644 Chapter 14 Decision Making: Relevant Costs and Benefits

Bo Vonderweidt, Sportway’s production manager, has come to the conclusion that the company
could make better use of its Plastics Department by manufacturing skateboards. Vonderweidt has a
market study that indicates an expanding market for skateboards and a need for additional suppliers.
Vonderweidt believes that Sportway could expect to sell 17,500 skateboards annually at a price of
$45.00 per skateboard.
After his lunch with the company president, Vonderweidt worked out the following estimates with
the assistant controller.

Selling price per skateboard ........................................................................................................ $45.00

Costs per skateboard:
Molded plastic ......................................................................................................................... $5.50
Wheels, hardware .................................................................................................................... 7.00
Direct labor ($15.00 per hour) ................................................................................................ 7.50
Manufacturing overhead ......................................................................................................... 5.00
Selling and administrative cost ............................................................................................... 9.00 34.00
Profit per skateboard ................................................................................................................... $11.00

In the Plastics Department, Sportway uses direct-labor hours as the application base for manufac-
turing overhead. Included in the manufacturing overhead for the current year is $50,000 of factorywide,
fixed manufacturing overhead that has been allocated to the Plastics Department. For each unit of prod-
uct that Sportway sells, regardless of whether the product has been purchased or is manufactured by
Sportway, there is an allocated $6.00 fixed overhead cost per unit for distribution that is included in the
selling and administrative cost for all products. Total selling and administrative costs for the purchased
tackle boxes would be $10.00 per unit.

Required: In order to maximize the company’s profitability, prepare an analysis that will show which
product or products Sportway Corporation should manufacture or purchase.
1. First determine which of Sportway’s options makes the best use of its scarce resources. How
many skateboards and tackle boxes should be manufactured? How many tackle boxes should be
purchased?
2. Calculate the improvement in Sportway’s total contribution margin if it adopts the optimal strategy
rather than continuing with the status quo.

(CMA, adapted)

 Case 14–63
Drop a Product Line Alberta Gauge Company, Ltd., a small manufacturing company in Calgary, Alberta, manufactures three
(LO 14-4, 14-5) types of electrical gauges used in a variety of machinery. For many years the company has been profit-
able and has operated at capacity. However, in the last two years, prices on all gauges were reduced and
Unit contribution, E-gauge: selling expenses increased to meet competition and keep the plant operating at capacity. Second-quarter
$19.00 results for the current year, which follow, typify recent experience.

ALBERTA GAUGE COMPANY, LTD.

Income Statement
Second Quarter
(in thousands)

Q-Gauge E-Gauge R-Gauge Total

Sales .................................................................................. $1,600 $900 $ 900 $3,400
Cost of goods sold ............................................................ 1,048 770  950 2,768
Gross margin ..................................................................... $ 552 $130 $  (50) $  632
Selling and administrative expenses ................................ 370 185  135 690
Income before taxes ......................................................... $ 182 $ (55) $(185) $  (58)

Alice Carlo, the company’s president, is concerned about the results of the pricing, selling, and pro-
duction prices. After reviewing the second-quarter results, she asked her management staff to consider
the following three suggestions:

ģ
Discontinue the R-gauge line immediately. R-gauges would not be returned to the product line
unless the problems with the gauge can be identified and resolved.

ģ
Increase quarterly sales promotion by $100,000 on the Q-gauge product line in order to increase
sales volume by 15 percent.
 Chapter 14 Decision Making: Relevant Costs and Benefits 645

ģ
Cut production on the E-gauge line by 50 percent, and cut the traceable advertising and promotion
for this line to $20,000 each quarter.
Jason Sperry, the controller, suggested a more careful study of the financial relationships to deter-
mine the possible effects on the company’s operating results of the president’s proposed course of
action. The president agreed and assigned JoAnn Brower, the assistant controller, to prepare an analysis.
Brower has gathered the following information.

ģ
All three gauges are manufactured with common equipment and facilities.

ģ
The selling and administrative expense is allocated to the three gauge lines based on average sales
volume over the past three years.

ģ
Special selling expenses (primarily advertising, promotion, and shipping) are incurred for each
gauge as follows:

Quarterly Advertising
and Promotion Shipping Expenses
Q-gauge .................................................... $210,000 $10 per unit
E-gauge ....................................................   100,000     4 per unit
R-gauge ....................................................     40,000 10 per unit

ģ
The unit manufacturing costs for the three products are as follows:

Q-Gauge E-Gauge R-Gauge

Direct material ................................................................................ $ 31 $17 $  50
Direct labor ..................................................................................... 40 20 60
Variable manufacturing overhead ................................................. 45 30 60
Fixed manufacturing overhead ......................................................  15 10  20
Total ................................................................................................ $131 $77 $190

ģ
The unit sales prices for the three products are as follows:

Q-gauge .......................................................................................................... $200

E-gauge .......................................................................................................... 90
R-gauge .......................................................................................................... 180

ģ
The company is manufacturing at capacity and is selling all the gauges it produces.

Required:
1. JoAnn Brower says that Alberta Gauge Company’s product-line income statement for the second
quarter is not suitable for analyzing proposals and making decisions such as the ones suggested by
Alice Carlo. Write a memo to Alberta Gauge’s president that addresses the following points.
a. Explain why the product-line income statement as presented is not suitable for analysis and
decision making.
b. Describe an alternative income-statement format that would be more suitable for analysis and
decision making, and explain why it is better.
2. Use the operating data presented for Alberta Gauge Company and assume that the president’s pro-
posed course of action had been implemented at the beginning of the second quarter. Then evalu-
ate the president’s proposal by specifically responding to the following points.
a. Are each of the three suggestions cost-effective? Support your discussion with an analysis that
shows the net impact on income before taxes for each of the three suggestions.
b. Was the president correct in proposing that the R-gauge line be eliminated? Explain your answer.
c. Was the president correct in promoting the Q-gauge line rather than the E-gauge line? Explain
your answer.
d. Does the proposed course of action make effective use of the company’s capacity? Explain
your answer.
3. Are there any qualitative factors that Alberta Gauge Company’s management should consider
before it drops the R-gauge line? Explain your answer.

(CMA, adapted)