs 24,000 18,000* 6,000
Purchase price –0– 149,400** (149,400)
Total cost $166,000 $167,400 $ (1,400)
*$24,000 × .75
**166,000 × $0.90
This analysis indicates that Juanita Company will incur $1,400 of additional costs if it buys the
electrical cords rather than making them.
b.
Net Income
Make Buy Increase (Decrease)
Total cost $166,000 $167,400 $(1,400)
Opportunity cost 5,000 –0– 5,000
Total cost $171,000 $167,400 $ 3,600
Yes, the answer is different. The analysis shows that net income increases by $3,600 if Juanita
Company purchases the electrical cords rather than making them.
Related exercise material: BE20.4, DO IT! 20.3, E20.5, E20.6, E20.7, and E20.8.
Sell or Process Further

Analyze the relevant costs and revenues in determining whether to sell or process
materials further.
Many manufacturers have the option of selling products at a given point in the production
cycle or continuing to process with the expectation of selling them at a later point at a higher
price. For example, a bicycle manufacturer such as Trek could sell its bicycles to retailers
either unassembled or assembled. A furniture manufacturer such as IKEA could sell its
Sell or Process Further 20-11
furniture to stores either unfinished or finished. The sell-or-process-further decision should be

made on the basis of incremental analysis. The basic decision rule is: Process further as long
as the incremental revenue from such processing exceeds the incremental processing costs.
Single-Product Case
Assume, for example, that Woodmasters Inc. makes tables. It sells unfinished tables for $50.
The cost to manufacture an unfinished table is $35, computed as shown in Illustration 20.8.
Direct materials $15 ILLUSTRATION 20.8

Direct labor 10 Per unit cost of unfinished table
Variable manufacturing overhead 6
Fixed manufacturing overhead 4
Manufacturing cost per unit $35
Woodmasters currently has unused productive capacity that is expected to continue indefi- HELPFUL HINT
nitely. Some of this capacity could be used to finish the tables and sell them at $60 per unit.
Current net income is known.
For a finished table, direct materials will increase $2 and direct labor costs will increase $4.
Net income from process-
Variable manufacturing overhead costs will increase by $2.40 (60% of direct labor). No ing further is an estimate.
increase is anticipated in fixed manufacturing overhead. In making its decision, man-
Should the company sell the unfinished tables, or should it process them further (see agement could add a “risk”
Helpful Hint)? Illustration 20.9 shows the incremental analysis on a per unit basis. factor for the estimate.
ILLUSTRATION 20.9 Incremental analysis—sell or process further

Incremental Analysis - Sell or process further
P18 fx
A B C D
Net Income
1 Sell Unfinished Process Further Increase (Decrease)
2 Sales price per unit $50.00 $60.00 $10.00
3 Cost per unit
4 Direct materials 15.00 17.00 (2.00)
5 Direct labor 10.00 14.00 (4.00)
6 Variable manufacturing overhead 6.00 8.40 (2.40)
7 Fixed manufacturing overhead 4.00 4.00 0.00
8 Total 35.00 43.40 (8.40)
9 Net income per unit $15.00 $16.60 $ 1.60
10
It would be advantageous for Woodmasters to process the tables further. The incremental
revenue of $10.00 from the additional processing is $1.60 higher than the incremental
processing costs of $8.40.
Multiple-Product Case
Sell-or-process-further decisions are particularly applicable to processes that produce
multiple products simultaneously. In many industries, a number of end-products are produced
from a single raw material and a common production process. These multiple end-products are
commonly referred to as joint products. For example, in the meat-packing industry, Armour
processes a cow or pig into meat, internal organs, hides, bones, and fat products. In the
petroleum industry, ExxonMobil refines crude oil to produce gasoline, lubricating oil, kerosene,
paraffin, and ethylene.
Illustration 20.10 presents a joint product situation for Marais Creamery involving a
decision to sell or process further cream and skim milk. Cream and skim milk are joint
products that result from the processing of raw milk.
ILLUSTRATION 20.10 Joint production process—Creamery
Further Cottage Sell

Cream
Processing Cheese
Raw Common
Milk Process
Skim Further Condensed Sell
Milk Processing Milk
Split-Off
Point
Joint Joint
Costs Products
Marais incurs many costs prior to the manufacture of the cream and skim milk. All costs
incurred prior to the point at which the two products are separately identifiable (the split-off
point) are called joint costs. For purposes of determining the cost of each product, joint
product costs must be allocated to the individual products. This is frequently done based on
the relative sales value of the joint products. While this allocation is important for determination
of product cost, it is irrelevant for any sell-or-process-further decisions. The reason is that
these joint product costs are sunk costs. That is, they have already been incurred, and they
cannot be changed or avoided by any subsequent decision.
Illustration 20.11 provides the daily cost and revenue data for Marais Creamery related to
cream and cottage cheese.
ILLUSTRATION 20.11 Costs (per day)

Cost and revenue data per day Joint cost allocated to cream $ 9,000
for cream Cost to process cream into cottage cheese 10,000
Revenues from Products (per day)
Cream $19,000
Cottage cheese 27,000
From this information, we can determine whether the company should simply sell the cream
or process it further into cottage cheese. Illustration 20.12 shows the necessary analysis. Note
that the joint cost that is allocated to the cream is not included in this decision. It is not relevant
to the decision because it is a sunk cost. It has been incurred in the past and will remain the same
no matter whether the cream is subsequently processed into cottage cheese or not.
ILLUSTRATION 20.12 Analysis of whether to sell cream or process into cottage cheese
Incremental Analysis - Sell or process further - Cream or cottage cheese

P18 fx
A B C D
Net Income
1 Sell Process Further Increase (Decrease)
2 Sales per day $19,000 $27,000 $ 8,000
Cost per day to process cream
3
into cottage cheese 0 10,000 (10,000)
4 Net income per day $19,000 $17,000 $ (2,000)
5
From this analysis, we can see that Marais should not process the cream further because it will
sustain an incremental loss of $2,000.
Sell or Process Further 20-13
Illustration 20.13 provides the daily cost and revenue data for the company related to
skim milk and condensed milk.
Costs (per day) ILLUSTRATION 20.13
Joint cost allocated to skim milk $ 5,000 Cost and revenue data per
Cost to process skim milk into condensed milk 8,000 day for skim milk
Revenues from Products (per day)

Skim milk $11,000
Condensed milk 26,000
Illustration 20.14 shows that Marais Company should process the skim milk into condensed
milk, as it will increase net income by $7,000.
ILLUSTRATION 20.14 Analysis of whether to sell skim milk or process into condensed milk
Incremental Analysis - Sell or process further - Skim milk or condensed milk

P18 fx
A B C D
Net Income
1 Sell Process Further Increase (Decrease)
2 Sales per day $11,000 $26,000 $15,000
Cost per day to process skim milk
3
into condensed milk 0 8,000 (8,000)
4 Net income per day $11,000 $18,000 $ 7,000
5
Again, note that the $5,000 of joint cost allocated to the skim milk is irrelevant in decid-
ing whether to sell or process further. Why? The joint cost remains the same, whether or not
further processing is performed.
These decisions need to be reevaluated as market conditions change. For example, if the
price of skim milk increases relative to the price of condensed milk, it may become more
profitable to sell the skim milk rather than process it into condensed milk. Consider also oil
refineries. As market conditions change, the companies must constantly re-assess which prod-
ucts to produce from the oil they receive at their plants.
DO IT! 4 Sell or Process Further ACTION PLAN

• Identify the revenues
Easy Does It manufactures unpainted furniture for the do-it-yourself (DIY) market. It currently that change as a result of
sells a child’s rocking chair for $25. Production costs per unit are $12 variable and $8 fixed. Easy painting the rocking chair.
Does It is considering painting the rocking chair and selling it for $35. Variable costs to paint each
chair are expected to be $9, and fixed costs are expected to be $2. • Identify all costs that change
Prepare an analysis showing whether Easy Does It should sell unpainted or painted chairs. as a result of painting the
rocking chair, and net
the amount against the
Solution revenues.
Process Net Income
Sell Further Increase (Decrease)
Revenues $25 $35 $10
Variable costs 12 21a (9)
Fixed costs 8 10b (2)
Net income $ 5 $ 4 $ (1)
a b
$12 + $9 $8 + $2
The analysis indicates that the rocking chair should be sold unpainted because net income per
chair will be $1 greater.
Related exercise material: BE20.5, BE20.6, DO IT! 20.4, E20.9, E20.10, E20.11, and E20.12.
Repair, Retain, or Replace Equipment

Analyze the relevant costs to be considered in repairing, retaining, or replacing
equipment.
Management often has to decide whether to continue using an asset, repair, or replace it. For
example, Delta Airlines must decide whether to replace old jets with new, more fuel-efficient ones.
To illustrate, assume that Jeffcoat Company has a factory machine that originally cost $110,000. It
has a balance in Accumulated Depreciation of $70,000, so the machine’s book value is $40,000. It
has a remaining useful life of four years. The company is considering replacing this machine with
a new machine. A new machine is available that costs $120,000. It is expected to have zero salvage
value at the end of its four-year useful life. If the new machine is acquired, variable manufacturing
costs are expected to decrease from $160,000 to $125,000 annually, and the old unit could be sold
for $5,000. Illustration 20.15 shows the incremental analysis for the four-year period.
ILLUSTRATION 20.15 Incremental analysis—retain or replace equipment
Incremental Analysis - Retain or replace equipment

P18 fx
A B C D E F
Retain Replace Net Income
1 Equipment Equipment Increase (Decrease)
2 Variable manufacturing costs $640,000 a $500,000 b $140,000
3 New machine cost 120,000 (120,000)
4 Sale of old machine (5,000) 5,000
5 Total $640,000 $615,000 $ 25,000
6
7 a(4 years × $160,000)
8 b(4 years × $125,000)
9
In this case, it would be to the company’s advantage to replace the equipment. The lower
variable manufacturing costs due to replacement more than offset the cost of the new equip-
ment. Note that the $5,000 received from the sale of the old machine is relevant to the decision
because it will only be received if the company chooses to replace its equipment. In general,
any trade-in allowance or cash disposal value of existing assets is relevant to the decision to
retain or replace equipment.
One other point should be mentioned regarding Jeffcoat’s decision: The book value of
the old machine does not affect the decision. Book value is a sunk cost, which is a cost that
cannot be changed by any present or future decision. Sunk costs are not relevant in incre-
mental analysis. In this example, if the asset is retained, book value will be depreciated over
its remaining useful life. Or, if the new unit is acquired, book value will be recognized as a loss
of the current period. Thus, the effect of book value on cumulative future earnings is the same
regardless of the replacement decision.
Sometimes, decisions regarding whether to replace equipment are clouded by behavioral
decision-making errors. For example, suppose a manager spent $90,000 repairing a machine
two months ago. Suppose that the machine now breaks down again. The manager might be
inclined to think that because the company recently spent a large amount of money to repair the
machine, the machine should be repaired again rather than replaced. However, the amount
spent in the past to repair the machine is irrelevant to the current decision. It is a sunk cost.
Similarly, suppose a manager spent $5,000,000 to purchase a machine. Six months later, a
new machine comes on the market that is significantly more efficient than the one recently
purchased. The manager might be inclined to think that he or she should not buy the new machine
Eliminate Unprofitable Segment or Product 20-15
because of the recent purchase. In fact, the manager might fear that buying a different machine
so quickly might call into question the merit of the previous decision. Again, the fact that the
company recently bought a machine is not relevant. Instead, the manager should use incremen-
tal analysis to determine whether the savings generated by the efficiencies of the new machine
would justify its purchase.
DO IT! 5 Repair or Replace Equipment ACTION PLAN

• Those costs and revenues
Rochester Roofing is faced with a decision. The company relies very heavily on the use of its that differ across the
60-foot extension lift for work on large homes and commercial properties. Last year, the company alternatives are relevant to
spent $60,000 refurbishing the lift. It has just determined that another $40,000 of repair work is the decision.
required. Alternatively, Rochester Roofing has found a newer used lift that is for sale for $170,000.
• Past costs that cannot be
The company estimates that both the old and new lifts would have useful lives of 6 years. However,
changed are sunk costs.
the new lift is more efficient and thus would reduce operating expenses by about $20,000 per year.
The company could also rent out the new lift for about $2,000 per year. The old lift is not suitable
for rental. The old lift could currently be sold for $25,000 if the new lift is purchased. Prepare an
incremental analysis that shows whether the company should repair or replace the equipment.
Solution
Retain Replace Net Income
Equipment Equipment Increase (Decrease)
Operating expenses $120,000* $120,000
Repair costs 40,000 40,000
Rental revenue $ (12,000)** 12,000
New machine cost 170,000 (170,000)
Sale of old machine (25,000) 25,000
Total cost $160,000 $133,000 $ 27,000
*(6 years × $20,000)
**(6 years × $2,000)
The analysis indicates that purchasing the new machine would increase net income for the 6-year
period by $27,000.
Related exercise material: BE20.7, DO IT! 20.5, E20.13, and E20.14.
Eliminate Unprofitable Segment or Product
LEARNING OBJECTIVE 6
Analyze the relevant costs in deciding whether to eliminate an unprofitable
segment or product.
Management sometimes must decide whether to eliminate an unprofitable business segment

or product. For example, in recent years, many airlines quit servicing certain cities or cut back
on the number of flights. Goodyear quit producing several brands in the low-end tire market.
Again, the key is to focus on the relevant costs—the data that change under the alternative HELPFUL HINT
courses of action (see Helpful Hint). To illustrate, assume that Venus Company manufac- A decision to discontinue a
tures tennis racquets in three models: Pro, Master, and Champ. Pro and Master are profitable segment based solely on the
lines. Champ (highlighted in red in the table below) operates at a loss. Condensed income bottom line—net loss—is
statement data are as shown in Illustration 20.16. inappropriate.
You might think that total net income will increase by $20,000 to $240,000 if the unprof-
itable Champ line of racquets is eliminated. However, net income may actually decrease if
the Champ line is discontinued. The reason is that the company’s total fixed costs will be the
same whether or not the Champ line is discontinued. That is, the fixed costs allocated to the
Champ racquets cannot be eliminated, so they will have to be absorbed by the other products.
ILLUSTRATION 20.16 Pro Master Champ Total

Segment income data Sales $800,000 $300,000 $100,000 $1,200,000
Variable costs 520,000 210,000 90,000 820,000
Contribution margin 280,000 90,000 10,000 380,000
Fixed costs 80,000 50,000 30,000 160,000
Net income $200,000 $ 40,000 $ (20,000) $ 220,000
To illustrate, assume that the $30,000 of fixed costs applicable to the unprofitable segment
are instead allocated 2⁄3 to the Pro model and 1⁄3 to the Master model if the Champ model is elimi-
nated. Fixed costs will increase to $100,000 ($80,000 + $20,000) in the Pro line and to $60,000
($50,000 + $10,000) in the Master line. Illustration 20.17 shows the revised income statement.
ILLUSTRATION 20.17 Pro Master Total

Income data after eliminating Sales $800,000 $300,000 $1,100,000
unprofitable product line Variable costs 520,000 210,000 730,000
Contribution margin 280,000 90,000 370,000
Fixed costs 100,000 60,000 160,000
Net income $180,000 $ 30,000 $ 210,000
Total net income would decrease $10,000 ($220,000 − $210,000). This result is also
obtained in the incremental analysis of the Champ racquets shown in Illustration 20.18.
ILLUSTRATION 20.18 Incremental analysis—eliminating unprofitable segment with no reduction in fixed costs
Incremental Analysis - Eliminating an unprofitable segment

P18 fx
A B C D
Net Income
1 Continue Eliminate Increase (Decrease)
2 Sales $100,000 $ 0 $(100,000)
3 Variable costs 90,000 0 90,000
4 Contribution margin 10,000 0 (10,000)
5 Fixed costs 30,000 30,000 0
6 Net income $(20,000) $(30,000) $ (10,000)
7
The loss in net income is attributable to the Champ line’s $10,000 contribution margin
($220,000 − $210,000) that will not be realized if the segment is discontinued.
Assume the same facts as above, except now assume that $22,000 of the fixed costs
attributed to the Champ line can be eliminated if the line is discontinued. Illustration 20.19
presents the incremental analysis based on this revised assumption.
ILLUSTRATION 20.19 Incremental analysis—eliminating unprofitable segment with reduction in fixed costs
Incremental Analysis - Eliminating an unprofitable segment

P18 fx
A B C D
Net Income
1 Continue Eliminate Increase (Decrease)
2 Sales $100,000 $ 0 $(100,000)
3 Variable costs 90,000 0 90,000
4 Contribution margin 10,000 0 (10,000)
5 Fixed costs 30,000 8,000 22,000
6 Net income $ (20,000) $(8,000) $ 12,000
7
Eliminate Unprofitable Segment or Product 20-17
In this case, because the company is able to eliminate some of its fixed costs by eliminating the
division, it can increase its net income by $12,000. This occurs because the $22,000 savings that
results from the eliminated fixed costs exceeds the $10,000 in lost contribution margin by
$12,000 ($22,000 − $10,000).
In deciding on the future status of an unprofitable segment, management should consider
the effect of elimination on related product lines. It may be possible for continuing product
lines to obtain some or all of the sales lost by the discontinued product line. In some busi-
nesses, services or products may be linked—for example, free checking accounts at a bank, or
coffee at a donut shop. In addition, management should consider the effect of eliminating the
product line on employees who may have to be discharged or retrained.
Management Insight
Batteries Are Included! learned the hard way that making your own batteries can be a
risky venture. It made a big investment in battery production for
Top managers at every major car its electric car, the Leaf, but then suffered huge losses when sales
manufacturer face a massive of the Leaf were far below projections. Alternatively, Tesla,
“make or buy” decision. For ex- which only makes electric cars, has fully committed to making its
ample, consider the production own batteries. In fact, it often describes itself as a battery
Nerthuz / Getty Images of electric cars. By far, the most company.
expensive component in an elec-
tric car is the battery, which costs about $7,500. The battery is
critical to vehicle performance since it determines both the power Source: Stephen Milmot, “Auto Companies: Better with Batteries Not
and range of the vehicle. Mercedes and Volkswagen plan to make Included,” Wall Street Journal (December 19, 2016).
their own batteries, but General Motors, BMW, and Renault
have decided to buy their batteries from suppliers such as Panasonic
and Samsung. What are the factors that companies must consider in deciding
It is not an easy decision. Battery production requires huge whether to make or to buy the batteries for their vehicles? (Go to
investments in plant assets and research and development. Nissan WileyPLUS for this answer and additional questions.)
DO IT! 6 Unprofitable Segments ACTION PLAN

• Identify the revenues
Lambert, Inc. manufactures several types of accessories. For the year, the knit hats and scarves
that change as a result of
line had sales of $400,000, variable expenses of $310,000, and fixed expenses of $120,000.
eliminating a product line.
Therefore, the knit hats and scarves line had a net loss of $30,000. If Lambert eliminates the knit
hats and scarves line, $20,000 of fixed costs will remain. Prepare an analysis showing whether • Identify all costs that change
the company should eliminate the knit hats and scarves line. as a result of eliminating
a product line, and net
the amount against the
Solution revenues.
Net Income
Continue Eliminate Increase (Decrease)
Sales $400,000 $ 0 $(400,000)
Variable costs 310,000 0 310,000
Contribution margin 90,000 0 (90,000)
Fixed costs 120,000 20,000 100,000
Net income $ (30,000) $(20,000) $ 10,000
The analysis indicates that Lambert should eliminate the knit hats and scarves line because net
income will increase $10,000.
Related exercise material: BE20.8, DO IT! 20.6, E20.15, E20.16, and E20.17.
Review and Practice

Learning Objectives Review
manufacturing costs, (b) the purchase price, and (c) opportunity

1 Describe management’s decision-making process and cost.
incremental analysis.
Management’s decision-making process consists of (a) identifying

4 Analyze the relevant costs and revenues in determining
the problem and assigning responsibility for the decision, (b) deter- whether to sell or process materials further.
mining and evaluating possible courses of action, (c) making the
decision, and (d) reviewing the results of the decision. Incremental The decision rule for whether to sell or process materials further is:
analysis identifies financial data that change under alternative courses Process further as long as the incremental revenue from processing
of action. These data are relevant to the decision because they vary exceeds the incremental processing costs.
across the possible alternatives.
5 Analyze the relevant costs to be considered in repair-

2 Analyze the relevant costs in accepting an order at a ing, retaining, or replacing equipment.
special price.
The relevant costs to be considered in determining whether equip-
The relevant costs are those that change if the order is accepted. ment should be repaired, retained, or replaced are the effects on vari-
The relevant information in accepting an order at a special price is able costs and the cost of the new equipment. Also, any disposal value
the difference between the variable manufacturing costs to produce of the existing asset must be considered.
the special order and expected revenues. Any changes in fixed costs,
opportunity cost, or other incremental costs or savings (such as
additional shipping) should be considered. 6 Analyze the relevant costs in deciding whether to elim-
inate an unprofitable segment or product.
3 Analyze the relevant costs in a make-or-buy decision. In deciding whether to eliminate an unprofitable segment or product,
the relevant costs are the variable costs that drive the contribution
In a make-or-buy decision, the relevant costs are (a) the variable margin, if any, produced by the segment or product. Opportunity cost
manufacturing costs that will be saved as well as changes to fixed and reduction of fixed expenses must also be considered.
Glossary Review
Incremental analysis The process of identifying the financial data that Opportunity cost The potential benefit that is lost when one course of
change under alternative courses of action. (p. 20-3). action is chosen rather than an alternative course of action. (p. 20-4).
Joint costs For joint products, all costs incurred prior to the point at Relevant costs and revenues Those costs and revenues that differ across
which the two products are separately identifiable (known as the split-off alternatives. (p. 20-4).
point). (p. 20-12). Sunk cost A cost incurred in the past that cannot be changed or avoided
Joint products Multiple end-products produced from a single raw ma- by any present or future decision. (p. 20-4).
terial and a common production process. (p. 20-11).
Practice Multiple-Choice Questions
1. (LO 1) Three of the steps in management’s decision-making 2. (LO 1) Incremental analysis is the process of identifying the finan-
process are (1) review results of decision, (2) determine and evaluate cial data that:
possible courses of action, and (3) make the decision. The steps are a. do not change under alternative courses of action.
prepared in the following order: b. change under alternative courses of action.
a. (1), (2), (3). c. (2), (1), (3). c. are mixed under alternative courses of action.
b. (3), (2), (1). d. (2), (3), (1). d. No correct answer is given.
Practice Multiple-Choice Questions 20-19
3. (LO 1) In making business decisions, management ordinarily c. the opportunity cost.

considers: d. All of the above.
a. quantitative factors but not qualitative factors. 9. (LO 3) Derek is performing incremental analysis in a make-or-buy
b. financial information only. decision for Item X. If Derek buys Item X, he can use its released
c. both financial and nonfinancial information. productive capacity to produce Item Z. Derek will sell Item Z for
$12,000 and incur production costs of $8,000. Derek’s incremental
d. relevant costs, opportunity cost, and sunk costs.
analysis should include an opportunity cost of:
4. (LO 1) A company is considering the following alternatives: a. $12,000. c. $4,000.
Alternative A Alternative B b. $8,000. d. $0.
Revenues $50,000 $50,000 10. (LO 4) The decision rule in a sell-or-process-further decision is: pro-
Variable costs 24,000 24,000 cess further as long as the incremental revenue from processing exceeds:
Fixed costs 12,000 15,000 a. incremental processing costs.
Which of the following are relevant in choosing between these alter- b. variable processing costs.
natives? c. fixed processing costs.
a. Revenues, variable costs, and fixed costs. d. No correct answer is given.
b. Variable costs and fixed costs.
11. (LO 4) Walton, Inc. makes an unassembled product that it cur-
c. Variable costs only. rently sells for $55. Production costs are $20. Walton is considering
d. Fixed costs only. assembling the product and selling it for $68. The cost to assemble
the product is estimated at $12. What decision should Walton make?
5. (LO 2) It costs a company $14 of variable costs and $6 of fixed
costs to produce product Z200 that sells for $30. A foreign buyer a. Sell before assembly; net income per unit will be $12 greater.
offers to purchase 3,000 units at $18 each. If the special offer is b. Sell before assembly; net income per unit will be $1 greater.
accepted and produced with unused capacity, net income will: c. Process further; net income per unit will be $13 greater.
a. decrease $6,000. c. increase $12,000. d. Process further; net income per unit will be $1 greater.
b. increase $6,000. d. increase $9,000.
12. (LO 5) In a decision to retain or replace equipment, the book
6. (LO 2) It costs a company $14 of variable costs and $6 of fixed value of the old equipment is a (an):
costs to produce product Z200. Product Z200 sells for $30. A buyer a. opportunity cost. c. incremental cost.
offers to purchase 3,000 units at $18 each. The seller will incur spe-
cial shipping costs of $5 per unit. If the special offer is accepted and b. sunk cost. d. marginal cost.
produced with unused capacity, net income will: 13. (LO 6) If an unprofitable segment is eliminated:
a. increase $3,000. c. decrease $12,000. a. net income will always increase.
b. increase $12,000. d. decrease $3,000. b. variable costs of the eliminated segment will have to be ab-
7. (LO 3) Jobart Company is currently operating at full capacity. It is sorbed by other segments.
considering buying a part from an outside supplier rather than making it c. fixed costs allocated to the eliminated segment will have to be
in-house. If Jobart purchases the part, it can use the released productive absorbed by other segments.
capacity to generate additional income of $30,000 from producing a d. net income will always decrease.
different product. When conducting incremental analysis in this make-
or-buy decision, the company should: 14. (LO 6) A segment of Hazard Inc. has the following data.
a. ignore the $30,000. Sales $200,000
b. add $30,000 to other costs in the “Make” column. Variable expenses 140,000
Fixed expenses 100,000
c. add $30,000 to other costs in the “Buy” column.
If this segment is eliminated, what will be the effect on the remaining
d. subtract $30,000 from the other costs in the “Make” column. company? Assume that 50% of the fixed expenses will be eliminated
8. (LO 3) In a make-or-buy decision, relevant costs are: and the rest will be allocated to the segments of the remaining company.
a. manufacturing costs that will be saved. a. $120,000 increase. c. $50,000 increase.
b. the purchase price of the units. b. $10,000 decrease. d. $10,000 increase.
Solutions
1. d. The order of the steps in the decision process is (2) determine data that (a) do not change or (c) are mixed. Choice (d) is wrong as
and evaluate possible courses of action, (3) make the decision, and there is a correct answer given.
(1) review the results of decision. Choices (a), (b), and (c) list the
3. c. Management ordinarily considers both financial and nonfinan-
steps in the incorrect order.
cial information in making business decisions. The other choices are
2. b. Incremental analysis is the process of identifying the financial incorrect because they are all limited to financial data and do not
data that change under alternative courses of action, not the financial consider nonfinancial information.
4. d. Fixed costs is the only relevant factor, that is, the only factor 10. a. The decision rule in a sell-or-process-further decision is to
that differs across Alternatives A and B. The other choices are incor- process further as long as the incremental revenue from such process-
rect because they list either revenues, variable costs, or both, which ing exceeds incremental processing costs, not (b) variable processing
are the same amounts for both alternatives. costs or (c) fixed processing costs. Choice (d) is wrong as there is a
correct answer given.
5. c. If the special offer is accepted and produced with unused capac-
ity, variable cost per unit = $14, income per unit = ($18 − $14), so 11. d. If Walton processes further, net income per unit will increase
net income will increase by $12,000 (3,000 × $4), not (a) decrease $13 ($68 − $55), which is $1 more than its additional production costs
$6,000, (b) increase $6,000, or (d) increase $9,000. ($12). The other choices are therefore incorrect.
6. d. If the special offer is accepted and produced with unused capac- 12. b. In the decision to retain or replace equipment, the book value
ity, variable cost per unit = $19 ($14 variable + $5 shipping costs), of the old equipment is a sunk cost (it reflects the original cost less
income per unit = −$1 ($18 − $19), so net income will decrease by accumulated depreciation, neither of which is relevant to the deci-
$3,000 (3,000 × −$1), not (a) increase $3,000, (b) increase $12,000, sion), not (a) an opportunity cost, (c) an incremental cost, or (d) a
or (c) decrease $12,000. marginal cost.
7. b. Jobart Company should add $30,000 to other costs in the 13. c. Even though the segment is eliminated, the fixed costs allo-
“Make” column as it represents lost income of continuing to make cated to that segment will still have to be covered. This is done by
the part in-house. The other choices are incorrect because the having other segments absorb the fixed costs of that segment. Choices
$30,000 (a) should not be ignored as it is an opportunity cost, (a) and (d) are incorrect because net income can either increase or
(c) represents potential lost income if the company continues to make decrease if a segment is eliminated. Choice (b) is incorrect because
the part instead of buying it so therefore should not be placed in the when a segment is eliminated, the variable costs of that segment
“Buy” column, and (d) should be added to, not subtracted from, the will also be eliminated and will not need to be absorbed by other
other costs in the “Make” column. segments.
8. d. All the costs in choices (a), (b), and (c) are relevant in a make- 14. b. If the segment continues, net income = −$40,000 ($200,000 −
or-buy decision. So although choices (a), (b), and (c) are true state- $140,000 − $100,000). If the segment is eliminated, the contribution
ments, choice (d) is a better answer. margin will also be eliminated but $50,000 ($100,000 × .50) of the
9. c. Derek’s opportunity cost in its make-or-buy decision is $12,000 fixed costs will remain. Therefore, the effect of eliminating the seg-
(revenue for Item Z) − $8,000 (production costs for Item Z) = $4,000, ment will be a $10,000 decrease not (a) a $120,000 increase, (c) a
not (a) $12,000, (b) $8,000, or (d) $0. $50,000 increase, or (d) a $10,000 increase.
Practice Exercises
Use incremental analysis 1. (LO 3) Maningly Inc. has been manufacturing its own lampshades for its table lamps. The company
for make-or-buy decision. is currently operating at 100% of capacity. Variable manufacturing overhead is charged to production
at the rate of 50% of direct labor cost. The direct materials and direct labor cost per unit to make the
lampshades are $4 and $6, respectively. Normal production is 50,000 table lamps per year.
A supplier offers to make the lampshades at a price of $13.50 per unit. If Maningly accepts
the supplier’s offer; all variable manufacturing costs will be eliminated, but the $50,000 of fixed
manufacturing overhead currently being charged to the lampshades will have to be absorbed by other
products.
Instructions
a. Prepare the incremental analysis for the decision to make or buy the lampshades.
b. Should Maningly buy the lampshades?
c. Would your answer be different in (b) if the productive capacity released by not making the
lampshades could be used to produce income of $40,000?
Solution
1. a.
Net Income
Increase
Make Buy (Decrease)
Direct materials (50,000 × $4.00) $200,000 $ 0 $ 200,000
Direct labor (50,000 × $6.00) 300,000 0 300,000
Variable manufacturing costs
($300,000 × 50%) 150,000 0 150,000
Fixed manufacturing costs 50,000 50,000 0
Purchase price (50,000 × $13.50) 0 675,000 (675,000)
Total annual cost $700,000 $725,000 $ (25,000)
Practice Exercises 20-21
b. No, Maningly should not purchase the lampshades. As indicated by the incremental analysis, it
would cost the company $25,000 more to purchase the lampshades.
c. Yes, by purchasing the lampshades, a total cost saving of $15,000 will result as shown below.
Net Income
Increase
Make Buy (Decrease)
Total annual cost (from (a)) $700,000 $725,000 $(25,000)
Opportunity cost 40,000 0 40,000
Total cost $740,000 $725,000 $ 15,000
2. (LO 4) A company manufactures three products using same production process. The costs Use incremental analysis for whether
incurred up to the split-off point are $200,000. These costs are allocated to the products on the basis to sell or process materials further.
of their sales value at the split-off point. The number of units produced, the selling prices per unit of
the three products at the split-off point and after further processing, and the additional processing
costs are as follows.
Number of Selling Price Selling Price Additional
Product Units Produced at Split-Off after Processing Processing Costs
D 3,000 $11.00 $15.00 $14,000
E 6,000 12.00 16.20 16,000
F 2,000 19.40 24.00 9,000
Instructions
a. Which information is relevant to the decision on whether or not to process the products further?
Explain why this information is relevant.
b. Which product(s) should be processed further and which should be sold at the split-off point?
c. Would your decision be different if the company was using the quantity of output to allocate
joint costs? Explain.
(CGA adapted)
Solution
2. a. The costs that are relevant in this decision are the incremental revenues and the incremental
costs associated with processing the material past the split-off point. Any costs incurred up to
the split-off point are sunk costs and therefore irrelevant to this decision.
b. Revenue after further processing:
Product D: $45,000 (3,000 units × $15.00 per unit)
Product E: $97,200 (6,000 units × $16.20 per unit)
Product F: $48,000 (2,000 units × $24.00 per unit)
Revenue at split-off:
Product D: $33,000 (3,000 units × $11.00 per unit)
Product E: $72,000 (6,000 units × $12.00 per unit)
Product F: $38,800 (2,000 units × $19.40 per unit)
D E F
Incremental revenue $ 12,000a $ 25,200b $ 9,200c
Incremental cost (14,000) (16,000) (9,000)
Increase (decrease) in profit $ (2,000) $ 9,200 $ 200
a
$45,000 − $33,000; b$97,200 − $72,000; c$48,000 − $38,800
Products E and F should be processed further, but Product D should not be processed
further.
c. The decision would remain the same. It does not matter how the joint costs are allocated
because joint costs are irrelevant to this decision.
Use incremental analysis for retaining 3. (LO 5) Tek Enterprises uses a computer to process its sales invoices. Lately, business has been so
or replacing equipment. good that it takes an extra 3 hours per night, plus every third Saturday, to keep up with the volume
of sales invoices. Management is considering updating its computer with a faster model that would
eliminate all of the overtime processing.
Current Machine New Machine

Original purchase cost $15,000 $25,000
Accumulated depreciation 6,000 —
Estimated annual operating costs 25,000 20,000
Useful life 6 years 6 years
If sold now, the current machine would have a salvage value of $5,000. If operated for the remainder
of its useful life, the current machine would have zero salvage value. The new machine is expected to
have zero salvage value after 6 years.
Instructions
Should the current machine be replaced? (Ignore the time value of money.)
Solution
3.
Net Income
Retain Replace Increase
Machine Machine (Decrease)
Operating costs $150,000* $120,000** $30,000
New machine cost 0 25,000 (25,000)
Salvage value (old) 0 (5,000) 5,000
Total $150,000 $140,000 $10,000
*$25,000 × 6
**$20,000 × 6
The current machine should be replaced. The incremental analysis shows that net income for the
6-year period will be $10,000 higher by replacing the current machine.
Use incremental analysis 4. (LO 6) Benai Lorenzo, a recent graduate of Bonita’s accounting program, evaluated the operat-
for elimination of division. ing performance of Wasson Company’s six divisions. Benai made the following presentation to the
Wasson board of directors and suggested the Ortiz Division be eliminated. “If the Ortiz Division is
eliminated,” she said, “our total profits would increase by $23,870.”
The Other Ortiz

Five Divisions Division Total
Sales $1,664,200 $ 96,200 $1,760,400
Cost of goods sold 978,520 76,470 1,054,990
Gross profit 685,680 19,730 705,410
Net income $ 157,740 $(23,870) $ 133,870
In the Ortiz Division, cost of goods sold is $70,000 variable and $6,470 fixed, and operating expenses
are $15,000 variable and $28,600 fixed. None of the Ortiz Division’s fixed costs will be eliminated
if the division is discontinued.
Instructions
Is Benai right about eliminating the Ortiz Division? Prepare an incremental analysis schedule to sup-
port your answer.
Practice Problem 20-23
Solution
4.
Net Income
Increase
Continue Eliminate (Decrease)
Sales $ 96,200 $ 0 $(96,200)
Variable expenses
Cost of goods sold 70,000 0 70,000
Operating expenses 15,000 0 15,000
Total variable 85,000 0 85,000
Contribution margin 11,200 0 (11,200)
Fixed expenses
Cost of goods sold 6,470 6,470 0
Operating expenses 28,600 28,600 0
Total fixed 35,070 35,070 0
Net income (loss) $(23,870) $(35,070) $(11,200)
Benai is incorrect. The incremental analysis shows that net income will be $11,200 less if the Ortiz
Division is eliminated. This amount equals the contribution margin that would be lost by discontinuing
the division.
Practice Problem
(LO 2) Walston Company produces kitchen cabinets for homebuilders across the western United Use incremental analysis for a special
States. The cost of producing 5,000 cabinets is as follows. order.
Materials $ 500,000
Labor 250,000
Variable overhead 100,000
Fixed overhead 400,000
Total $1,250,000
Walston also incurs selling expenses of $20 per cabinet. Wellington Corp. has offered Walston
$165 per cabinet for a special order of 1,000 cabinets. The cabinets would be sold to homebuilders in
the eastern United States and thus would not conflict with Walston’s current sales. Selling expenses
per cabinet would be only $5 per cabinet. Walston has available capacity to do the work.
Instructions
a. Prepare an incremental analysis for the special order.
b. Should Walston accept the special order? Why or why not?
Solution
a. Relevant costs per unit would be:
Materials $500,000/5,000 = $100
Labor 250,000/5,000 = 50
Variable overhead 100,000/5,000 = 20
Selling expenses 5
Total relevant cost per unit $175
Net Income
Reject Order Accept Order Increase (Decrease)
Revenues $0 $165,000* $ 165,000
Costs 0 175,000** (175,000)
Net income $0 $ (10,000) $ (10,000)
*$165 × 1,000; **$175 × 1,000

b. Walston should reject the offer. The incremental benefit of $165 per cabinet is less than the incremental
cost of $175. By accepting the order, Walston’s net income would actually decline by $10,000.
Brief Exercises, Exercises, DO IT! Exercises Problems, and many additional resources are
available for practice in WileyPLUS.
Questions
1. What steps are frequently involved in management’s decision- 7. Define the term “opportunity cost.” How may this cost be relevant
making process? in a make-or-buy decision?
2. Your roommate, Anna Polis, contends that accounting contributes 8. What is the decision rule in deciding whether to sell a product or
to most of the steps in management’s decision-making process. Is process it further?
your roommate correct? Explain. 9. What are joint products? What accounting issue results from the
3. “Incremental analysis involves the accumulation of information production process that creates joint products?
concerning a single course of action.” Do you agree? Why? 10. How are allocated joint costs treated when making a sell-or-
4. Sydney Greene asks for your help concerning the relevance of process-further decision?
variable and fixed costs in incremental analysis. Help Sydney with 11. Your roommate, Gale Dunham, is confused about sunk costs.
her problem. Explain to your roommate the meaning of sunk costs and their
5. What data are relevant in deciding whether to accept an order at a relevance to a decision to retain or replace equipment.
special price? 12. Huang Inc. has one product line that is unprofitable. What
6. Emil Corporation has an opportunity to buy parts at $9 each circumstances may cause overall company net income to be lower if
that currently cost $12 to make. What manufacturing costs are rele- the unprofitable product line is eliminated?
vant to this make-or-buy decision?
Brief Exercises
Identify the steps in management’s BE20.1 (LO 1) The steps in management’s decision-making process are listed in random order below.
decision-making process. Indicate the order in which the steps should be executed.
________ Make a decision ________ Review results of the decision
________ Identify the problem and assign ________ Determine and evaluate possible courses
responsibility of action
Determine incremental changes. BE20.2 (LO 1) Bogart Company is considering two alternatives. Alternative A will have revenues of
$160,000 and costs of $100,000. Alternative B will have revenues of $180,000 and costs of $125,000.
Compare Alternative A to Alternative B showing incremental revenues, costs, and net income.
Determine whether to accept a special BE20.3 (LO 2) At Bargain Electronics, it costs $30 per unit ($20 variable and $10 fixed) to make an
order. MP3 player that normally sells for $45. A foreign wholesaler offers to buy 3,000 units at $25 each.
Bargain Electronics will incur special shipping costs of $3 per unit. Assuming that Bargain Electronics
has excess operating capacity, indicate the net income (loss) Bargain Electronics would realize by
accepting the special order.
Determine whether to make or buy BE20.4 (LO 3) Manson Industries incurs unit costs of $8 ($5 variable and $3 fixed) in making an assem-
a part. bly part for its finished product. A supplier offers to make 10,000 of the assembly part at $6 per unit. If
the offer is accepted, Manson will save all variable costs but no fixed costs. Prepare an analysis showing
the total cost saving, if any, Manson will realize by buying the part.
Determine whether to BE20.5 (LO 4) Pine Street Inc. makes unfinished bookcases that it sells for $62. Production costs are
sell or process further. $36 variable and $10 fixed. Because it has unused capacity, Pine Street is considering finishing the book-
cases and selling them for $70. Variable finishing costs are expected to be $6 per unit with no increase
in fixed costs. Prepare an analysis on a per unit basis showing whether Pine Street should sell unfinished
or finished bookcases.
Determine whether to sell or process BE20.6 (LO 4) Each day, Adama Corporation processes 1 ton of a secret raw material into two result-
further, joint products. ing products, AB1 and XY1. When it processes 1 ton of the raw material, the company incurs joint
DO IT! Exercises 20-25
processing costs of $60,000. It allocates $25,000 of these costs to AB1 and $35,000 of these costs to
XY1. The resulting AB1 can be sold for $100,000. Alternatively, it can be processed further to make
AB2 at an additional processing cost of $45,000, and sold for $150,000. Each day’s batch of XY1 can
be sold for $95,000. Or, it can be processed further to create XY2, at an additional processing cost of
$50,000, and sold for $130,000. Discuss what products Adama Corporation should make.
BE20.7 (LO 5) Bryant Company has a factory machine with a book value of $90,000 and a remaining Determine whether to retain or
useful life of 5 years. It can be sold for $30,000. A new machine is available at a cost of $400,000. This replace equipment.
machine will have a 5-year useful life with no salvage value. The new machine will lower annual variable
manufacturing costs from $600,000 to $500,000. Prepare an analysis showing whether the old machine
should be retained or replaced.
BE20.8 (LO 6) Lisah, Inc., manufactures golf clubs in three models. For the year, the Big Bart line has Determine whether to eliminate an
a net loss of $10,000 from sales $200,000, variable costs $180,000, and fixed costs $30,000. If the Big unprofitable segment.
Bart line is eliminated, $20,000 of fixed costs will remain. Prepare an analysis showing whether the Big
Bart line should be eliminated.
DO IT! Exercises
DO IT! 20.1 (LO 1) Nathan T Corporation is comparing two different options. Nathan T currently Determine incremental costs.
uses Option 1, with revenues of $65,000 per year, maintenance expenses of $5,000 per year, and
operating expenses of $26,000 per year. Option 2 provides revenues of $60,000 per year, maintenance
expenses of $5,000 per year, and operating expenses of $22,000 per year. Option 1 employs a piece
of equipment which was upgraded 2 years ago at a cost of $17,000. If Option 2 is chosen, it will free
up resources that will bring in an additional $4,000 of revenue. Complete the following table to show
the change in income from choosing Option 2 versus Option 1. Designate Sunk costs with an “S.”
Net Income
Increase
Revenues
Maintenance expenses
Operating expenses
Equipment upgrade
Opportunity cost
DO IT! 20.2 (LO 2) Maize Company incurs a cost of $35 per unit, of which $20 is variable, to make Evaluate special order.
a product that normally sells for $58. A foreign wholesaler offers to buy 6,000 units at $30 each.
Maize will incur additional costs of $4 per unit to imprint a logo and to pay for shipping. Compute
the increase or decrease in net income Maize will realize by accepting the special order, assuming
Maize has sufficient excess operating capacity. Should Maize Company accept the special order?
DO IT! 20.3 (LO 3) Wilma Company must decide whether to make or buy some of its components. Evaluate make-or-buy opportunity.
The costs of producing 60,000 switches for its generators are as follows.
Direct materials $30,000 Variable overhead $45,000
Direct labor $42,000 Fixed overhead $60,000
Instead of making the switches at an average cost of $2.95 ($177,000 ÷ 60,000), the company has an
opportunity to buy the switches at $2.70 per unit. If the company purchases the switches, all the
variable costs and one-fourth of the fixed costs will be eliminated. (a) Prepare an incremental anal-
ysis showing whether the company should make or buy the switches. (b) Would your answer be dif-
ferent if the released productive capacity will generate additional income of $34,000?
DO IT! 20.4 (LO 4) Mesa Verde manufactures unpainted furniture for the do-it-yourself (DIY) market. Sell or process further.
It currently sells a table for $75. Production costs per unit are $40 variable and $10 fixed. Mesa Verde
is considering staining and sealing the table to sell it for $100. Variable costs per unit to finish each
table are expected to be an additional $19 per unit, and fixed costs are expected to be an additional
$3 per unit. Prepare an analysis showing whether Mesa Verde should sell unpainted or finished tables.
DO IT! 20.5 (LO 5) Darcy Roofing is faced with a decision. The company relies very heavily on the Repair or replace equipment.
use of its 60-foot extension lift for work on large homes and commercial properties. Last year, Darcy
Roofing spent $60,000 refurbishing the lift. It has just determined that another $40,000 of repair work
is required. Alternatively, it has found a newer used lift that is for sale for $170,000. The company
estimates that both lifts would have useful lives of 6 years. The new lift is more efficient and thus
would reduce operating expenses by about $20,000 per year. Darcy Roofing could also rent out the
new lift for about $10,000 per year. The old lift is not suitable for rental. The old lift could currently
be sold for $25,000 if the new lift is purchased. Prepare an incremental analysis showing whether the
company should repair or replace the equipment.
Analyze whether to eliminate DO IT! 20.6 (LO 6) Gator Corporation manufactures several types of accessories. For the year, the
unprofitable segment. gloves and mittens line had sales of $500,000, variable expenses of $370,000, and fixed expenses of
$150,000. Therefore, the gloves and mittens line had a net loss of $20,000. If Gator eliminates the
line, $38,000 of fixed costs will remain. Prepare an analysis showing whether the company should
eliminate the gloves and mittens line.
Exercises
Analyze statements about decision- E20.1 (LO 1) As a study aid, your classmate Pascal Adams has prepared the following list of statements
making and incremental analysis. about decision-making and incremental analysis.
1. The first step in management’s decision-making process is, “Determine and evaluate possible
courses of action.”
2. The final step in management’s decision-making process is to actually make the decision.
3. Accounting’s contribution to management’s decision-making process occurs primarily in evaluat-
ing possible courses of action and in reviewing the results.
4. In making business decisions, management ordinarily considers only financial information because
it is objectively determined.
5. Decisions involve a choice among alternative courses of action.
6. The process used to identify the financial data that change under alternative courses of action is
called incremental analysis.
7. Costs that are the same under all alternative courses of action sometimes affect the decision.
8. When using incremental analysis, some costs will always change under alternative courses of ac-
tion, but revenues will not.
9. Variable costs will change under alternative courses of action, but fixed costs will not.
Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.
Use incremental analysis for E20.2 (LO 2) Gruden Company produces golf discs which it normally sells to retailers for $7 each. The
special-order decision. cost of manufacturing 20,000 golf discs is:
Materials $ 10,000
Labor 30,000
Variable overhead 20,000
Fixed overhead 40,000
Total $100,000
Gruden also incurs 5% sales commission ($0.35) on each disc sold.

McGee Corporation offers Gruden $4.80 per disc for 5,000 discs. McGee would sell the discs under
its own brand name in foreign markets not yet served by Gruden. If Gruden accepts the offer, its fixed
overhead will increase from $40,000 to $46,000 due to the purchase of a new imprinting machine. No sales
commission will result from the special order.
Instructions
b. Should Gruden accept the special order? Why or why not?
c. What assumptions underlie the decision made in part (b)?
Exercises 20-27
E20.3 (LO 2) Moonbeam Company manufactures toasters. For the first 8 months of 2020, the com- Use incremental analysis
pany reported the following operating results while operating at 75% of plant capacity: for special order.
Sales (350,000 units) $4,375,000

Cost of goods sold 2,600,000
Gross profit 1,775,000
Operating expenses 840,000
Net income $ 935,000
Cost of goods sold was 70% variable and 30% fixed; operating expenses were 80% variable and 20%
fixed.
In September, Moonbeam receives a special order for 15,000 toasters at $7.60 each from Luna
Company of Ciudad Juarez. Acceptance of the order would result in an additional $3,000 of shipping
costs but no increase in fixed costs.
Instructions
b. Should Moonbeam accept the special order? Why or why not?
E20.4 (LO 2) Klean Fiber Company is the creator of Y-Go, a technology that weaves silver into its Use incremental analysis for special
fabrics to kill bacteria and odor on clothing while managing heat. Y-Go has become very popular in order.
undergarments for sports activities. Operating at capacity, the company can produce 1,000,000 Y-Go
undergarments a year. The per unit and the total costs for an individual garment when the company
operates at full capacity are as follows.
Per Undergarment Total
Direct materials $2.00 $2,000,000
Direct labor 0.75 750,000
Variable manufacturing overhead 1.00 1,000,000
Fixed manufacturing overhead 1.50 1,500,000
Variable selling expenses 0.25 250,000
Totals $5.50 $5,500,000
The U.S. Army has approached Klean Fiber and expressed an interest in purchasing 250,000
Y-Go undergarments for soldiers in extremely warm climates. The Army would pay the unit cost for
direct materials, direct labor, and variable manufacturing overhead costs. In addition, the Army has
agreed to pay an additional $1 per undergarment to cover all other costs and provide a profit. Presently,
Klean Fiber is operating at 70% capacity and does not have any other potential buyers for Y-Go. If
Klean Fiber accepts the Army’s offer, it will not incur any variable selling expenses related to this
order.
Instructions
Using incremental analysis, determine whether Klean Fiber should accept the Army’s offer.
E20.5 (LO 3) Pottery Ranch Inc. has been manufacturing its own finials for its curtain rods. The Use incremental analysis for make-or-
company is currently operating at 100% of capacity, and variable manufacturing overhead is charged buy decision.
to production at the rate of 70% of direct labor cost. The direct materials and direct labor cost
per unit to make a pair of finials are $4 and $5, respectively. Normal production is 30,000 curtain Excel
rods per year.
A supplier offers to make a pair of finials at a price of $12.95 per unit. If Pottery Ranch accepts the
supplier’s offer, all variable manufacturing costs will be eliminated, but the $45,000 of fixed manufac-
turing overhead currently being charged to the finials will have to be absorbed by other products.
Instructions
a. Prepare the incremental analysis for the decision to make or buy the finials.
b. Should Pottery Ranch buy the finials?
c. Would your answer be different in (b) if the productive capacity released by not making the finials
could be used to produce income of $20,000?
E20.6 (LO 3) Jobs, Inc. has recently started the manufacture of Tri-Robo, a three-wheeled robot that can Use incremental analysis for make-or-
scan a home for fires and gas leaks and then transmit this information to a smartphone. The cost structure buy decision.
to manufacture 20,000 Tri-Robos is as follows.
Cost
Direct materials ($50 per robot) $1,000,000
Direct labor ($40 per robot) 800,000
Variable overhead ($6 per robot) 120,000
Allocated fixed overhead ($30 per robot) 600,000
Total $2,520,000
Jobs is approached by Tienh Inc., which offers to make Tri-Robo for $115 per unit or $2,300,000.
Instructions
a. Using incremental analysis, determine whether Jobs should accept this offer under each of the fol-
lowing independent assumptions.
1. Assume that $405,000 of the fixed overhead cost can be avoided.
2. Assume that none of the fixed overhead can be avoided. However, if the robots are purchased
from Tienh Inc., Jobs can use the released productive resources to generate additional income of
$375,000.
b. Describe the qualitative factors that might affect the decision to purchase the robots from an outside
supplier.
Prepare incremental analysis for E20.7 (LO 3) Riggs Company purchases sails and produces sailboats. It currently produces 1,200 sail-
make-or-buy decision. boats per year, operating at normal capacity, which is about 80% of full capacity. Riggs purchases sails
at $250 each, but the company is considering using the excess capacity to manufacture the sails instead.
The manufacturing cost per sail would be $100 for direct materials, $80 for direct labor, and $90 for
overhead. The $90 overhead is based on $78,000 of annual fixed overhead that is allocated using normal
capacity.
The president of Riggs has come to you for advice. “It would cost me $270 to make the sails,” she
says, “but only $250 to buy them. Should I continue buying them, or have I missed something?”
Instructions
a. Prepare a per unit analysis of the differential costs. Briefly explain whether Riggs should make or
buy the sails.
b. If Riggs suddenly finds an opportunity to rent out the unused capacity of its factory for $77,000 per
year, would your answer to part (a) change? Briefly explain.
c. Identify three qualitative factors that should be considered by Riggs in this make-or-buy decision.
(CGA adapted)
Prepare incremental analysis E20.8 (LO 3) Innova uses 1,000 units of the component IMC2 every month to manufacture one of its
concerning make-or-buy decision. products. The unit costs incurred to manufacture the component are as follows.
Excel Direct materials $ 65.00

Direct labor 45.00
Overhead 126.50
Total $236.50
Overhead costs include variable material handling costs of $6.50, which are applied to products on the
basis of direct material costs. The remainder of the overhead costs are applied on the basis of direct labor
dollars and consist of 60% variable costs and 40% fixed costs.
A vendor has offered to supply the IMC2 component at a price of $200 per unit.
Instructions
a. Should Innova purchase the component from the outside vendor if Innova’s capacity remains idle?
b. Should Innova purchase the component from the outside vendor if it can use its facilities to manu-
facture another product? What information will Innova need to make an accurate decision? Show
your calculations.
c. What are the qualitative factors that Innova will have to consider when making this decision?
(CGA adapted)
Use incremental analysis for further E20.9 (LO 4) Anna Garden recently opened her own basketweaving studio. She sells finished baskets in
processing of materials decision. addition to selling the raw materials needed by customers to weave baskets of their own. Unfortunately,
owing to space limitations, Anna is unable to carry all varieties of kits originally assembled and must
choose between two basic packages.
Exercises 20-29
The Basic Kit includes undyed, uncut reeds (with dye included) for weaving one basket. This
basic package costs Anna $16 and sells for $30. The second kit, called Stage 2, includes cut
reeds that have already been dyed. With this kit the customer need only soak the reeds and weave the
basket. Anna produces the Stage 2 kit by using the materials included in the Basic Kit. Because she
is more efficient at cutting and dying reeds than her average customer, Anna is able to produce two
Stage 2 kits in one hour from one Basic Kit. (She values her time at $18 per hour.) The Stage 2
kit sells for $36.
Instructions
Determine whether Anna’s basketweaving studio should carry the Basic Kit with undyed and uncut
reeds or the Stage 2 kit with reeds already dyed and cut. Prepare an incremental analysis to support your
answer.
E20.10 (LO 4) Stahl Inc. produces three separate products from a common process costing $100,000. Determine whether to sell or process
Each of the products can be sold at the split-off point or can be processed further and then sold for a further, joint products.
higher price. Shown below are cost and selling price data for a recent period.
Excel
Sales Value Cost to Sales Value
at Split-Off Process after Further
Point Further Processing
Product 10 $60,000 $100,000 $190,000
Product 12 15,000 30,000 35,000
Product 14 55,000 150,000 215,000
Instructions
a. Determine total net income if all products are sold at the split-off point.
b. Determine total net income if all products are sold after further processing.
c. Using incremental analysis, determine which products should be sold at the split-off point and
which should be processed further.
d. Determine total net income using the results from (c) and explain why the net income is different
from that determined in (b).
E20.11 (LO 4) Kirk Minerals processes materials extracted from mines. The most common raw material Determine whether to sell or process
that it processes results in three joint products: Spock, Uhura, and Sulu. Each of these products can be further, joint products.
sold as is, or each can be processed further and sold for a higher price. The company incurs joint costs of
$180,000 to process one batch of the raw material that produces the three joint products. The following Excel
cost and sales information is available for one batch of each product.
Sales Value at Allocated Cost to Process Sales Value of

Split-Off Point Joint Costs Further Processed Product
Spock $210,000 $40,000 $110,000 $300,000
Uhura 300,000 60,000 85,000 400,000
Sulu 455,000 80,000 250,000 800,000
Instructions
Determine whether each of the three joint products should be sold as is, or processed further.
E20.12 (LO 4) A company manufactures three products using the same production process. The costs Prepare incremental analysis for
incurred up to the split-off point are $200,000. These costs are allocated to the products on the basis of whether to sell or process materials
their sales value at the split-off point. The number of units produced, the selling prices per unit of the further.
three products at the split-off point and after further processing, and the additional processing costs are
as follows.
Number of Selling Price Selling Price Additional

Product Units Produced at Split-Off after Processing Processing Costs
D 4,000 $10.00 $15.00 $14,000
E 6,000 11.60 16.20 20,000
F 2,000 19.40 22.60 9,000
Instructions
a. Which information is relevant to the decision on whether or not to process the products further?
Explain why this information is relevant.
b. Which product(s) should be processed further and which should be sold at the split-off point?
c. Would your decision be different if the company was using the quantity of output to allocate joint
costs? Explain.
(CGA adapted)
Use incremental analysis for retaining E20.13 (LO 5) Service On January 2, 2019, Twilight Hospital purchased a $100,000 special radiol-
or replacing equipment decision. ogy scanner from Bella Inc. The scanner had a useful life of 4 years and was estimated to have no dis-
posal value at the end of its useful life. The straight-line method of depreciation is used on this scanner.
Annual operating costs with this scanner are $105,000.
Approximately one year later, the hospital is approached by Dyno Technology salesperson, Jacob
Cullen, who indicated that purchasing the scanner in 2019 from Bella Inc. was a mistake. He points out
that Dyno has a scanner that will save Twilight Hospital $25,000 a year in operating expenses over its
3-year useful life. Jacob notes that the new scanner will cost $110,000 and has the same capabilities as
the scanner purchased last year. The hospital agrees that both scanners are of equal quality. The new
scanner will have no disposal value. Jacob agrees to buy the old scanner from Twilight Hospital for
$50,000.
Instructions
a. If Twilight Hospital sells its old scanner on January 2, 2020, compute the gain or loss on the sale.
b. Using incremental analysis, determine if Twilight Hospital should purchase the new scanner on
January 2, 2020.
c. Explain why Twilight Hospital might be reluctant to purchase the new scanner, regardless of the
results indicated by the incremental analysis in (b).
Use incremental analysis for retaining E20.14 (LO 5) Johnson Enterprises uses a computer to handle its sales invoices. Lately, business has
or replacing equipment decision. been so good that it takes an extra 3 hours per night, plus every third Saturday, to keep up with the vol-
ume of sales invoices. Management is considering updating its computer with a faster model that would
eliminate all of the overtime processing.
Current Machine New Machine

Original purchase cost $15,000 $25,000
Accumulated depreciation $ 6,000 —
Estimated annual operating costs $25,000 $20,000
Remaining useful life 5 years 5 years
If sold now, the current machine would have a salvage value of $6,000. If operated for the remainder of
its useful life, the current machine would have zero salvage value. The new machine is expected to have
zero salvage value after 5 years.
Instructions
Prepare an incremental analysis to determine whether the current machine should be replaced.
Use incremental analysis concerning E20.15 (LO 6) Veronica Mars, a recent graduate of Bell’s accounting program, evaluated the operating
elimination of division. performance of Dunn Company’s six divisions. Veronica made the following presentation to Dunn’s
board of directors and suggested the Percy Division be eliminated. “If the Percy Division is eliminated,”
Excel she said, “our total profits would increase by $26,000.”
The Other Percy

Five Divisions Division Total
Sales $1,664,200 $100,000 $1,764,200
Cost of goods sold 978,520 76,000 1,054,520
Gross profit 685,680 24,000 709,680
Net income $ 157,740 $ (26,000) $ 131,740
In the Percy Division, cost of goods sold is $61,000 variable and $15,000 fixed, and operating expenses
are $30,000 variable and $20,000 fixed. None of the Percy Division’s fixed costs will be eliminated if
the division is discontinued.
Instructions
Is Veronica right about eliminating the Percy Division? Prepare a schedule to support your answer.
Exercises 20-31
E20.16 (LO 6) Cawley Company makes three models of tasers. Information on the three products is Use incremental analysis for
given below. elimination of a product line.
Tingler Shocker Stunner

Sales $300,000 $500,000 $200,000
Variable expenses 150,000 200,000 145,000
Contribution margin 150,000 300,000 55,000
Fixed expenses 120,000 230,000 95,000
Net income $ 30,000 $ 70,000 $ (40,000)
Fixed expenses consist of $300,000 of common costs allocated to the three products based on relative
sales, as well as direct fixed expenses unique to each model of $30,000 (Tingler), $80,000 (Shocker), and
$35,000 (Stunner). The common costs will be incurred regardless of how many models are produced.
The direct fixed expenses would be eliminated if that model is phased out.
James Watt, an executive with the company, feels the Stunner line should be discontinued to in-
crease the company’s net income.
Instructions
a. Compute current net income for Cawley Company.
b. Compute net income by product line and in total for Cawley Company if the company discontinues
the Stunner product line. (Hint: Allocate the $300,000 common costs to the two remaining product
lines based on their relative sales.)
c. Should Cawley eliminate the Stunner product line? Why or why not?
E20.17 (LO 6) Tharp Company operates a small factory in which it manufactures two products: C and Prepare incremental analysis
D. Production and sales results for last year were as follows. concerning keeping or dropping
a product to maximize operating
C D income.
Units sold 9,000 20,000
Selling price per unit $95 $75
Variable cost per unit 50 40
Fixed cost per unit 24 24
For purposes of simplicity, the firm averages total fixed costs over the total number of units of C and D
produced and sold.
The research department has developed a new product (E) as a replacement for product D.
Market studies show that Tharp Company could sell 10,000 units of E next year at a price of $115; the
variable cost per unit of E is $45. The introduction of product E will lead to a 10% increase in demand
for product C and discontinuation of product D. If the company does not introduce the new product, it
expects next year’s results to be the same as last year’s.
Instructions
Should Tharp Company introduce product E next year? Explain why or why not. Show calculations to
support your decision.
(CMA-Canada adapted)
E20.18 (LO 1, 2, 3, 4, 5, 6) The costs listed below relate to a variety of different decision situations. Identify relevant costs for different
decisions.
Cost Decision
1. Unavoidable fixed overhead Eliminate an unprofitable segment
2. Direct labor Make or buy
3. Original cost of old equipment Equipment replacement
4. Joint production costs Sell or process further
5. Opportunity cost Accepting a special order
6. Segment manager’s salary Eliminate an unprofitable segment
(manager will be terminated)
7. Cost of new equipment Equipment replacement
8. Incremental production costs Sell or process further
9. Direct materials Equipment replacement (the amount of
materials required does not change)
10. Rent expense Purchase or lease a building
Instructions
For each cost listed above, indicate if it is relevant or not to the related decision. For those costs
determined to be irrelevant, briefly explain why.
Problems: Set A
Use incremental analysis for special P20.1A (LO 2) Writing ThreePoint Sports Inc. manufactures basketballs for the Women’s National
order and identify nonfinancial Basketball Association (WNBA). For the first 6 months of 2020, the company reported the following
factors in the decision. operating results while operating at 80% of plant capacity and producing 120,000 units.
Amount
Sales $4,800,000
Cost of goods sold 3,600,000
Selling and administrative expenses 405,000
Net income $ 795,000
Fixed costs for the period were cost of goods sold $960,000, and selling and administrative expenses
$225,000.
In July, normally a slack manufacturing month, ThreePoint Sports receives a special order for
10,000 basketballs at $28 each from the Greek Basketball Association (GBA). Acceptance of the order
would increase variable selling and administrative expenses $0.75 per unit because of shipping costs but
would not increase fixed costs and expenses.
Instructions
a. NI increase $37,500 a. Prepare an incremental analysis for the special order.
b. Should ThreePoint Sports Inc. accept the special order? Explain your answer.
c. What is the minimum selling price on the special order to produce net income of $5.00 per
ball?
d. What nonfinancial factors should management consider in making its decision?
Use incremental analysis related to P20.2A (LO 3) Writing The management of Shatner Manufacturing Company is trying to decide
make or buy, consider opportunity whether to continue manufacturing a part or to buy it from an outside supplier. The part, called CISCO,
cost, and identify nonfinancial factors. is a component of the company’s finished product.
The following information was collected from the accounting records and production data for the
year ending December 31, 2020.
1. 8,000 units of CISCO were produced in the Machining Department.
2. Variable manufacturing costs applicable to the production of each CISCO unit were: direct materi-
als $4.80, direct labor $4.30, indirect labor $0.43, utilities $0.40.
3. Fixed manufacturing costs applicable to the production of CISCO were:
Cost Item Direct Allocated

Depreciation $2,100 $ 900
Property taxes 500 200
Insurance 900 600
$3,500 $1,700
All variable manufacturing and direct fixed costs will be eliminated if CISCO is purchased.
Allocated costs will not be eliminated if CISCO is purchased. So if CISCO is purchased, the
fixed manufacturing costs allocated to CISCO will have to be absorbed by other production
departments.
4. The lowest quotation for 8,000 CISCO units from a supplier is $80,000.
5. If CISCO units are purchased, freight and inspection costs would be $0.35 per unit, and receiving
costs totaling $1,300 per year would be incurred by the Machining Department.
Problems: Set A 20-33
Instructions
a. Prepare an incremental analysis for CISCO. Your analysis should have columns for (1) Make a. NI (decrease) $(1,160)
CISCO, (2) Buy CISCO, and (3) Net Income Increase/(Decrease).
b. Based on your analysis, what decision should management make?
c. Would the decision be different if Shatner Company has the opportunity to produce $3,000 c. NI increase $1,840
of net income with the facilities currently being used to manufacture CISCO? Show
computations.
d. What nonfinancial factors should management consider in making its decision?
P20.3A (LO 4) Thompson Industrial Products Inc. (TIPI) is a diversified industrial-cleaner processing Determine if product should be sold
company. The company’s Dargan plant produces two products: a table cleaner and a floor cleaner from or processed further.
a common set of chemical inputs (CDG). Each week, 900,000 ounces of chemical input are processed at
a cost of $210,000 into 600,000 ounces of floor cleaner and 300,000 ounces of table cleaner. The floor Excel
cleaner has no market value until it is converted into a polish with the trade name FloorShine. The addi-
tional processing costs for this conversion amount to $240,000.
FloorShine sells at $20 per 30-ounce bottle. The table cleaner can be sold for $17 per 25-ounce
bottle. However, the table cleaner can be converted into two other products by adding 300,000
ounces of another compound (TCP) to the 300,000 ounces of table cleaner. This joint process
will yield 300,000 ounces each of table stain remover (TSR) and table polish (TP). The additional
processing costs for this process amount to $100,000. Both table products can be sold for $14 per
25-ounce bottle.
The company decided not to process the table cleaner into TSR and TP based on the following
analysis.
Process Further
Table Stain
Table Remover Table Polish
Cleaner (TSR) (TP) Total
Production in ounces 300,000 300,000 300,000
Revenues $204,000 $168,000 $168,000 $336,000
Costs:
CDG costs 70,000* 52,500 52,500 105,000**
TCP costs 0 50,000 50,000 100,000
Total costs 70,000 102,500 102,500 205,000
Weekly gross profit $134,000 $ 65,500 $ 65,500 $131,000
*If table cleaner is not processed further, it is allocated 1/3 of the $210,000 of CDG cost, which is equal to 1/3 of the
total physical output.
**If table cleaner is processed further, total physical output is 1,200,000 ounces. TSR and TP combined account for
50% of the total physical output and are each allocated 25% of the CDG cost.
Instructions
a. Determine if management made the correct decision to not process the table cleaner further by
doing the following.
1. Calculate the company’s total weekly gross profit assuming the table cleaner is not processed
further.
2. Calculate the company’s total weekly gross profit assuming the table cleaner is processed a. 2. Gross profit $186,000
further.
3. Compare the resulting net incomes and comment on management’s decision.
b. Using incremental analysis, determine if the table cleaner should be processed further.
(CMA adapted)
P20.4A (LO 5) Service Writing At the beginning of last year (2019), Richter Condos installed a Compute gain or loss, and determine
mechanized elevator for its tenants. The owner of the company, Ron Richter, recently returned from an if equipment should be replaced.
industry equipment exhibition where he watched a computerized elevator demonstrated. He was impressed
with the elevator’s speed, comfort of ride, and cost efficiency. Upon returning from the exhibition, he asked
his purchasing agent to collect price and operating cost data on the new elevator. In addition, he asked
the company’s accountant to provide him with cost data on the company’s elevator. This information is
presented below.
Old Elevator New Elevator
Purchase price $120,000 $160,000
Estimated salvage value 0 0
Estimated useful life 5 years 4 years
Depreciation method Straight-line Straight-line
Annual operating costs
other than depreciation:
Variable $ 35,000 $ 10,000
Fixed 23,000 8,500
Annual revenues are $240,000, and selling and administrative expenses are $29,000, regardless of
which elevator is used. If the old elevator is replaced now, at the beginning of 2020, Richter Condos will
be able to sell it for $25,000.
Instructions
a. Determine any gain or loss if the old elevator is replaced.
b. Prepare a 4-year summarized income statement for each of the following assumptions:
1. The old elevator is retained.
b. 2. NI $539,000 2. The old elevator is replaced.
c. NI increase $23,000 c. Using incremental analysis, determine if the old elevator should be replaced.
d. Write a memo to Ron Richter explaining why any gain or loss should be ignored in the decision to
replace the old elevator.
Prepare incremental analysis P20.5A (LO 6) Brislin Company has four operating divisions. During the first quarter of 2020,
concerning elimination of divisions. the company reported aggregate income from operations of $213,000 and the following divisional
results.
Excel
Division
I II III IV
Sales $250,000 $200,000 $500,000 $450,000
Cost of goods sold 200,000 192,000 300,000 250,000
Selling and administrative expenses 75,000 60,000 60,000 50,000
Income (loss) from operations $ (25,000) $ (52,000) $140,000 $150,000
Analysis reveals the following percentages of variable costs in each division.
I II III IV
Cost of goods sold 70% 90% 80% 75%
Selling and administrative expenses 40 60 50 60
Discontinuance of any division would save 50% of the fixed costs and expenses for that division.
Top management is very concerned about the unprofitable divisions (I and II). Consensus is that
one or both of the divisions should be discontinued.
Instructions
a. Contribution margin I $80,000 a. Compute the contribution margin for Divisions I and II.
b. Prepare an incremental analysis concerning the possible discontinuance of (1) Division I and
(2) Division II. What course of action do you recommend for each division?
c. Income III $132,800 c. Prepare a columnar condensed income statement for Brislin Company, assuming Division II is
eliminated. (Use the CVP format.) Division II’s unavoidable fixed costs are allocated equally to the
continuing divisions.
d. Reconcile the total income from operations ($213,000) with the total income from operations with-
out Division II.
Continuing Cases 20-35
Continuing Cases
Current Designs Excel

CD20 Current Designs faces a number of important decisions that require incremental analysis.
Consider each of the following situations independently.
Situation 1
Recently, Mike Cichanowski, owner and CEO of Current Designs, received a phone call from the president
of a brewing company. He was calling to inquire about the possibility of Current Designs producing “floating
coolers” for a promotion his company was planning. These coolers resemble a kayak but are about one-third
the size. They are used to float food and beverages while paddling down the river on a weekend leisure trip.
The company would be interested in purchasing 100 coolers for the upcoming summer. It is willing to pay
$250 per cooler. The brewing company would pick up the coolers upon completion of the order.
Mike met with Diane Buswell, controller, to identify how much it would cost Current Designs to
produce the coolers. After careful analysis, the following costs were identified.
Direct materials $80/unit Variable overhead $20/unit
Direct labor $60/unit Fixed overhead $1,000
Current Designs would be able to modify an existing mold to produce the coolers. The cost of these
modifications would be approximately $2,000.
Instructions
a. Prepare an incremental analysis to determine whether Current Designs should accept this special
order to produce the coolers.
b. Discuss additional factors that Mike and Diane should consider if Current Designs is currently
operating at full capacity.
Situation 2
Current Designs is always working to identify ways to increase efficiency while becoming more environ-
mentally conscious. During a recent brainstorming session, one employee suggested to Diane Buswell,
controller, that the company should consider replacing the current rotomold oven as a way to realize
savings from reduced energy consumption. The oven operates on natural gas, using 17,000 therms of
natural gas for an entire year. A new, energy-efficient rotomold oven would operate on 15,000 therms of
natural gas for an entire year. After seeking out price quotes from a few suppliers, Diane determined that
it would cost approximately $250,000 to purchase a new, energy-efficient rotomold oven. She determines
that the expected useful life of the new oven would be 10 years, and it would have no salvage value at the
end of its useful life. Current Designs would be able to sell the current oven for $10,000.
Instructions
a. Prepare an incremental analysis to determine if Current Designs should purchase the new rotomold
oven, assuming that the average price for natural gas over the next 10 years will be $0.65 per therm.
b. Diane is concerned that natural gas prices might increase at a faster rate over the next 10 years. If
the company projects that the average natural gas price of the next 10 years could be as high as
$0.85 per therm, discuss how that might change your conclusion in (a).
Situation 3
One of Current Designs’ competitive advantages is found in the ingenuity of its owner and CEO, Mike
Cichanowski. His involvement in the design of kayak molds and production techniques has led to
Current Designs being recognized as an industry leader in the design and production of kayaks. This
ingenuity was evident in an improved design of one of the most important components of a kayak,
the seat. The “Revolution Seating System” is a one-of-a-kind, rotating axis seat that gives unmatched,
full-contact, under-leg support. It is quickly adjustable with a lever-lock system that allows for a custom-
izable seat position that maximizes comfort for the rider.
Having just designed the “Revolution Seating System,” Current Designs must now decide whether
to produce the seats internally or buy them from an outside supplier. The costs for Current Designs to
produce the seats are as follows.
Direct materials $20/unit Direct labor $15/unit
Variable overhead $12/unit Fixed overhead $20,000
Current Designs will need to produce 3,000 seats this year; 25% of the fixed overhead will be avoided if
the seats are purchased from an outside vendor. After soliciting prices from outside suppliers, the com-
pany determined that it will cost $50 to purchase a seat from an outside vendor.
Instructions
a. Prepare an incremental analysis showing whether Current Designs should make or buy the “Rev-
olution Seating System.”
b. Would your answer in (a) change if the productive capacity released by not making the seats could
be used to produce income of $20,000?
Waterways
(Note: This is a continuation of the Waterways case from Chapters 14–19.)
WP20 Waterways Corporation is considering various business opportunities. It wants to make the best
use of its production facilities to maximize income. This problem asks you to help Waterways do incre-
mental analysis on these various opportunities.
Go to WileyPLUS for complete case details and instructions.
Expand Your Critical Thinking
Decision-Making Across the Organization

CT20.1 Aurora Company is considering the purchase of a new machine. The invoice price of the
machine is $140,000, freight charges are estimated to be $4,000, and installation costs are expected to be
$6,000. Salvage value of the new equipment is expected to be zero after a useful life of 5 years. Existing
equipment could be retained and used for an additional 5 years if the new machine is not purchased. At
that time, the salvage value of the equipment would be zero. If the new machine is purchased now, the
existing machine would have to be scrapped. Aurora’s accountant, Lisah Huang, has accumulated the
following data regarding annual sales and expenses with and without the new machine.
1. Without the new machine, Aurora can sell 12,000 units of product annually at a per unit selling
price of $100. If the new machine is purchased, the number of units produced and sold would in-
crease by 10%, and the selling price would remain the same.
2. The new machine is faster than the old machine, and it is more efficient in its usage of materials.
With the old machine the gross profit rate will be 25% of sales, whereas the rate will be 30% of sales
with the new machine.
3. Annual selling expenses are $180,000 with the current equipment. Because the new equipment
would produce a greater number of units to be sold, annual selling expenses are expected to increase
by 10% if it is purchased.
4. Annual administrative expenses are expected to be $100,000 with the old machine, and $113,000
with the new machine.
5. The current book value of the existing machine is $36,000. Aurora uses straight-line depreciation.
Instructions
With the class divided into groups, prepare an incremental analysis for the 5 years showing whether
Aurora should keep the existing machine or buy the new machine. (Ignore income tax effects.)
Managerial Analysis
CT20.2 MiniTek manufactures private-label small electronic products, such as alarm clocks, calcula-
tors, kitchen timers, stopwatches, and automatic pencil sharpeners. Some of the products are sold as sets,
and others are sold individually. Products are studied as to their sales potential, and then cost estimates
are made. The Engineering Department develops production plans, and then production begins. The
company has generally had very successful product introductions. Only two products introduced by the
company have been discontinued.
One of the products currently sold is a multi-alarm clock. The clock has four alarms that can be
programmed to sound at various times and for varying lengths of time. The company has experienced
Expand Your Critical Thinking 20-37
a great deal of difficulty in making the circuit boards for the clocks. The production process has never
operated smoothly. The product is unprofitable at the present time, primarily because of warranty re-
pairs and product recalls. Two models of the clocks were recalled, for example, because they sometimes
caused an electric shock when the alarms were being shut off. The Engineering Department is attempt-
ing to revise the manufacturing process, but the revision will take another 6 months at least.
The clocks were very popular when they were introduced, and since they are private-label, the
company has not suffered much from the recalls. Presently, the company has a very large order for sev-
eral items from Kmart Stores. The order includes 5,000 of the multi-alarm clocks. When the company
suggested that Kmart purchase the clocks from another manufacturer, Kmart threatened to rescind the
entire order unless the clocks were included.
The company has therefore investigated the possibility of having another company make the clocks
for them. The clocks were bid for the Kmart order based on an estimated $6.90 cost to manufacture:
Circuit board, 1 each @ $2.00 $2.00

Plastic case, 1 each @ $0.80 0.80
Alarms, 4 @ $0.15 each 0.60
Labor, 15 minutes @ $12/hour 3.00
Overhead, $2.00 per labor hour 0.50
MiniTek could purchase clocks to fill the Kmart order for $10 from Trans-Tech Asia, a Korean manu-
facturer with a very good quality record. Trans-Tech has offered to reduce the price to $7.50 after MiniTek
has been a customer for 6 months, placing an order of at least 1,000 units per month. If MiniTek becomes a
“preferred customer” by purchasing 15,000 units per year, the price would be reduced still further to $4.50.
Omega Products, a local manufacturer, has also offered to make clocks for MiniTek. They have
offered to sell 5,000 clocks for $5 each. However, Omega Products has been in business for only 6
months. They have experienced significant turnover in their labor force, and the local press has reported
that the owners may face tax evasion charges soon. The owner of Omega Products is an electronic engi-
neer, however, and the quality of the clocks is likely to be good.
If MiniTek decides to purchase the clocks from either Trans-Tech or Omega, all the costs to
manufacture could be avoided, except a total of $1,000 in overhead costs for machine depreciation. The
machinery is fairly new, and has no alternate use.
Instructions
a. What is the difference in profit under each of the alternatives if the clocks are to be sold for $14.50
each to Kmart?
b. What are the most important nonfinancial factors that MiniTek should consider when making this
decision?
c. What do you think MiniTek should do in regard to the Kmart order? What should it do in regard to
continuing to manufacture the multi-alarm clocks? Be prepared to defend your answer.
Real-World Focus
CT20.3 Founded in 1983 and foreclosed in 1996 Beverly Hills Fan Company was located in Wood-
land Hills, California. With 23 employees and sales of less than $10 million, the company was relatively
small. Management felt that there was potential for growth in the upscale market for ceiling fans and
lighting. They were particularly optimistic about growth in Mexican and Canadian markets.
Presented below is information from the president’s letter in one of the company’s last annual reports.
Beverly Hills Fan Company

President’s Letter
An aggressive product development program was initiated during the past year resulting in new
ceiling fan models planned for introduction this year. Award winning industrial designer Ron Rezek
created several new fan models for the Beverly Hills Fan and L.A. Fan lines, including a new Show-
room Collection, designed specifically for the architectural and designer markets. Each of these
models has received critical acclaim, and order commitments for this year have been outstanding.
Additionally, our Custom Color and special order fans continued to enjoy increasing popularity
and sales gains as more and more customers desire fans that match their specific interior decors.
Currently, Beverly Hills Fan Company offers a product line of over 100 models of contemporary,
traditional, and transitional ceiling fans.
Instructions
a. What points did the company management need to consider before deciding to offer the special-order
fans to customers?
b. How would have incremental analysis been employed to assist in this decision?
Communication Activity
CT20.4 Hank Jewell is a production manager at a metal fabricating plant. Last night, he read an article
about a new piece of equipment that would dramatically reduce his division’s costs. Hank was very
excited about the prospect, and the first thing he did this morning was to bring the article to his supervi-
sor, Preston Thiese, the plant manager. The following conversation occurred:
Hank: Preston, I thought you would like to see this article on the new PDD1130; they’ve made
some fantastic changes that could save us millions of dollars.
Preston: I appreciate your interest, Hank, but I actually have been aware of the new machine for two
months. The problem is that we just bought a new machine last year. We spent $2 million on
that machine, and it was supposed to last us 12 years. If we replace it now, we would have to
write its book value off of the books for a huge loss. If I go to top management now and say
that I want a new machine, they will fire me. I think we should use our existing machine for
a couple of years, and then when it becomes obvious that we have to have a new machine, I
will make the proposal.
Instructions
Hank just completed a course in managerial accounting, and he believes that Preston is making a big
mistake. Write a memo from Hank to Preston explaining Preston’s decision-making error.
Ethics Case
CT20.5 Blake Romney became Chief Executive Officer of Peters Inc. two years ago. At the time, the
company was reporting lagging profits, and Blake was brought in to “stir things up.” The company has
three divisions, electronics, fiber optics, and plumbing supplies. Blake has no interest in plumbing sup-
plies, and one of the first things he did was to put pressure on his accountants to reallocate some of the
company’s fixed costs away from the other two divisions to the plumbing division. This had the effect of
causing the plumbing division to report losses during the last two years; in the past it had always reported
low, but acceptable, net income. Blake felt that this reallocation would shine a favorable light on him
in front of the board of directors because it meant that the electronics and fiber optics divisions would
look like they were improving. Given that these are “businesses of the future,” he believed that the stock
market would react favorably to these increases, while not penalizing the poor results of the plumbing
division. Without this shift in the allocation of fixed costs, the profits of the electronics and fiber optics
divisions would not have improved. But now the board of directors has suggested that the plumbing
division be closed because it is reporting losses. This would mean that nearly 500 employees, many of
whom have worked for Peters their whole lives, would lose their jobs.
Instructions
a. If a division is reporting losses, does that necessarily mean that it should be closed?
b. Was the reallocation of fixed costs across divisions unethical?
c. What should Blake do?
All About You

CT20.6 Managerial accounting techniques can be used in a wide variety of settings. As we have fre-
quently pointed out, you can use them in many personal situations. They also can be useful in trying to
find solutions for societal issues that appear to be hard to solve.
Instructions
Read the Fortune article, “The Toughest Customers: How Hardheaded Business Metrics Can Help the
Hard-Core Homeless,” by Cait Murphy (do an Internet search on the title), and then answer the following
questions.
a. How does the article define “chronic” homelessness?
b. In what ways does homelessness cost a city money? What are the estimated costs of a chronic
homeless person to various cities?
Expand Your Critical Thinking 20-39
c. What are the steps suggested to address the problem?

d. What is the estimated cost of implementing this program in New York? What results have been seen?
e. In terms of incremental analysis, frame the relevant costs in this situation.
Considering Your Costs and Benefits

CT20.7 School costs money. Is this an expenditure that you should have avoided? A year of tuition at a
public four-year college costs about $8,655, and a year of tuition at a public two-year college costs about
$1,359. If you did not go to college, you might avoid mountains of school-related debt. In fact, each year,
about 600,000 students decide to drop out of school. Many of them never return. Suppose that you are
working two jobs and going to college, and that you are not making ends meet. Your grades are suffering
due to your lack of available study time. You feel depressed. Should you drop out of school?
YES: You can always go back to school. If your grades are bad and you are depressed, what good
is school doing you anyway?
NO: Once you drop out, it is very hard to get enough momentum to go back. Dropping out will
dramatically reduce your long-term opportunities. It is better to stay in school, even if you take only
one class per semester. While you cannot go back and redo your initial decision, you can look at
some facts to evaluate the wisdom of your decision.
Instructions
Write a response indicating your position regarding this situation. Provide support for your view.

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CHAPTER 20

companies in the world dominate the soap market (e.g., Proctor

LO 1 Describe management’s • Incremental analysis approach DO IT! 1 Incremental Analysis

LO 2 Analyze the relevant costs in • Special price DO IT! 2 Special Orders

LO 3 Analyze the relevant costs in a • Make-or-buy DO IT! 3 Make or Buy

LO 6 Analyze the relevant costs in • Unprofitable segments DO IT! 6 Unprofitable Segments

Decision-Making and Incremental Analysis

Making decisions is an important management function. Management’s decision-making

ILLUSTRATION 20.1 Management’s decision-making process

1. Identify the 2. Determine and evaluate 3. Make a decision 4. Review results

Accounting’s contribution to the decision-making process occurs primarily in Steps 2

Incremental Analysis Approach

How Incremental Analysis Works

ILLUSTRATION 20.2 Basic approach in incremental analysis

ILLUSTRATION 20.3 Key cost concepts in incremental analysis

r3FMFWBOUDPTUBOESFWFOVFT In incremental analysis, the only

Service Company Insight American Express

Relationship of Incremental Analysis

Types of Incremental Analysis

DO IT! 1 Incremental Analysis ACTION PLAN

LEAR NING OBJECTIVE 2

Sometimes a company has an opportunity to obtain additional business if it is willing to make

ILLUSTRATION 20.4 Incremental analysis—accepting an order at a special price

DO IT! 2 Special Orders ACTION PLAN

LEAR NING OBJECTIVE 3

When a manufacturer assembles component parts in producing a ﬁnished product, manage-

ILLUSTRATION 20.5 Direct materials $ 50,000

ILLUSTRATION 20.6 Incremental analysis—make or buy

ILLUSTRATION 20.7 Incremental analysis—make or buy, with opportunity cost

Service Company Insight Amazon.com

DO IT! 3 Make or Buy ACTION PLAN

Sell or Process Further

LEAR NING OBJECTIVE 4

furniture to stores either unﬁnished or ﬁnished. The sell-or-process-further decision should be

Direct materials $15 ILLUSTRATION 20.8

ILLUSTRATION 20.9 Incremental analysis—sell or process further

ILLUSTRATION 20.10 Joint production process—Creamery

Further Cottage Sell

ILLUSTRATION 20.11 Costs (per day)

Incremental Analysis - Sell or process further - Cream or cottage cheese

Costs (per day) ILLUSTRATION 20.13

Revenues from Products (per day)

Incremental Analysis - Sell or process further - Skim milk or condensed milk

DO IT! 4 Sell or Process Further ACTION PLAN

Repair, Retain, or Replace Equipment

LEAR NING OBJECTIVE 5

ILLUSTRATION 20.15 Incremental analysis—retain or replace equipment

Incremental Analysis - Retain or replace equipment

DO IT! 5 Repair or Replace Equipment ACTION PLAN

Eliminate Unprofitable Segment or Product

Management sometimes must decide whether to eliminate an unproﬁtable business segment

ILLUSTRATION 20.16 Pro Master Champ Total

ILLUSTRATION 20.17 Pro Master Total

Incremental Analysis - Eliminating an unprofitable segment

Incremental Analysis - Eliminating an unprofitable segment

DO IT! 6 Unprofitable Segments ACTION PLAN

Review and Practice

manufacturing costs, (b) the purchase price, and (c) opportunity

Management’s decision-making process consists of (a) identifying