Chapter 13

Decision-Making and

Relevant Information

DIFFERENTIAL COSTS AND REVENUES

Bill is currently employed as a lifeguard, but he has been offered a job in an auto service center in the same town. The

differential revenues and costs between the two jobs are listed below:

Life-

guard

Auto

Service

Center

Differential costs

and revenues

Monthly salary $1,200 $1,500 $300 

Monthly expenses:

Commuting 30 90 60 

Meals 150 150 0 

Apartment rent 450 450 0 

Uniform rental 0 50 50 

Union dues      10        0  (10)

Total monthly expenses    640    740  100 

Net monthly income $  560 $  760 $200 

Identifying Relevant Costs

7 Reduction in resale value of car per mile of wear 0.026$ 8 Round-trip train fare 104$ 9 Cost of hotel in New York 200$

10 Cost of putting dog in kennel while gone 40$ 11 Benefit of having car in New York ????12 Hassle of parking car in New York ????13 Per day cost of parking car in New York 25$

Some Additional Information

Annual Cost of Fixed Items

Cost per Mile

1 Annual straight-line depreciation on car 2,800$ 0.280$ 2 Cost of gasoline 0.050 3 Annual cost of auto insurance and license 1,380 0.138 4 Maintenance and repairs 0.065 5 Parking fees at school 360 0.036 6 Total average cost 0.569$

Automobile Costs (based on 10,000 miles driven per year)

Total and Differential Cost Approaches

The management of a company is considering a new labor saving machine that rents for $3,000 per year. Data about the company’s

annual sales and costs with and without the new machine are:

Current Situation

Situation With New Machine

Differential Costs and Benefits

Sales (5,000 units @ $40 per unit) 200,000$ 200,000$ - Less variable expenses: Direct materials (5,000 units @ $14 per unit) 70,000 70,000 - Direct labor (5,000 units @ $8 and $5 per unit) 40,000 25,000 15,000 Variable overhead (5,000 units @ $2 per unit) 10,000 10,000 - Total variable expenses 120,000 105,000 - Contribution margin 80,000 95,000 15,000 Less fixed expense: Other 62,000 62,000 - Rent on new machine - 3,000 (3,000) Total fixed expenses 62,000 65,000 (3,000) Net operating income 18,000$ 30,000$ 12,000

Add or Drop a Product LineDiscount Drug Company has three major product lines. What can be done to improve the company’s overall performance?

Product Line Total Drug Cosmetics Housewares Sales 250,000 125,000 75,000 50,000 Less: Variable Expenses 105,000 50,000 25,000

30,000

Contribution Margin 145,000 75,000 50,000 20,000 Less: Fixed Expenses Salaries 50,000 29,500 12,500 8,000 Advertising 15,000 1,000 7,500 6,500 Utilities 2,000 500 500 1,000 Depreciation – fixtures 5,000 1,000 2,000 2,000 Rent 20,000 10,000 6,000 4,000 Insurance 3,000 2,000 500 500 Administrative 30,000 15,000 9,000 6,000 Total 125,000 59,000 38,000 28,000 Net Op Income (Loss) 20,000 16,000 12,000 (8,000)

Add or Drop a Product Line

Total Unavoidable Avoidable

Salaries 8,000 8,000

Advertising 6,500 6,500

Utilities 1,000 1,000

Depreciation - fixtures 2,000 2,000

Rent 4,000 4,000

Insurance 500 500

General Administrative 6,000 6,000

Total Fixed Expenses 28,000 13,000 15,000

Which fixed expenses in Housewares will Discount Drug be able to avoid?

Add or Drop a Product Line

• Contribution margin lost if housewares $ line is discontinued

• Less fixed costs that can be avoided if the housewares line is discontinued $

• Inc/(Dec) in overall company net operating inc. $

DECISION RULE:• The Housewares Line should be dropped only if the fixed

cost savings exceed the lost contribution margin.

“Make or Buy” Decision

• Essex manufactures part 4A that is currently used in one of its products.

• The unit cost to make this part is:

Direct materials $ 9 Direct labor 5 Variable overhead 1 Depreciation of special equip. 3 Supervisor's salary 2 General factory overhead 10 Total cost per unit 30$

Direct materials $ 9 Direct labor 5 Variable overhead 1 Depreciation of special equip. 3 Supervisor's salary 2 General factory overhead 10 Total cost per unit 30$

“Make or Buy” Decision

• The special equipment used to manufacture part 4A has no resale value

• General factory overhead is allocated on the basis of direct labor hours

• The $30 total unit cost is based on 20,000 parts produced each year

• An outside supplier has offered to provide the 20,000 parts at a cost of $25 per part

• Should we accept the supplier’s offer?Should we accept the supplier’s offer?

Pop Quiz

Konrade’s Engine Company manufactures part TE456 used in several of its engine Konrade’s Engine Company manufactures part TE456 used in several of its engine models. Monthly production costs for 1,000 units are as follows:models. Monthly production costs for 1,000 units are as follows:

Direct materialsDirect materials $ 40,000 $ 40,000

Direct laborDirect labor 10,000 10,000

Variable overhead costsVariable overhead costs 30,000 30,000

Fixed overhead costsFixed overhead costs 20,000 20,000

Total costsTotal costs $100,000$100,000

It is estimated that 10% of the fixed overhead costs assigned to TE456 will no It is estimated that 10% of the fixed overhead costs assigned to TE456 will no longer be incurred if the company purchases TE456 from the outside supplier. longer be incurred if the company purchases TE456 from the outside supplier. Konrade’s Engine Company has the option of purchasing the part from an Konrade’s Engine Company has the option of purchasing the part from an outside supplier at $85 per unit.outside supplier at $85 per unit.

The The maximummaximum price that Konrade’s Engine Company should be willing to pay the price that Konrade’s Engine Company should be willing to pay the outside supplier is:outside supplier is:

a.a. $80 per TE456 part.$80 per TE456 part.

b.b. $82 per TE456 part.$82 per TE456 part.

c.c. $98 per TE456 part.$98 per TE456 part.

d.d. $100 per TE456 part.$100 per TE456 part.

Accept or Reject a Special Order

Jamestown Candleworks has just received a request from the Williamsburg Foundation for 800 candles to be used in a special event for major donors. The candles will be used as the only illumination in the reception room and will be given out as gifts to the donors as they leave. The candles will be imprinted with the Williamsburg Foundation logo. This sale will have no effect on the company’s normal sales to retail outlets. The normal selling price of a candle of about the size and weight of the special candles is $3.95 and its unit product cost is $2.30, as shown below:

Direct materials $1.35 Direct labor 0.15 Manufacturing overhead   0.80 Unit product cost $2.30

The variable portion of the manufacturing overhead is $0.05 per candle; the other $0.75 represents fixed manufacturing costs that would not be affected by this special order.

Accept or Reject a Special Order (continued)

Jamestown Candleworks would have to order a special candle mold in which the Williamsburg Foundation logo is inscribed. Such a mold would cost $800. In addition, the Williamsburg Foundation wants a special wick containing gold-like thread that would add $0.20 to the cost of each candle.

Because of the large size of the order and the charitable nature of the work, the Williamsburg Foundation has asked to pay only $2.95 each for this candle.

If accepted, what effect would this order have on the company’s net operating income?

Accept or Reject a Special Order

Your firm has the capacity to produce 10,000 pencils monthly.

It’s December 15th. To date your firm has orders for 8,000 pencils. You don’t anticipate getting any more orders until next January.

Your cost and revenue information is as follows:

Sales price per pencil $ 10

Variable cost per pencil 3

Total fixed costs $28,000

Accept or Reject a Special Order

Jack Frost,Mayor of Burnsville, comes to you and says he would like to give all his staff pencils as Christmas presents, but doesn’t want to pay a lot for them. He offers you $4 per pencil for 2,000 pencils.

Should you take this deal?

Accept or Reject a Special Order

What if, instead, Jack Frost says he will give you $4 per pencil for 4,000 pencils.

Should you take this deal?

Scarce Resource Constraint

A company has two products: a plain cellular phone and a fancier cellular phone with many special features:

Plain Fancy

Phone Phone

Selling price $ 80 $ 120

Variable costs 64 84

Contribution margin $ 16 $ 36

Contribution-margin ratio 20% 30%

Scarce Resource Constraint

Suppose annual demand for phones of both types is more than the company can produce in the next year.

Only 10,000 hours of capacity are available

If in one hour plant workers can make either three plain phones or one fancy phone, which phone is more profitable?

Scarce Resource Constraint

Plain Fancy

Phone Phone

1. Units per hour 3 1

2. Contribution margin per unit $16 $36

Contribution margin per hour

Total contribution for

10,000 hours

Pop Quiz

Colonial Heritage makes reproduction colonial furniture from select hardwoods.

The company’s supplier of hardwood will only be able to supply 2,000 board feet this month. Is this enough hardwood to satisfy demand?

a. Yes

b. No

Chairs Tables Selling price per unit $80 $400 Variable cost per unit $30 $200 Board feet per unit 2 10 Monthly demand 600 100

Pop Quiz

The company’s supplier of hardwood will only be able to supply 2,000 board feet this month. What plan would maximize profits?

a. 500 chairs and 100 tables

b. 600 chairs and 80 tables

c. 500 chairs and 80 tables

d. 600 chairs and 100 tables

Chairs Tables Selling price per unit $80 $400 Variable cost per unit $30 $200 Board feet per unit 2 10 Monthly demand 600 100

Joint Products

JointInput

CommonProduction

Process

SeparateProcessing

SeparateProcessing

FinalSale

FinalSale

FinalSale

Split-OffSplit-OffPointPoint

JointJointCostsCosts

SeparateSeparateProductProduct

CostsCosts

Oil

Gasoline

Chemicals

Cocoa beanscosting $500

per ton

Joint Productionprocess costing

$600 per ton

Cocoa buttersales value$750 for

1,500 pounds

Cocoa powdersales value$500 for

500 pounds

Separableprocesscosting$800

Instant cocoamix sales value

$2,000 for500 pounds

Joint Processingof Cocoa Bean

Total joint cost:$1,100 per ton

Split-off point

Joint Products

Relative Sales Value Method

Sell or Process Further?

Joint processing leads to cocoa butter and cocoa beans.

Cocoa butter is sold at the end of the joint processing.

Cocoa powder may be sold now or processed into instant cocoa mix. Further processing costs of $800 will be incurred if the company elects to make instant cocoa mix.

Should the cocoa powder be processed into instant cocoa mix?

Joint Products - Practice

The wood spirits company produces two products, turpentine and methanol, by a joint process.

Joint costs are $120,000 per batch of output. Each batch totals 10,000 gallons, 25% methanol and 75% turpentine.

At split-off, methanol sells for $21/gallon and turpentine sells for $14/ gallon.

Joint Products - Practice (continued)

The company has discovered an new process by which the methanol can be made into a pleasant-tasting beverage.

The selling price for this beverage would be $40 per gallon. The additional processing would cost $12 per gallon s and the company would have to pay excise taxes of 20% on the selling price.

Should the company undertake further processing?