CHAPTER 7

Incremental Analysis

EXERCISE 7-2

(a) Net Income

Reject Accept Increase (Decrease)
Order Order
Revenues ($4.80) $ –0– $24,000 $24,000
Materials ($0.50)  –0–   (2,500) (2,500)
Labor ($1.50)  –0–   (7,500) (7,500)
Variable overhead ($1.00)  –0–   (5,000) (5,000)
Fixed overhead  –0–   (6,000) (6,000)
Sales commissions   –0–   –0–   –0–
Net income $ –0– $ 3,000 $ 3,000
(b) As shown in the incremental analysis, Gruden should accept the special order
because incremental revenue exceeds incremental expenses by $3,000.
(c) It is assumed that sales of the golf discs in other markets would not be affected
by this special order. If other sales were affected, Gruden would have to consider
the lost sales in making the decision. Second, if Gruden is operating at full
capacity, it is likely that the special order would be rejected.

EXERCISE 7-3

(a) Net Income

Reject Accept Increase
Order Order (Decrease)
Revenues (15,000 X $7.60) $0 $114,000 ($114,000)
Cost of goods sold  0   78,000 (1) (  (78,000)
Operating expenses  0   30,000 (2) (  (30,000)
Net income $0 $  6,000 ($  6,000)

(1) Variable cost of goods sold = $2,600,000 X 70% = $1,820,000.

Variable cost of goods sold per unit = $1,820,000 ÷ 350,000 = $5.20
Variable cost of goods sold for the special order = $5.20 X 15,000
= $78,000.
 (2) Variable operating expenses = $840,000 X 75% = $630,000
$630,000 ÷ 350,000 = $1.80 per unit
15,000 X $1.80 = $27,000
$27,000 + $3,000 = $30,000

(b) As shown in the incremental analysis, Leno Company should accept

the special order because incremental revenues exceed incremental expenses by
$6,000.

EXERCISE 7-4

Net Income
Reject Accept Increase
Order Order (Decrease)
Revenues $0 $1,187,500 (1) $1,187,500
Variable costs:
Direct materials 0 500,000 (500,000)
Direct labor 0 187,500 (187,500)
Variable overhead 0 250,000 (250,000)
Total variable costs 0 937,500 (937,500)
Net income $0 $ 250,000 $ 250,000
(1) [($2.00 + $0.75 + $1.00 + $1.00) X 250,000]

Klean Fiber should accept the Army’s offer since it would increase net income by
$250,000.

EXERCISE 7-5

(a) Net Income

Increase
Make Buy (Decrease)
Direct materials (30,000 X $4.00) $120,000 $      0 $ 120,000
Direct labor (30,000 X $5.00)  150,000        0 150,000
Variable overhead costs
  ($150,000 X 70%)  105,000        0 105,000
Fixed manufacturing costs   45,000   45,000        0
Purchase price (30,000 X $12.75)        0  382,500 ( (382,500)
Total annual cost $420,000 $427,500 ($ (7,500)
(b) No, Schopp Inc. should not purchase the shades. As indicated by the
incremental analysis, it would cost the company $7,500 more to purchase the
lamp shades.

(c) Yes, by purchasing the lamp shades, a total cost saving of $17,500 will result as
shown below.
Net Income
Increase
Make Buy (Decrease)
Total annual cost (above) $420,000 $427,500 $ (7,500)
Opportunity cost   25,000        0  (25,000)
Total cost $445,000 $427,500 $(17,500)

EXERCISE 7-6

(a) 1.
Net Income
Increase
Make Buy (Decrease)
Direct materials $1,000,000 $ –0– $ 1,000,000
Direct labor 800,000 –0– 800,000
Variable overhead 120,000 –0– 120,000
Fixed overhead 600,000 195,000 405,000
Purchase price 0 2,300,000 (2,300,000)
Total annual cost $2,520,000 $2,495,000 $ 25,000

Yes. The offer should be accepted as net income will increase by $25,000.

EXERCISE 7-6 (Continued)

2.
Net Income
Increase
Make Buy (Decrease)
Direct materials $1,000,000 $ 0 $ 1,000,000
Direct labor 800,000 0 800,000
Variable overhead 120,000 0 120,000
Fixed overhead 600,000 600,000 0
Opportunity cost 405,000 0 405,000
Purchase price 0 2,300,000 (2,300,000)
Totals $2,925,000 $2,900,000 $ 25,000
Yes. The offer should be accepted as net income would be $25,000 more.

(b) Qualitative factors include the possibility of laying off those employees that
produced the robot and the resulting poor morale of the remaining employees,
maintaining quality standards, and controlling the purchase price in the future.

EXERCISE 7-7

(a) Net Income

Increase
Make Sails Buy Sails (Decrease)
Direct materials $100 $ 0 $ 100
Direct labor 80 0 80
Variable overhead 35 0 35
Purchase price 0 250 (250)
Total unit cost $215 $250 $ (35)

Gibbs should be making the sails, because they could save $35 per unit or
$42,000. The president was including the fixed overhead cost in the
calculation. Variable overhead = Total overhead ($100) – Fixed overhead
($78,000 ÷ 1,200) = $35. This amount has been allocated, so Gibbs will incur
the cost whether or not they make the sails. This is an example of an irrelevant
cost, because it does not differ between the two alternatives.

EXERCISE 7-7 (Continued)

(b) The best decision would be to rent out the space as shown below. The
differential savings would be $77,000 – $42,000 = $35,000.

Net Income
Per Make
Increase
(Based on 1,200 units) Unit Sails Buy Sails (Decrease)
Manufacturing cost $215 $258,000 $ 0 $ 258,000
Purchase price $250 0 300,000 (300,000)
Opportunity cost 77,000 0 77,000
Total annual cost $335,000 $300,000 $ 35,000

(c) Qualitative factors to consider would be (1) whether Gibbs will be able to
exercise control over the future price of the product (2) whether Gibbs will be
 able to exercise control over the quality of the product and
(3) the potential for interruptions in the supply of the product.

EXERCISE 7-8

(a) Net Income

Increase
Make IMC2 Buy IMC2 (Decrease)
Direct materials $ 65.00 $ 0 $ 65.00
Direct labor 45.00 0 45.00
Material handling 6.50 0 6.50
Variable overhead 72.00* 0 72.00
Purchase price 0 200.00 (200.00)
Total unit cost $188.50 $200.00 $ (11.50)

*Variable overhead = 60% X ($126.50 – 6.50)

The unit should not be purchased from the outside vendor, as

the per unit cost would be $11.50 greater than if they made
it.

EXERCISE 7-8 (Continued)

(b) In order for Innova to make an accurate decision, they would

have to know the opportunity cost of manufacturing the other
product. As determined in (a), purchasing the product from
outside would cost $11,500 more (1,000 X $11.50). Innova
would have to increase their contribution margin by more
than $11,500 through the manufacture of the other product,
before it would be economical for them to purchase the
IMC2 from the outside vendor.

(c) Qualitative factors to consider would be (1) quality of the

component (2) on-time delivery, and (3) reliability of the
vendor.
EXERCISE 7-9

Net Income
Sell Process Further Increase
(Basic Kit) (Stage 2 Kit) (Decrease)
Sales per unit $30 ( )$35( ) $(5)
Costs per unit
Direct materials $14 ( ) $ 7 (1) $(7)
Direct labor   0 ( )   9 (2) (9)
Total $14 ( ) $16 ( ) $(2)

Net income per unit $16 ( ) $19 ( ) $(3)

(1) The cost of materials decreases because Rachel can make two Stage
2 Kits from the materials for a basic kit.

(2) The total time to make the two kits is one hour at $18 per hour or
$9 per unit.

EXERCISE 7-9 (Continued)

Rachel should carry the Stage 2 Kits. The incremental revenue, $5, exceeds the
incremental processing costs, $2. Thus, net income will increase by processing the
kits further.

EXERCISE 7-10

(a) Sales ($60,000 + $15,000 + $55,000) $ 130,000

Joint costs (100,000)
Net income $ 30,000

(b) Sales ($190,000 + $35,000 + $215,000) $ 440,000

Joint costs (100,000)
Additional costs ($100,000 + $30,000 + $150,000)  (280,000)
Net income $ 60,000

(c)
Product 10 Product 12 Product 14
 Incremental revenue(1) $ 130,000 $ 20,000 $ 160,000
Incremental costs (100,000) (30,000) (150,000)
Incremental profit (loss) $ 30,000 $(10,000) $ 10,000
(1)
Sales value after further processing – Sales value @ split-off point

Products 10 and 14 should be processed further and product 12 should be sold at the
split-off point.

(d) Sales ($190,000 + $15,000 + $215,000) $ 420,000

Joint costs (100,000)
Additional costs ($100,000 + $150,000) (250,000)
Net income $ 70,000

Net income is $10,000 ($70,000 – $60,000) higher in (d) than in (b) because product
12 is not processed further, thereby increasing overall profit $10,000.

EXERCISE 7-11

To determine whether each of the three joint products should be sold as is, or
processed further, we must determine the incremental profit or loss that would be
earned by each. The allocated joint costs are irrelevant to the decision since these
costs will not change whether or not the products are sold as is or processed further.
Larco Marco Narco
Incremental revenue $100,000* $100,000** $395,000**
Incremental cost (110,000)   (85,000) (250,000*
Incremental profit (loss) $ (10,000) $ 15,000 $145,000)
From this analysis we see that Marco and Narco should be processed further because
the incremental revenue exceeds the incremental costs, but Larco should be sold as
is.
*$300,000 – $200,000    **$400,000 – $300,000    ***$800,000 – $405,000

EXERCISE 7-12

(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— $60,000 (4,000 units X $15.00 per unit)
Product E— $97,200 (6,000 units X $16.20 per unit)
Product F— $45,200 (2,000 units X $22.60 per unit)
Revenue at split-off:
Product D— $40,000 (4,000 units X $10.00 per unit)
Product E— $69,600 (6,000 units X $11.60 per unit)
Product F— $38,800 (2,000 units X $19.40 per unit)

D E F
Incremental revenue $20,000 $27,600 $ 6,400
Incremental cost (14,000) (20,000) (9,000)
Increase (decrease) in profit$ 6,000 $ 7,600 $(2,600)
Products D and E should 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.

EXERCISE 7-13

(a) Cost $100,000

Accumulated depreciation (25,000*)
Book value 75,000
Sales proceeds 40,000
Loss on sale $ 35,000

*One year’ s depreciation: ($100,000 – $0) ÷ 4 years

(b)
Net Income
Retain Replace Increase
Scanner Scanner (Decrease)
Annual operating costs $315,000* $225,000** $ 90,000
New scanner cost 110,000 (110,000)
Old scanner salvage (40,000) 40,000
Total $315,000 $295,000 $ 20,000

*(3 years X $105,000)

**[3 years X ($105,000 – $30,000)]

Yes. Benson Hospital should replace the old scanner because it will result in a
savings of $20,000 over the next four years.
(c) As shown in (a) above, replacing the old scanner will result in reporting a loss
of $35,000. Reluctance to report losses of this nature is the usual reason for not
recognizing that a poor decision was made in the past. The remaining book
value of the old scanner ($75,000) is a sunk cost. It will be deducted in the
future, if the scanner is retained, or written off now if it is replaced. However,
if it is replaced now, that cost will be partially offset by the salvage value that
Dyno is willing to pay ($40,000).

EXERCISE 7-14

Net Income
Retain Replace Increase
Machine Machine (Decrease)
Operating costs $125,000 (1) ($100,000) (2) ($ 25,000
New machine cost        0 (  25,000) ( (25,000)
Salvage value (old)        0 (   (6,000) (   6,000
Total $125,000 ($119,000) ($ 6,000

(1) $25,000 X 5.
(2) $20,000 X 5.

The current machine should be replaced. The incremental analysis shows that net
income for the five-year period will be $6,000 higher by replacing the current machine.

EXERCISE 7-15
Net Income
Increase
Continue Eliminate (Decrease)
Sales $100,000) $(     0) $(100,000)
Variable costs
Cost of goods sold  ( 61,000)  (     0)   (61,000)
Operating expenses   (26,000)  (     0)   (26,000)
Total variable   (87,000)  (     0)   (87,000)
Contribution margin   (13,000)  (     0)   (13,000)
Fixed costs
Cost of goods sold   (15,000)  (15,000)    (     0)
Operating expenses   (24,000)  (24,000)    (     0)
Total fixed   (39,000)  (39,000)    (     0)
Net income (loss) $(26,000) $(39,000) $ (13,000)
Judy is incorrect. The incremental analysis shows that net income will be $13,000
less if the Huron Division is eliminated. This amount equals the contribution margin
that would be lost through discontinuing the division.

(Note: None of the fixed costs can be avoided.)

EXERCISE 7-16

(a) $30,000 + $70,000 – $40,000 = $60,000

(b) Tingler Shocker Total

Sales $300,000 $500,000 $800,000
Variable expenses 150,000 200,000 350,000
Contribution margin 150,000 300,000 450,000
Fixed expenses 142,500* 267,500** 410,000
Net income $ 7,500 $ 32,500 $ 40,000
*$30,000 + [($300,000 ÷ $800,000) X $300,000]
**$80,000 + [($500,000 ÷ $800,000) X $300,000]
(c) As shown in the analysis above, Cawley should not eliminate the Stunner
product line. Elimination of the line would cause net income to drop from
$60,000 to $40,000. The reason for this decrease in net income is that
elimination of the product line would result in the loss of $55,000 of
contribution margin while saving only $35,000 of fixed expenses.

EXERCISE 7-17

Calculation of contribution margin per unit:

C D E
Selling price per unit $95 $75 $115
Less: variable costs/unit 50 40 40
Contribution margin/unit $45 $35 $ 75

Fixed costs = $22 X (9,000 + 20,000) = $638,000

Company profit with Products C and D:

C D Total
Units sold 9,000 20,000
Sales revenue $855,000 $1,500,000 $2,355,000
Less: Variable costs 450,000 800,000 $1,250,000
Contribution margin $405,000 $ 700,000 1,105,000
Less: Fixed costs 638,000
Net income $ 467,000

EXERCISE 7-17 (Continued)

Company profit with Products C and E:

C E Total
Units sold 9,900* 10,000

Sales revenue $940,500 $1,150,000 $2,090,500

Less: Variable costs 495,000 400,000 895,000
Contribution margin $445,500 $ 750,000 1,195,500
Less: Fixed costs 638,000
Net income $ 557,500

*Product C sales increase by 10%, (9,000 X 110%)

Yes they should introduce Product E since net profit would

increase by $90,500 ($557,500 – $467,000).
 SOLUTIONS TO PROBLEMS

PROBLEM 7-1A

(a) Net Income

Reject Accept Increase
Order Order (Decrease)
Revenues (10,000 X $27) $0 $270,000 $ 270,000
Cost of goods sold  0  220,000 (1) ( (220,000)
Selling and administrative
  expenses  0   20,000 (2) (  (20,000)
Net income $0 $ 30,000 $  30,000

(1) Variable costs = $3,600,000 – $960,000 = $2,640,000;

$2,640,000 ÷ 120,000 units = $22.00 per unit;
10,000 X $22.00 = $220,000.

(2) Variable costs = $405,000 – $225,000 = $180,000;

$180,000 ÷ 120,000 units = $1.50 per unit;
10,000 X ($1.50 + $0.50) = $20,000.

(b) Yes, the special order should be accepted because net income will increase by
$30,000.

(c) Unit selling price = $22.00 (variable manufacturing costs) + $2.00 variable selling
and administrative expenses + $4.00 net income = $28.

(d) Nonfinancial factors to be considered are: (1) possible effect on domestic sales, (2)
possible alternative uses of the unused plant capacity, and (3) ability to meet
customer’ s schedule for delivery without increasing costs.
 PROBLEM 7-2A

(a) Net Income

Increase
Make CISCO Buy CISCO (Decrease)
Direct materials
(8,000 X $4.80) $38,400 $     0 ($38,400)
Direct labor
(8,000 X $4.30)  34,400       0 ( 34,400)
Indirect labor
(8,000 X $.43)   3,440       0 (  3,440)
Utilities (8,000 X $.40)   3,200       0 (  3,200)
Depreciation   3,000     900 (  2,100)
Property taxes     700     200 (    500)
Insurance   1,500     600 (    900)
Purchase price       0  80,000 ( (80,000)
Freight and inspection
(8,000 X $.35)       0   2,800 (  (2,800)
Receiving costs       0   1,300 (  (1,300)
Total annual cost $84,640 $85,800 ($ (1,160)

(b) The company should continue to make CISCO because net income would be
$1,160 less if CISCO were purchased from the supplier.

(c) The decision would be different. Because of the opportunity cost of $3,000, net
income will be $1,840 higher if CISCO is purchased as shown below:
Net Income
Increase
Make CISCO Buy CISCO (Decrease)
Total annual cost $84,640 $85,800 $(1,160)
Opportunity cost   3,000       0  (3,000)
Total cost $87,640 $85,800 $(1,840)

(d) Nonfinancial factors include: (1) the adverse effect on employees if CISCO is
purchased, (2) how long the supplier will be able to satisfy
the Shatner Manufacturing Company’s quality control standards at the quoted
price per unit, and (3) whether the supplier will deliver the units when they are
needed by Shatner.
PROBLEM 7-3A
(a) (1) Table Cleaner Not Processed Further

Sales:
FloorShine (600,000 ÷ 30) X $20 $400,000
Table Cleaner (300,000 ÷ 25) X $18 216,000
Total revenue $616,000
Costs:
CDG 210,000
Additional costs of FloorShine 240,000
Total costs 450,000
Gross profit $166,000

(2) Table Cleaner Processed Further

Sales:
FloorShine $400,000
Table Stain Remover (300,000 ÷ 25) X $14 168,000
Table Polish (300,000 ÷ 25) X $14 168,000
Total revenue $736,000
Costs:
CDG 210,000
Additional costs of FloorShine 240,000
TCP 100,000
Total costs 550,000
Gross profit $186,000

(3) If the table cleaner is processed further overall company profits will be
$20,000 higher. Therefore, management made the wrong decision by choosing
to not process table cleaner further.
 PROBLEM 7-3A (Continued)

(b) Don’ t Process Process Net Income

Table Cleaner Table Cleaner Increase
Further Further (Decrease)
Incremental revenue $216,000 $336,000 $120,000
Incremental costs 0 100,000 (100,000)
Totals $216,000 $236,000 $ 20,000

When trying to decide if the table cleaner should be processed further into TSR and
TP, only the relevant data need be considered. All of the costs that occurred prior to
the creation of the table cleaner are sunk costs and can be ignored. The decision
should be made by comparing the incremental revenue from further processing to
the incremental costs.

PROBLEM 7-4A

(a) Cost $120,000

Accumulated depreciation (24,000*)
Book value 96,000
Sales proceeds (25,000)
Loss on sale $ 71,000
*$120,000 ÷ 5 years = $24,000

(b) (1) Retain Old Elevator

Revenues ($240,000 X 4 yrs.) $960,000
Less costs:
Variable costs ($35,000 X 4) $140,000
Fixed costs ($23,000 X 4) 92,000
Selling & administrative 116,000*
Depreciation 96,000 444,000
Net income $516,000
*($29,000 X 4)

(2) Replace Old Elevator

Revenues $960,000
Less costs:
Variable costs ($10,000 X 4) $ 40,000
Fixed costs ($8,500 X 4) 34,000
Selling and administrative 116,000
 Depreciation 160,000 350,000
Operating income 610,000
Less: Loss on old elevator 71,000
Net income $539,000

(c) Net Income

Retain Replace Increase
Old Elevator Old Elevator (Decrease)
Variable operating costs $140,000 $ 40,000 $ 100,000
Fixed operating costs 92,000 34,000 58,000
New elevator cost 160,000 (160,000)
Salvage on old elevator . (25,000) 25,000
Totals $232,000 $209,000 $ 23,000

PROBLEM 7-4A (Continued)

(d) MEMO

TO: Ron Richter

FROM: Student

SUBJECT: Relevant Data for Decision to Replace Old Elevator

When deciding whether or not to replace any old equipment, the analysis should
only include cost data relevant to the replacement decision. The $71,000 loss that
would be experienced if we replace the old elevator with the newer model is related
to a sunk cost, namely the cost of the old elevator. Sunk costs are irrelevant in
decision making.

The loss occurs when comparing the book value of the old elevator to the cash
proceeds that would be received. The book value of $96,000 would be deducted as
depreciation expense over the next four years if the elevator were retained. If the
elevator is replaced with the newer model, the book value will be expensed in the
current year, less the cash proceeds received on disposal. Therefore, the $96,000
book value will be expensed under either alternative, making it irrelevant.
 PROBLEM 7-5A

(a) Division I Division II

Sales $250,000 $200,000
Variable costs
Cost of goods sold  150,000  172,800
Selling and administrative   30,000   42,000
Total variable expenses  180,000  214,800
Contribution margin ($ 70,000) $ (14,800)

(b) (1) Net Income

Increase
Division I Continue Eliminate (Decrease)
Contribution margin (above) $(70,000) $(     0) $(70,000)
Fixed costs
Cost of goods sold  (50,000)  (25,000)   25,000
Selling and administrative  (45,000)  (22,500)   22,500
Total fixed expenses  (95,000)  (47,500)   47,500
Income (loss) from operations $(25,000) $(47,500) $(22,500)

(2) Net Income

Increase
Division II Continue Eliminate (Decrease)
Contribution margin (above) $(14,800) $(     0) $14,800
Fixed costs
Cost of goods sold (19,200  ( 9,600)  ( 9,600
Selling and administrative ( 18,000  ( 9,000)   9,000
Total fixed expenses ( 37,200  (18,600) 18,600
Income (loss) from operations $(52,000) $(18,600) $33,400

Division II should be eliminated as its negative contribution margin is $14,800.

Income from operations would increase $33,400 if Division II is eliminated.

Division I should be continued because it is producing positive contribution

margin of $70,000. Income from operations will decrease $22,500 by
discontinuing this division.
PROBLEM 7-5A (Continued)

(c) GUTIERREZ COMPANY

CVP Income Statement
For the Quarter Ended March 31, 2014

Divisions
I III IV Total
Sales $250,000 $500,000 $450,000 $1,200,000
Variable costs
Cost of goods sold  150,000  240,000  187,500    577,500
Selling and
  administrative   30,000   30,000   30,000     90,000
Total variable
  costs  180,000  270,000  217,500    667,500
Contribution margin   70,000  230,000  232,500    532,500
Fixed costs
Cost of goods sold (1)   53,200   63,200   65,700    182,100
Selling and
  administrative (2)   48,000   33,000   23,000    104,000
Total fixed
  costs  101,200   96,200   88,700    286,100
Income (loss) from
  operations $(31,200) $133,800 $143,800 $  246,400

(1) Division’s fixed cost of goods sold plus 1/3 of Division II’s unavoidable
fixed cost of goods sold [$192,000 X (100% – 90%) X 50% = $9,600].
Each division’s share is $3,200.

(2) Division’ s fixed selling and administrative expense plus 1/3 of Division II ’s
unavoidable fixed selling and administrative expenses [$60,000 X (100% –
70%) X 50% = $9,000]. Each division’s share
is $3,000.

(d) Income from operations with Division II of $213,000 (given) plus

incremental income of $33,400 from eliminating Division II = $246,400 income
from operations without Division II.
 PROBLEM 7-1B

(a) Net Income

Reject Accept Increase
Order Order (Decrease)
Revenues (10,000 X $30) $0 $300,000 $ 300,000
Cost of goods sold  0  240,000 (1) ( (240,000)
Selling and administrative
  expenses  0   25,000 (2) (  (25,000)
Net income $0 $ 35,000 $  35,000

(1) Variable costs = $3,060,000 – $900,000 = $2,160,000;

$2,160,000 ÷ 90,000 units = $24 per unit;
10,000 X $24 = $240,000.

(2) Variable costs = $360,000 – $180,000 = $180,000;

$180,000 ÷ 90,000 units = $2.00 per unit;
10,000 X ($2.00 + $0.50) = $25,000.

(b) Yes, the special order should be accepted because net income will be increased
by $35,000.

(c) Unit selling price = $24 (variable manufacturing costs) + $2.50 (variable selling
and administrative expenses) + $5.50 (net income) = $32.00.

(d) Nonquantitative factors to be considered are: (1) possible effect on

domestic sales, (2) possible alternative uses of the unused plant
capacity, and (3) ability to meet customer’s schedule for delivery without
increasing costs.
 PROBLEM 7-2B

(a) Net Income

Increase
Make FIZBE Buy FIZBE (Decrease)
Direct materials (5,000 X $4.75) $23,750 $ 0 ($ 23,750
Direct labor (5,000 X $4.60)  23,000 0 ( 23,000
Indirect labor (5,000 X $.45)   2,250 0 (  2,250
Utilities (5,000 X $.35)   1,750 0 (  1,750
Depreciation   2,000 900 (  1,100
Property taxes     700 200 (    500
Insurance   1,500 600 (    900
Purchase price       0 56,000 ( (56,000)
Freight and inspection (
(5,000 X $.30)       0 1,500   (1,500)
Receiving costs 0 500 (500)
Total annual cost $54,950 $59,700 ($  (4,750)

(b) The company should continue to make FIZBE because net income would be
$4,750 less if FIZBE were purchased from the supplier.

(c) The decision would be different. Because of the opportunity cost of $6,000, net
income will be $1,250 higher if FIZBE is purchased as shown below:

Net Income
Increase
Make FIZBE Buy FIZBE (Decrease)
Total annual cost $54,950 $59,700 $(4,750)
Opportunity cost 6,000 0  6,000
Total cost $60,950 $59,700 $ 1,250

(d) Nonfinancial factors include: (1) the adverse effect on employees

if FIZBE is purchased, (2) how long the supplier will be able to satisfy the Gill
Corporation’s quality control standards at the quoted price per unit, and (3) will
the supplier deliver the units when they are needed
by Gill?
 PROBLEM 7-3B

(a) (1) General-Purpose Cleaner Not Processed Further

Sales
ShineBrite (750,000 ÷ 25) X $15 $450,000
General-Purpose Cleaner (250,000 ÷ 20) X $20 250,000
Total revenue $700,000
Costs
NPR 200,000
Additional costs for ShineBrite 300,000
Total costs 500,000
Gross profit $200,000

(2) General-Purpose is Processed Further

Sales
ShineBrite (750,000 ÷ 25) X $15 $450,000
Premium Cleaner (250,000 ÷ 20) X $16 200,000
Premium Stain Remover (250,000 ÷ 20) X $16 200,000
Total revenue $850,000
Costs
NPR 200,000
Additional costs for ShineBrite 300,000
PST 140,000
Total costs 640,000
Gross profit $210,000

(3) If the general-purpose cleaner is processed further overall company profits

will be $10,000 higher. Therefore, management made the wrong decision by
choosing to not process the general-purpose cleaner further.
PROBLEM 7-3B (Continued)

(b) Don’ t Process Process Net Income

G-P Cleaner G-P Cleaner Increase
Further Further (Decrease)
Incremental revenue $250,000 $400,000 $150,000
Incremental costs 0 140,000 (140,000)
Totals $250,000 $260,000 $ 10,000

When trying to decide if the general-purpose cleaner should be processed further

into PC and PSR, only the relevant data need be considered. All of the costs that
occurred prior to the creation of the general-purpose cleaner are sunk costs and can
be ignored. The decision should be made by comparing the incremental revenue
from further processing to the incremental costs.

PROBLEM 7-4B

(a) Cost $210,000

Accumulated depreciation (42,000*)
Book value 168,000
Sales proceeds (58,000)
Loss on sale $110,000
*$210,000 ÷ 5 years = $42,000

(b) (1) Retain Old Equipment

Revenues ($360,000 X 4 yrs.) $1,440,000
Less costs:
Variable costs $200,000
Fixed costs 120,000
Selling & administrative 180,000
Depreciation 168,000 668,000
Net income $ 772,000

(2) Replace Old Equipment

Revenues $1,440,000
Less costs:
Variable costs $ 48,000
Fixed costs 20,000
 Selling and administrative 180,000
Depreciation 250,000 498,000
Operating income 942,000
Less: Loss on old equipment 110,000
Net income $ 832,000

(c) Net Income

Retain Old Replace Old Increase
Equipment Equipment (Decrease)
Variable costs $200,000 $ 48,000 $152,000
Fixed costs 120,000 20,000 100,000
New equipment cost 250,000 (250,000)
Salvage on old equipment . (58,000) 58,000
Totals $320,000 $260,000 $ 60,000

PROBLEM 7-4B (Continued)

(d) MEMO

TO: Gene Simmons

FROM: Student

SUBJECT: Relevant Data for Decision to Replace Old Equipment

When deciding whether or not to replace any old equipment, the analysis should
only include cost data relevant to the replacement decision. The $110,000 loss that
would be experienced if we replace the old equipment with the newer equipment is
related to a sunk cost, namely the cost of the old equipment. Sunk costs are
irrelevant in decision making.

The loss occurs when comparing the book value of the old equipment to the cash
proceeds that would be received. The book value of $168,000 would be deducted as
depreciation expense over the next four years if the equipment were retained. If the
equipment is replaced with the newer model the book value will be expensed in the
current year, less the cash proceeds received on disposal. Therefore, the $168,000
book value will be expensed under either alternative, making it irrelevant.
 PROBLEM 7-5B

(a) Division Division

III IV
Sales $310,000 $170,000
Variable expenses
Cost of goods sold  189,000  140,400
Selling and administrative 45,000 49,000
Total variable expenses 234,000 189,400
Contribution margin $ 76,000 ($ (19,400)

(b) (1) Net Income

Increase
Division III Continue Eliminate (Decrease)
Contribution margin (above) $ 76,000 $ 0 $(76,000)
Fixed expenses
Cost of goods sold 81,000  (40,500 40,500
Selling and administrative 30,000 15,000 15,000
Total fixed expenses 111,000 55,500 55,500
Income (loss) from operations ($(35,000) $(55,500) $(20,500)

(2) Net Income

Increase
Division IV Continue Eliminate (Decrease)
Contribution margin (above) $(19,400) $ 0 $19,400
Fixed expenses
Cost of goods sold  (15,600)  7,800   7,800
Selling and administrative 21,000) 10,500 10,500
Total fixed expenses 36,600) 18,300 18,300
Income (loss) from operations $(56,000) $(18,300) $37,700

Division III should be continued as contribution margin ($76,000) is greater

than the savings in fixed costs ($55,500) that would result from elimination.
Therefore, income from operations would decrease $20,500 if Division III is
eliminated.
Division IV should be eliminated because it is producing negative contribution
margin ($19,400). Income from operations will increase $37,700 by discontinuing
this division.
PROBLEM 7-5B (Continued)

(c) PANDA COMPANY

CVP Income Statement
For the Quarter Ended March 31, 2014

Divisions
I II III Total
Sales $510,000 $400,000 $310,000 $1,220,000
Variable expenses
Cost of goods sold  210,000  200,000  189,000    599,000
Selling and
  administrative 24,000 40,000 45,000 109,000
Total variable
  expenses 234,000 240,000 234,000 708,000
Contribution margin 276,000 160,000 76,000 512,000
Fixed expenses
Cost of goods sold (1)   92,600   52,600   83,600    228,800
Selling and
  administrative (2) 39,500 43,500 33,500 116,500
Total fixed 117,
  expenses 132,100 96,100 100 345,300
Income (loss) from operations $143,900 $ 63,900 $ (41,100) $ 166,700

(1) Division’s fixed cost of goods sold plus 1/3 of Division IV’s unavoidable fixed
cost of goods sold [$156,000 X (100% – 90%) X 50% = $7,800]. Each
division’ s share is $2,600.

(2) Division’ s fixed selling and administrative expenses plus 1/3 of Division
IV’s unavoidable fixed selling and administrative expenses [$70,000 X (100%
– 70%) X 50% = $10,500]. Each division’s share
is $3,500.

(d) Income from operations with Division IV of $129,000 (given) plus incremental
income of $37,700 from eliminating Division IV = $166,700 income from
operations without Division IV.