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CHAPTER

8

Chapter 8 – Using Accounting Information to Make Managerial Decisions

Using Accounting Information to Make Managerial Decisions

Learning Objectives

1. Identify relevant information for decision making. (Unit 8.1)2. Determine the qualitative and quantitative impacts of special-order pricing. (Unit 8.2)3. Determine the qualitative and quantitative impacts of outsourcing decisions. (Unit 8.3)4. Determine how to allocate constrained resources to maximize income. (Unit 8.4)5. Calculate the effects on operating income of keeping or eliminating operations. (Unit 8.5)

Summary of End of Chapter Material

Difficulty: E = Easy, M = Moderate, D = DifficultBloom: K = Knowledge, C = Comprehension, AP = Application, AN = Analysis, S = Synthesis, E = EvaluationAACSB: A = Analytic, C = Communication, E = EthicsAICPA FN: DM = Decision modeling, RA = Risk Analysis, M = Measurement, R = Reporting, RS = Research, T = TechnologyAICPA PC: C = Communication, I = Interaction, L = Leadership, P = Professional demeanor, PM = Project Management,

PS = Problem Solving and Decision Making, T = TechnologyIMA: BA = Business applications, BP = Budget Preparation, CM = Cost Management, DA = Decision Analysis,

PM = Performance Measurement, R = Reporting, SP = Strategic Planning

Item L. O. Difficulty Level

Minutes to Complete

Bloom’s Taxonomy

AACSB AICPA FN

AICPA PC

IMA EthicsCoverage

GUIDED UNIT PREPARATIONUnit 8.1

1 1 E 2 K A DM PS DA2 1 M 4 K, C A DM PS DA3 1 M 3 K A DM PS DA

Unit 8.21 2 M 4 C A DM PS DA2 2 D 2 C A DM PS DA3 2 D 4 C A DM PS DA4 2 E 2 C A DM PS DA

Unit 8.31 3 M 2 K A DM PS DA2 3 D 4 K A DM PS DA3 3 E 3 K A DM PS DA

Unit 8.41 4 M 2 C A DM PS DA2 4 M 2 C A DM PS DA3 4 D 3 C A DM PS DA4 4 E 1 K A DM PS DA5 4 M 3 C A DM PS DA

Unit 8.51 5 M 2 C A DM PS DA2 5 E 1 K A M PS DA

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photo: © jsnyderdesign / iStockphoto

Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

3 5 M 4 K, C A M PS DA4 5 M 2 C A DM PS DAItem L. O. Difficulty

LevelMinutes to Complete

Bloom’s Taxonomy

AACSB AICPA FN

AICPA PC

IMA EthicsCoverage

EXERCISES8-1 1 M 12 AP A M PS DA8-2 1 D 12 AP, AN A M, DM PS DA8-3 1 D 15 AP, AN A DM PS DA8-4 2 M 10 AP A M, DM PS DA8-5 2 D 10-15 AP A M, DM PS DA8-6 2 M 10-15 AP, AN A M PS DA8-7 2 D 15 AP A M, DM PS DA8-8 3 E 10-15 AP, AN A M, DM PS DA8-9 3 M 10-15 AP, AN A M, DM PS DA8-10 3 M 10 AP, AN A M, DM PS DA8-11 3 D 15-20 AP, AN A M, DM PS DA8-12 4 E 10-15 AP A M, DM PS DA8-13 4 M 15 AP A M, DM PS DA8-14 4 M 15 AP A M, DM PS DA8-15 4 M 15-20 AP, AN A M, DM PS DA8-16 5 E 10- AN A DM PS DA8-17 5 E 10-15 AP, AN A M, DM PS DA8-18 5 E 10 AP, AN A M, DM PS DA8-19 5 M 15-20 AP, AN A M, DM PS DAPROBLEMS8-20 2 M 25-30 AP, AN A M, DM PS DA8-21 2 D 40-45 AP, AN A M, DM PS DA8-22 1, 3 M 20-25 AP, AN, C A M, DM PS DA8-23 3 E 10 AP, AN A M, DM PS DA8-24 3 M 15-20 AP, AN A M, DM PS DA8-25 2, 3 D 20 AP, AN A M, DM PS DA8-26 4 D 30-35 AP, AN A M, DM PS DA8-27 4 D 35-40 AP, AN A M, DM PS DA8-28 3, 4 M 30 AP A M, DM PS DA8-29 5 M 20-25 AP, AN A M, DM PS DA8-30 5 E 30-35 AP, AN, E A M, DM PS DAC&C CONTINUING CASE8-31 4 D 45-50 AP, AN, E A M, DM PS DACASES8-32 1 D 50-55 AP, AN, E A M, DM PS DA8-33 2, 3,

5D 55-60 AP, AN, E A M, DM PS DA

8-34 3 D 25-30 AP, AN, E E R C BA

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SOLUTIONS TO GUIDED UNIT PREPARATION

Unit 8.1

1. To be relevant, information must pertain to the future and differ between the alternatives under consideration.

2. Avoidable costs are those that occur only when a particular decision is made. Unavoidable costs are those that are unaffected by a decision. For example, when deciding whether to continue to live in your current apartment or to rent one closer to work, the additional gas costs are avoidable but your car insurance is unavoidable.

3. A sunk cost is a cost that has occurred in the past; there is nothing that can be done to affect the cost. So sunk costs are never relevant to a future decision. However, sunk costs can be informative as they illustrate the results of prior decisions.

Unit 8.2

1. A company may be willing to sell its products at a price lower than normal for several reasons. Perhaps there is excess production capacity that would otherwise be unused, or the customer may be placing a one-time order. The order may be for a product of lower quality, or it may be for a large quantity.

2. If a business always has excess capacity to accept special orders, managers might consider selling the unused assets to reduce capacity, and thus fixed costs.

3. The company should compare the contribution margin earned on the special order to the contribution margin that will be lost from the regular orders that cannot be filled if the special order is accepted. Even if the financial result of the special order is positive, managers must consider the impact of not providing products to its existing customers and whether that will impact future business.

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4. The minimum price that a business can charge for a special order without losing money on the order is the total relevant cost of the special order.

Unit 8.3

1. While any process or input can be outsourced, companies generally concentrate on outsourcing those that are not core competencies or strategic advantages for the firm.

2. Information about the avoidable relevant cost to make the product or deliver the service must be compared to the cost to outsource the product or service. In addition, information about alternative uses of the freed-up capacity must be considered. Finally, various qualitative issues, such as the transfer of technological risk and the sharing of confidential information must be considered.

3. An opportunity cost is the cost of the next best alternative. In an outsourcing decision, the alternative use of freed-up capacity is an opportunity cost of not outsourcing and continuing to produce the product or deliver the service internally.

Unit 8.4

1. Any resource can be a constraint. Among the more common constraints are machine hours, labor hours, and direct materials.

2. The best way to allocate a constrained resource is on the basis of the contribution margin per unit of constrained resource.

3. Production is planned to meet customer demand. Therefore, even if a product has the highest contribution margin per unit of constrained resource, production should not be greater than the number of units customers will purchase.

4. A bottleneck is a production process that limits total output.

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5. A bottleneck can be alleviated by purchasing additional machinery, hiring additional workers, decreasing the amount of time the process requires, or reducing the number of defects.

Unit 8.5

1. Managers are often motivated to consider eliminating an operation or product line when it shows a net loss, particularly if the net loss occurs for several periods.

2. Segment margin is contribution margin minus direct fixed costs.

3. An allocated cost is a cost that is incurred to benefit the entire organization and thus is not directly traceable to specific segments of the business. These costs are also referred to as common costs. If a cost object, such as a product line, is eliminated, total allocated costs do not change, and they are reallocated to the remaining segments.

4. Managers should continue to produce the product until a better use of resources is found.

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SOLUTIONS TO EXERCISES

Exercise 8-1

Operating cost of old machine $10,000 RelevantProduction of old machine 50,000 units RelevantPurchase price of old machine $200,000 IrrelevantLoan balance $125,000 IrrelevantMarket value of old machine $70,000 RelevantCost of new machine $220,000 RelevantProduction of new machine 85,000 units RelevantOperating cost of new machine $12,000 Relevant

Exercise 8-2

a. Scrap (throw away) the defective unitsRework and sell for $100 per unitSell to liquidation company as is for $80 per unit

b. The $100,000 book value of the defective units

c. Scrap = $0Rework = ($100 - $10) per unit 500 units = $45,000Sell to liquidation company = $80 per unit 500 units = $40,000

Rework and sell generates the best financial result.

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Exercise 8-3

a.Stat-Max Buy Tracker

Purchase price $912,000 $500,000Programmer hours 80 hours 125 hoursAnnual License fee $0 $10,000Technical support 24-hour 8 a.m. – 5 p.m. CST

not relevant: disk storage space and hours of user training

b. Other information you would want to know includes ease of report customization, customer satisfaction/testimonies, frequency of upgrades, and other potential future costs.

c. The out-of-pocket cost will be more than the relevant cost due to the cost of purchasing the disk storage space.

Exercise 8-4

Avoidable costs of the special order:Variable costs $15,000Machine rent 21,000

$36,000

They should charge $36,000 at a minimum. Any amount over that will increase the company’s operating income.

Exercise 8-5

Since Byways only has capacity to produce 2,000 units, it will have to give up 3,000 units of its regular sales to complete the special order.

Special order contribution margin ($75 – $65) 5,000 units $50,000Lost contribution margin ($100 – $65) 3,000 units (105,000 )

($55,000 )

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Byways’ net income will decrease by $55,000 if it accepts the special order.

Exercise 8-6

Sales price $35Variable costs per unit:

Direct materials 6Direct labor 4Variable overhead ($15 .4) 6

Total variable costs 16Contribution margin $19 15,000 pairs = $285,000

Lybrand’s income will increase by $285,000

Exercise 8-7

Relevant cost to produce:Variable manufacturing costs $880,000Variable selling and administrative costs 128,000Total relevant costs to produce $1,008,000Units produced 16,000 Cost per unit $63

Contribution margin per unit = $60 – $63 = ($3)

If the company produces and sells 1,500 helmets to the American Motorcycle Club at $60 per helmet, operating income will decrease by $4,500 (1,500 helmets $3).

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Exercise 8-8

a. Direct Materials $ 2Direct Labor 3Variable Overhead 4Relevant cost to make $ 9

Outland should continue to make as the relevant cost to make ($9) is less than the cost to buy ($12).

b.Make Buy

Total relevant cost to make $9 1,000 = $9,000Total cost to buy $12 1,000 =

$12,000Contribution margin from released facilities (5,000 Net cost to buy $7,000

Now it makes financial sense to buy the parts and use the facilities to earn an additional $5,000 in contribution margin.

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Exercise 8-9

a.Make Buy

Direct materials $ 3Direct labor 4Variable overhead 1 Relevant cost per unit to make $8Cost to buy $12Units needed 5,000 5,000 Total variable cost $40,000 $60,000Additional fixed costs to make 28,000 - Total cost $68,000 $60,000

The company should continue to purchase the tires.

b. Qualitative factors to consider include: the quality of the purchased tires as compared to those it could

make the relationship with the supplier of the tires – consistent, timely

delivery of tires and future price increases the strain on the manufacturing facility by adding additional

production

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Exercise 8-10

Make BuyDirect materials $ 5Direct labor 12Variable overhead 8Avoidable fixed costs ($10 .4) 4 Relevant cost per unit to make $29Cost to buy $32Units needed 5,000 5,000 Total cost $145,000 $160,000Contribution margin from released facilities (10,000 ) Net cost $150,000

Do not accept offer. Financially, Kansas is $5,000 better off making the part.

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Exercise 8-11

a.Operate cafeteriaMeal revenue ($5/meal 5,000 meals 12 months) $300,000Relevant cost to operate ($180,000 + $90,000 + $12,000) (282,000 ) Relevant contribution from cafeteria operations $ 18,000

Outsourced cafeteriaMeal revenue ($.50/meal 5,000 meals 12 months) $30,000

Merit Bay should accept Best Ever’s offer since the net result is higher under the outsourcing option.

b. Assuming the same relative costs, the food cost per meal is $3.00 ($180,000 / 60,000 meals). Each worker costs $18,000 per year ($90,000 / 5 workers).

Operate cafeteriaMeal revenue ($5/meal 1,000 meals 12 months) $60,000Food costs ($3/meal 1,000 meals 12 months) (36,000)Worker salaries ($18,000 3) (54,000)Fixed operating costs (12,000 ) Net loss ($42,000 )

Outsourced cafeteriaMeal revenue ($.50/meal 1,000 meals 12 months) $6,000

The company should not resume the operation of the cafeteria.

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Exercise 8-12

Small Medium

Large

Contribution margin per unit $ 2.00 $ 3.00 $ 4.00Machine hours per unit 1.00 2.40 3.00 Contribution margin/machine hour $ 2.00 $ 1.25 $ 1.33Preference ranking #1 #3 #2

Produce Hours per unit Hours used Hours available2,000

Small 500 1 500 1,500Large 500a 3 1,500 0Medium 0

a Since only 1,500 hours remain to make large balloons, and it takes 3 hours to make a large balloon, only 500 larges can be made (1,500 3).

Exercise 8-13

A B CSales price per unit $ 3.00 $ 5.00 $16.00Variable costs per unit 1.20 3.40 10.00Contribution margin per unit 1.80 1.60 6.00Labor hours per unit 1.20 .50 5.00 Contribution margin/labor hour $ 1.50 $ 3.20 $ 1.20Preference ranking #2 #1 #3


B 600 .50 300 1,500A 500 1.20 600 900C 180a 5.00 900 0

a Since only 900 hours remain to make product C, and it takes 5 hours to make one C, only 180 Cs can be made (900 5).

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Exercise 8-14

a.Banners Kites

Sales price per unit $12.00 $15.00Variable costs per unit 9.00 14.00Contribution margin per unit 3.00 1.00Machine hours per unit 1.00 .25 Contribution margin/machine hour $ 3.00 $ 4.00Preference #2 #1


Kites 1,200 .25 300 700Banners 700a 1.00 700 0

a Since only 700 hours remain to make Banners, and it takes 1 hour to make one banner, only 700 banners can be made (700 1).

b. Managers need to rent machines so that 2,300 additional machine hours are available.

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Exercise 8-15

a.Chocolate Chip Sugar Oatmeal Raisin

Sales price $130 $110 $130Variable cost 81 62 88 Contribution margin $ 49 $ 48 $ 42

Make and sell chocolate chip cookies since they have the highest contribution margin per batch.

b. (12,000 × $49) + (8,000 × $48) + (10,000 × $42) = $1,392,000

c.Chocolate Chip Sugar Oatmeal Raisin

Contribution margin $ 49 $ 48 $ 42÷ lbs. flour per batch ÷ 2 ÷ 2 ÷ 1 .5 Contribution margin/lb. $24 .50 $24 .00 $28 .00 Production order 2 3 1

Flour Remaining50,000 lbs.

Oatmeal Raisin 10,000 batches × 1.5 lbs. = 15,000 lbs. used 35,000 lbs.Chocolate Chip 12,000 batches × 2 lbs. = 24,000 lbs. used 11,000 lbs.Sugar 5,500a batches × 2 lbs. = 11,000 lbs. used 0 lbs.

a 11,000 lbs. available ÷ 2 lbs. flour per batch

CM = (12,000 × $49) + (5,500 × $48) + (10,000 × $42) = $1,272,000

d. Yes, all products using gluten-free flour must be considered. Allocation of the flour will depend on the contribution margin per pound of flour generated by the other products.

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Exercise 8-16

There is not a single correct list of desired information; however, the desired information might include items such as:

Store segment margin for several years Comparable store segment margins for several years Projected population growth patterns Demographics for the surrounding area of the new stores Concentration of other fast food restaurants in the areas of interest

Exercise 8-17

Segment margin of Round:

Sales $6,600Variable costs 3,000Contribution margin 3,600Avoidable fixed costs 1,680 ($4,200 40%)Segment margin $1,920

Since the Round Game’s segment margin is positive, dropping the Round Game before the last quarter would have resulted in a lower operating income:

Operating income with Round $3,250Lost segment margin without Round (1,920 ) Operating income without Round $1,330

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Exercise 8-18

a.Weak Average Strong Total

Sales $125,000

$350,000 $500,000 $975,000

Variable expenses 50,000

200,000 300,000 550,000

Contribution margin 75,000 150,000 200,000 425,000Direct expenses 30,00

0 80,000 110,000 220,000

Segment margin $45,000

$70,000 $90,000 205,000

Allocated expenses 150,000Operating income $55,000

b. $45,000 decrease—the segment margin from the Weak Division.

c. It appears that the total allocated expense is split evenly among the divisions. If Weak is dropped, then $75,000 ($150,000 2) will be allocated to Average, resulting in a $5,000 loss for the division as currently reported.

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Exercise 8-19

a.Sales revenue $200,000Cost of goods sold Variable $130,000 Fixed 32,000 162,000 Gross margin 38,000Operating expenses Commissions 10,000 Advertising 10,000 Corporate support 25,000 45,000 Operating income ($7,000 )

b.Sales revenue $200,000Variable expenses Cost of goods sold $130,000 Commissions 10,000 140,000 Contribution margin 60,000Traceable fixed expenses Cost of goods sold 16,000 Advertising 10,000 26,000 Segment margin $ 34,000

c. Luis should use the segment margin income statement. If the company truly has capacity to absorb this new product line, then the company’s operating income will increase by the segment margin.

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SOLUTIONS TO PROBLEMS

Problem 8-20

a. The variable cost of Andrea’s special order is $0.28 per box.

Paper $0.15Direct labor 0.05Variable overhead 0 .08 Total variable cost per box $0 .28

Since the variable cost of $0.28 per box exceeds the sales price of $0.25 per box that Andrea is willing to pay, Guilford should not accept the order.

b. With the lighter, cheaper paper, the variable cost per box is $0.23.

Paper $0.10Direct labor 0.05Variable overhead 0 .08 Total variable cost per box $0 .23

Since the sales price of $0.25 per box that Andrea is willing to pay is greater than the variable cost per box, Guilford should accept the special order.

c. Sales price on special order = $0.50 × 110% = $0.55Contribution margin = $0.55 - $0.32 = $0.23 per box

Contribution margin on special order $2,300Less shipping expenses (800 ) Profit on special order $1,500

Guilford should accept the special order since it generates a positive profit.

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d. Given that the company has excess capacity, Guilford should consider options to increase sales volume. Andrea is a potential new customer that Guilford could develop a long-term relationship with, if she can get to a financial position where she can be a profitable customer. The company may want to continue to explore cheaper materials to use in producing a box that Andrea will find acceptable. Guilford will need to be careful, though, because producing lower quality boxes may affect the company’s reputation.

The London bakery is unlikely to be a regular customer, but if it does decide to switch to Guilford, a different arrangement needs to be made for the excess shipping costs that are incurred, as it is unlikely that the bakery will pay a premium price for a regular order.

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Problem 8-21

a. The variable costs are the only relevant costs of the special order, so those amounts need to be calculated first.

Total manufacturing overhead ($23/unit 400,000 units) $9,200,000Fixed overhead (5,000,000 ) Variable overhead $4,200,000Number of units in budget 400,000 Variable overhead per unit $10.50

Selling and administrative costs ($14/unit 400,000 units) $5,600,000Fixed selling and administrative costs (3,100,000 ) Variable selling and administrative costs $2,500,000Number of units in budget 400,000 Variable selling and administrative costs $6.25Distributor’s commission ($140 2%) (2 .80) Remaining variable selling and administrative costs $3 .45

Contribution from special order:Sales ($140 60%) $84.00Direct materials (37.00)Direct labor (16.00)Variable overhead (10.50)Distributor’s commission ($84 2%) (1.68)Variable selling and administrative costs (3 .45) Contribution margin $15.37Number of units 75,000 Total contribution from special order $1,152,750

The financial results suggest that Wayne should grant Nordic’s request.

b. Possibility that Nordic will become a regular customer – supports

request Possibility that Nordic will expect a permanent price reduction –

does not support request

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Problem 8-21, continued

Potential violation of the Robinson-Patman Act – does not support request

Current customer dissatisfaction with Nordic paying a lower price – does not support request

c.Contribution from special order:Sales $95.00Direct materials (37.00)Direct labor (16.00)Variable overhead (10.50)Variable selling and administrative costsa (1 .45) Contribution margin $30.05Number of units 125,000 Contribution from special order $3,756,250

a Total S&A costs 400,000 windows × $14 $5,600,000 Less fixed S&A costs 3,100,000 Total variable S&A costs 2,500,000

÷ 400,000 windows$6.25 per window

Less costs not incurred on special order: Commission $140 × .02 2.80 Shipping 2 .00 Variable S&A cost per unit $1 .45 per window

Contribution lost from regular sales:Sales $140.00Direct materials (37.00)Direct labor (16.00)Variable overhead (10.50)Distributor’s commission (2.80)Variable selling and administrative costs (3 .45) Contribution margin $70.25Number of units 25,000 Contribution lost from regular sales ($1,756,250 ) Net contribution from special order $2,000,000

The special order will generate $3,756,250 in additional contribution margin; however, $1,756,250 in contribution margin will be lost from

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the regular sales that cannot be made if the special order is filled. The net result of $2,000,000 in additional contribution margin suggests that Wayne should accept Ryster’s offer.

d.Contribution from outsourcing windowsSales $140.00Purchase price (105.00)Distribution ($140 × 0.02) (2.80)Variable selling and administrative costs (3 .45) Contribution margin $28.75Number of units 25,000 Contribution from outsourcing $718,750

Outsourcing the production of the 25,000 windows needed to fill both regular orders and the special order generates $718,750 in contribution margin. Therefore, the financial results suggest that outsourcing the window production is a good idea.

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Problem 8-22

a.Appropriate/Inappropriate

Correct/Incorrect

Explanation

1. Appropriate Correct2. Inappropriate Since the supervisor is

being transferred, the salary amount will be incurred regardless of the decision. Therefore, it is non-differential and not relevant to the decision.

3. Appropriatea Correct4. Appropriate Incorrect5. Appropriate Correct6. Appropriate Incorrect7. Appropriate Correct8. Appropriate Correct9. Appropriate Incorrect

aIf the company chooses not to outsource, there are two purchasing clerk salaries to pay – the one in the assembly department and the one in the sales department. If the company chooses to outsource, there is only one purchasing clerk salary to pay (in the sales department). Therefore, even though the assembly purchasing clerk is being paid under both scenarios, the cost of the assembly position is relevant since the net effect of ousourcing is a reduction in total purchasing clerk salaries from the elimination of the assembly department position.

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b.Reduction in assembly technicians $32,500 36

$1,170,000

Purchasing clerk transferred 19,000Storage rental savings 1,500 sq. ft. $12/sq. ft

18,000

Reduced purchase orders 1,200 P.O.s $1.40/P.O.

1,680

Increased component cost 125,000 units ($88 – $36 – $11.60)

(5,050,000)

Hire junior engineer (28,000)Hire quality control inspector (26,000)Storage costs for safety stock 125,000 units $3.25/unit 4% increase

(16,250)

Net annual cost ($3,911,570)

c. Financial stability of vendorQuality of workmanshipTimeliness of deliveriesLong-term financial evaluation – can’t start production back up easilyMorale of remaining employees

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Problem 8-23

a. The engineers’ time is an unavoidable fixed cost—it won’t be saved if Benson outsources the design to Longan.

Therefore, the relevant cost to make the module is $50 per unit. Compared to Longan’s proposed cost of $60, it is better for Benson to make the unit.

b. Total cost to buy = $60 1,000 = $60,000Total relevant cost to make = $50 1,000 = 50,000Savings/return from Benson projects $10,000

The projects that the Benson engineers work on instead of designing the module would have to save the company $10,000 to make it worthwhile to outsource the module.

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Problem 8-24

a.Make Buy

Direct materials $12.00Direct labor 6.00Variable overhead 3.00Salaries ($8 × 30%) 2 .40 Relevant cost per unit to make $23.40Cost to buy $32Units needed 40,000 40,000 Total cost $936,000 1,280,000

Do not accept Talbert’s offer. It is cheaper for Henry to make the units.

b.Make Buy

Direct materials $12Direct labor 6Variable overhead 3 Relevant cost per unit to make $21Cost to buy $32Units needed 40,000 40,000 Total cost $840,000 $1,280,000Contribution margin from alternative use of

facilities (($11 - $7) 100,000 units) (400,000 ) Net cost $880,000

Do not accept Talbert’s offer. It is still cheaper for Henry to make the units.

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Problem 8-25

a.Per unit Ratio

Revenues $18,000 $15 .00 100 .0% Variable CostsCartons (6,000) (5.00) (33.3%)Cushioning (600) (.50) (3.3%)Tape, labels (1,500 ) (1 .25) (8 .4% ) Total variable costs (8,100 ) (6 .75) (45 .0% )Contribution margin 9,900 $8 .25 55 .0 Fixed CostsSalaried Labor (4,000)Overhead (4,100 ) Total fixed costs (8,100 ) Income $1,800

On average, variable costs are $6.75 per unit and the selling price is $15 per unit. A 20% discount results in an average price of $12, which is high enough to cover variable costs. Labor is not included as a variable cost because the workers are paid a fixed salary.

Unless the proportions of the other material costs to sales price vary widely, it is unlikely that Roger will lose money.

b. If Elizabeth’s work increases the burden on the existing employees by a sufficient amount, Roger may need to hire additional workers, and that will reduce his profits. Also, if Elizabeth tells her friends about the discount, they will likely want one too. Finally, if Elizabeth’s work creates a backlog for other customers who are used to speedy service, those customers may decide to use another service provider.

c. Any problems with packing and shipping are still Elizabeth’s responsibility. She seems to be satisfied with the quality of the work, as it is, but she needs to articulate her expectations so that she doesn’t lose money on her side of the business.

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Problem 8-26

a. (4,000 units × .5 MH/unit) + (7,000 units × .8 MH/unit) = 7,600 MH

b.Dumbbell Rack Weight Bench

Sales price $50 $61Variable cost 27 29 Contribution margin $23 $32÷ MH/unit .5 .8 Contribution margin/MH $46 $40 Production order 1 2

MH Remaining6,000 MH

Dumbbell Rack 4,000 racks × .5 MH = 2,000 MH used 4,000 MHWeight Bench 5,000a benches × .8 MH = 4,000 MH used 0 MH

a 4,000 MH available ÷ .8 MH per bench

c. CM = (4,000 racks × $23) + (5,000 benches × $32) = $252,000

d. new contribution margin for weight bench = $69 - $29 = $40new contribution margin per MH = $40 ÷ .8 MH/bench = $50/MH


Weight Bench 5,800 benches × .8 MH = 4,640 MH used 1,360 MHDumbbell rack 2,720 a racks ×.5 MH = 1,360 MH used 0 MH

a 1,360 MH available ÷ .5 MH per bench

CM = (5,800 benches × $40) + (2,720 racks × $23) = $294,560

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e. new contribution margin for dumbbell rack = $56 - $27 = $29new contribution margin per MH = $29 ÷ .5 MH/rack = $58/MH


Dumbbell Rack 2,000 racks ×.5 MH = 1,000 MH used 5,000 MHWeight Bench 6,250a benches × .8 MH = 5,000 MH used 0 MH

a 5,000 MH available ÷ .8 MH per benchCM = (2,000 racks × $29) + (6,250 benches × $32) = $258,000

f. Raising the price of the weight bench results in the greatest total contribution margin. Because the company is unable to meet so much demand, Sarah should consider purchasing another machine to increase capacity.

8-30


Problem 8-27

a.

DemandHours per session

Hours needed

Math 120 .75 90Writing 210 1.50 315Science 100 .50 50 Total 455

Carie cannot satisfy current demand. She only has 350 hours available to meet total demand of 455 hours.

b.Math Writing Science

Sales price per session $25.00 $30.00 $15.00Variable costs per session 13.00 24.00 8.00Contribution margin per session 12.00 6.00 7.00Labor hours per session .75

1.50 .50

Contribution margin/labor hour $16.00 $4.00 $14.00Preference ranking #1 #3 #2

Sessions offered

Hours per session Hours used

Hoursavailable

350Math 120 .75 90 260Science 100 .50 50 210Writing 140a 1.50 210 0a Since only 210 hours remain to teach the Writing sessions, and it takes 1.5 hours per session, only

140 sessions can be offered (210 1.5).

c.Sessions offered

Contribution per session Total

Math 120 $12 $1,440Science 100 $7 700Writing 140 $6 840

$2,980

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d.

DemandStudents

per sessionSessions needed

Hours per session

Hours needed

Math 120 2 60 .75 45.0Writing 210 1 210 1.50 315.0Science 100 4 25 .50 12 .5 Total 372 .5

Carie still does not have enough capacity to cover all sessions.

Math(2)

Writing(1)

Science(4)

Revenue per session $50.00 $30.00 $60.00Less Labor costs per session 12.00 22.00 7.00 Supplies cost per session 2.00 2.00 4.00Contribution margin per session $36.00 $6.00 $49.00Labor hours per session .75

1.50 .50

Contribution margin/labor hour $48.00 $4.00 $98.00Preference ranking #2 #3 #1

Writing still generates the lowest contribution margin per labor hour, so hours will be allocated first to Science and then Math.

Sessions offered

Hours per session Hours used

Hoursavailable

350.00Science 25 .50 12.50 337.50Math 60 .75 45.00 292.50Writing 195a 1.50 292.50 0

a Since only 292.5 hours remain to teach the Writing sessions, and it takes 1.5 hours per session, only 195 sessions can be offered (292.5 1.5).

e. Space is now the constrained resource. Carie can lease another building to get the space she needs. She will need to ensure that the additional contribution margin generated by the 250 hours (600 – 350) is more than adequate to cover the new lease payments.

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Problem 8-28

First calculate fixed expenses in total:Manufacturing overhead ($6.25 8,000) $50,000Selling and administrative ($7.00 8,000) 56,000 Total fixed expenses $106,000

Option 1:Per unit

Sales revenue $688,000 $86.00Variable expenses Direct materials $136,000 17.00 Direct labor 150,000 18.75 Manufacturing overhead 56,000 7.00 Selling & administrative 80,000 10.00 Total variable expenses 422,000 52.75Contribution margin 266,000 $33.25Fixed expenses 106,000Operating income $160,000

Option 2:Regular Outsourced Total

Sales revenue $86.00 $86.00 Purchase price $68.00 Direct materials 17.00 Direct labor 18.75 Manufacturing overhead 7.00 Selling & administrative 10.00 10.00 Total variable cost 52.75 78.00Contribution margin 33.25 8.00Units sold

8,000 4,000

Total contribution margin $266,000 $32,000 $298,000Fixed expenses 106,000Operating income $192,000

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Option 3:Tackle boxes Skateboards Total

Sales revenue $86.00 $45.00 Variable production costs Purchase price $68.00 22.50 Selling & administrative 10.00 10.00 Total variable cost 78.00 32.50Contribution margin $8.00 12.50Units sold 9,000

17,500Total contribution margin $72,000 $218,750 $290,750Fixed expenses 106,000Operating income $184,750

Recap:Option 1 $160,000Option 2 $192,000Option 3 $184,750

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Problem 8-29a.

A B C TotalSales revenue $2,20

0$1,400 $1,800 $5,400

Variable expenses 1,400

800 1,080 3,280

Contribution margin 800 600 720 2,120Less direct fixed expenses Advertising 630 525 520 1,675 Depreciation 15 10 20 45Segment margin $ 155 $ 65 $ 180 400Less common fixed expenses 275Operating profit $ 125

b. Net income would decrease by $75,000. The $10 depreciation won’t go away or be saved as a result of eliminating product B.

c. New product contribution margin = $10 - $4 = $6/unit. To be as well off with the new product as the current product B, the new product must generate $600,000 in total contribution margin. At a $6/unit contribution margin, the company would have to sell 100,000

units of the new product.

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Problem 8-30

a. If Fenner Road is closed:

Sales revenue ($80,000 × .9) $72,000Variable expenses ($32,000 × .9) 28,800Contribution margin 43,200Less: Maple Avenue direct fixed expenses 20,000 Remaining Fenner Road direct fixed expenses 10,000 Total common fixed expenses 10,000Operating income $ 3,200

No, the Fenner Road store should not be closed. Closing the store will result in monthly operating income of $3,200, which is lower than the current monthly operating income. The reduced sales at Maple Avenue and the Fenner Road direct fixed expenses that remain after closing the store are greater than the current loss reported by the Fenner Road store.

b. The Maple Avenue store should not be closed since it generates a $28,000 segment margin each month.

Sales revenue $80,000Variable expenses 32,000Contribution margin 48,000Less direct fixed expenses 20,000Segment margin $28,000

c. 10% increase in Fenner contribution margin $3,600 ($36,000 × 0.10)Cost of advertising (6,000 ) Decrease in operating income with advertising ($2,400 )

The advertising campaign should not be implemented as the contribution margin generated is not sufficient to cover the cost.

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d.Sales at

Variable CostRemaining Sales

Total Fenner Road Sales

Sales $60,000 $60,000 $120,000Variable expenses 60,000 24,000 84,000Contribution margin $0 $36,000 $ 36,000

Contribution margin lost on remaining sales ($7,200) ($36,000 20%)Direct expenses saved ($40,000 15%) 6,000Decrease in operating income ($1,200 )

Management should not implement the changes as operating income will decrease.

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SOLUTIONS TO C&C CONTINUING CASE

Case 8-31

a.Pants Jerseys Jackets

Sales price $12 .00 $14 .80 $125 .00 Direct materials $ 4.47 $ 6.85 $ 44.72Direct labor 2.40 1.92 14.40Variable overhead 1.32 1.05 7.92Commission .60 .74 6.25Shipping .40 .40 .40 Total variable cost $ 9 .19 $10 .96 $ 73 .69 Contribution margin $ 2 .81 $ 3 .84 $ 51 .31

b.Pants Jerseys Jackets

Contribution margin $ 2.81 $ 3.84 $51.31÷ Direct labor hours per unit ÷ .25 ÷ .20 ÷ 1 .50 Contribution margin per DLH $11 .24 $19 .20 $34 .21

c. Jackets, jerseys, pants

d.Pants 200,000 pants × 0.25 DLH/pant = 50,000 DLHJerseys 70,000 jerseys × 0.20 DLH/jersey = 14,000 DLHJackets 18,000 jackets × 1.5 DLH/jacket = 27,000 DLH

91,000 DLH

91,000 DLH ÷ 52 weeks = 1,750 DLH per week

e. 1,750 DLH ÷ (2 shifts × 8 DLH × 5 days) = 22 workers11 sewing machines would be needed each shift

f. 3,500 additional jerseys would require 700 additional DLH (3,500 jerseys × 0.20 DLH/jersey) and would generate an additional contribution margin of $13,440 (3,500 jerseys × $3.84/jersey).

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If jerseys are made instead of pants, C&C will make 2,800 fewer pants (700 DLH ÷ 0.25 DLH/pant). This will result in a loss of $7,868 in contribution margin (2,800 pants × $2.81 CM/pant), for a net increase in contribution margin of $5,572 ($13,440 - $7,868).

If jerseys are made instead of jackets, C&C will make 467 fewer jackets (700 DLH ÷ 1.5 DLH/jacket). This will result in a loss of $23,962 in contribution margin (467 jackets × $51.31 CM/jacket), for a net decrease in contribution margin of $10,522 ($13,440 - $23,962).

If C&C Sports wants to produce the additional 3.500 jerseys without reducing production of pants or jackets, the company must find a way to supply the additional 700 DLH required for the jerseys’ production. While C&C Sports could hire an additional worker to provide these hours, there would not be enough hours to hire this person full-time for the year. Another option would be to ask two or three of the most productive workers to work overtime to produce the extra jerseys. C&C will also need to ensure that there is enough sewing machine time available for those additional direct labor hours.

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SOLUTIONS TO CASES

Case 8-32

a. Option 1: Hold conference as planned with 15 attendeesOption 2: Cancel the conference and return conference feesOption 3: Reschedule conference for Dec. 8th and 9th

b.Option 1 Option 2 Option 3

Registration fee revenuea $ 8,925 $ 0 $ 76,440ExpensesMeals 1,875 16,250Conference materials 675 5,850Direct mail advertising 4,500 4,500 6,000Meeting room rental 3,500 3,500Cancellation fee 10,000Guest room guarantee fee 5,000Equipment rental 500 500Speaker fees: Newton 600 600 Smith 2,000 2,000 Townsley 4,000 1,000 4,000Speaker travel: Newton 200 200 Smith 1,200 800 1,300 Townsley 1,000 Compton 200 200Total expenses 25,250 16,300 40,400Operating income ($16,325 ) ($16,300 ) $36,040

aRegistration fee income for option 3(6,500 mailings 2% 90% $595) + (6,500 mailings 2% 10% $525)

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Case 8-32, continued

c.Option 1 Option 2 Option 3

Net Income ($16,325) ($16,300) $36,040Add back unavoidable costs Direct mail advertising 4,500 4,500 4,500 Townsley speaker fees 1,000 1,000 1,000Relevant income (loss) ($10,825 ) ($10,800 ) $41,540

The $5,500 has already been spent or committed. The relevant income (loss) represents the additional amount that Flagstone will make or lose with each option.

d. Holding the conference as scheduled will maintain Flagstone's reputation with the speakers, hotel, and registrants. This will also allow for the possibility of more registrants before the actual conference date. Existing registration fees will not have to be returned. The conference should result in enhanced relationships with the registrants and may present the opportunity to sell additional consulting services to the registrants. Flagstone also is able to meet its internal goal of creating a new national conference. On the downside, the meeting room that is designed to hold up to 300 people will look bad with only 15 people in the audience. Additional fees must be paid to University Parks Inn for not meeting the minimum number of guest rooms. The speakers may resent coming to speak to such a small crowd and may not be willing to speak at future Flagstone conferences.

e. The obvious benefit to canceling the conference is that this action cuts the losses of the conference. Holding the conference with only 15 registrants will cost Flagstone more than canceling the conference and paying the cancellation fee to University Parks Inn. Canceling the conference at this time may result in ill will on the part of existing registrants. As a consulting firm, Flagstone is heavily dependent on its reputation in the marketplace. Canceling the conference may result in some damage to that reputation. There may also be some reputation damage in the eyes of the speakers that had been retained for the conference. While University Parks Inn is compensated for

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the cancellation, Flagstone may not be in a good bargaining position with the hotel for future conferences. With the difference between holding the conference as scheduled and canceling the conference being only $25, Flagstone managers need to focus more on the qualitative issues surrounding these options rather than the dollar amount.

f. In addition to the benefits of holding the conference as scheduled, rescheduling the conference will allow Flagstone more time to market the conference and increase attendance. This would generate additional exposure and revenue. However, there is no guarantee that the rescheduled conference will be better attended. Flagstone could spend additional funds for no additional benefit. Flagstone also runs the risk of alienating some of the existing registrants in changing the date, particularly if they cannot attend at that time. The potential for inclement weather in Boston in December may deter some professionals from registering and attending.

g. In looking at the conference, Flagstone needs to ensure that the conference supports the mission, vision, and values of the firm. While the initial reaction may be to look at the conference in the short term, particularly from a financial perspective, the conference may have much more benefit in the long term. It is difficult to measure at the current time what future consulting revenues may be generated from the conference registrants, but also from non-registrants who later hear about the conference. Flagstone is also learning valuable lessons for planning future conferences.

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Case 8-33

a. Pick the selling price that maximizes total contribution margin:

Household

Sales

Variable costsa

Contribution

marginUnits sold

Total contribu

tion margin

$18$16 $2

120,000

$240,000

$20$16 $4

100,000

$400,000

$21$16 $5

90,000

$450,000

$22$16 $6

80,000

$480,000

$23$16 $7

50,000

$350,000

aRaw materials + Direct labor + Variable overhead + Variable selling and administrative = $7 + 4 + 1 + 4= $16

Commercial

SalesVariable costsa

Contribution margin

Units sold

Total contribution

margin$25 $21 $4 175,000 $700,000$27 $21 $6 140,000 $840,000$30 $21 $9 100,000 $900,000$32 $21 $11 55,000 $605,000$35 $21 $14 35,000 $490,000

aRaw materials + Direct labor + Variable overhead + Variable selling and administrative = $8 + 4 + 2 + 7= $21

The selling prices/quantities that maximize net income are:Household: $22/80,000Commercial: $30/100,000

b.Household Commercial Total

Contribution margin $480,000 $900,000 $1,380,000

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Direct fixed expenses (400,000 ) (500,000 ) (900,000 ) Segment margin $80,000 $400,000 $480,000Selling and admin fixed (600,000 ) Operating income ($120,000 )

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c. The Household product should not be dropped because it has a positive segment margin.

d. The plant has capacity to make 175,000 cases of the Commercial product in the second half of the year. If it accepts the special order, it will only be able to sell 95,000 cases to regular customers:

Regular Special order TotalSales price $30 $20.00Variable costs 21 17 .80 a

Contribution margin/unit $9 2.20Units sold 95,000 80,000 Total contribution margin $855,000 $176,000 $1,031,000

a($21 - $3.20)

Compare this $1,031,000 contribution margin to the $900,000 contribution margin without the special order. The difference of $131,000 would go straight to the bottom line and increase operating income to $11,000 (($120,000) + $131,000). The special order allows the company to make better use of the facilities. While this is good in the short run, management needs to consider several things: Is the relationship with CleanMe on-going? If so, will they expect

this kind of price break indefinitely? If CleanMe becomes a regular customer, will commissions need

to be paid? If so, the price does not cover variable costs in that case. If CleanMe continues as a customer but commissions are not ever paid on this account, the sales representatives have lost the opportunity to earn commissions on the 5,000 units lost from regular sales, and there is no capacity for them to bring in new customers to increase commissions. That could result in a morale problem for the sales representatives.

What will current customers think of this price break for CleanMe? Is it a violation of the Robinson-Patman act?

This special order is a good one-time opportunity for Karpet Kleen to achieve a positive operating income. The company should consider taking the special order one time, but should not make it a continuing practice. Instead, management should either scale back capacity

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Case 8-33, continued (and direct fixed costs) or look for ways to use capacity to make a different product.

e. The outsourcing arrangement makes financial sense only if the contribution margin is higher than the planned total contribution margin of $1,380,000.

Household = ($22 – $13 – $4) 80,000 = $400,000Commercial = ($30 – $21) 100,000 90% = 810,000Extra Strength = ($40 – x – $7) 45,000 = 1,485,000 – 45,000 x

$1,380,000

$400,000 + $810,000 + $1,485,000 – 45,000x = $1,380,000x = 29.22

As long as the product costs $29.22 or less to produce, the company is no worse off financially than it is now. When the company designs the process to make the Extra Strength product, it will probably want to have a target cost much lower than $29.22. Altering the production process and product mix is a much riskier proposition than continuing existing operations. In addition, managers need to be assured that the quality and timeliness of delivery for the outsourced Household product is as good or better than what Karpet Kleen does now.

f.

Units soldHousehold

50,000Commercial

35,000Total

Sales revenue ($23/$35) $1,150,000 $1,225,000 $2,375,000Variable costs ($16/$21) (800,000 ) (735,000 ) (1,535,000 ) Contribution margin 350,000 $490,000 840,000Direct fixed costs (400,000 ) (500,000 ) (900,000 ) Segment margin ($50,000 ) ($10,000 ) (60,000)Fixed selling and administrative costs (600,000 ) Operating income ($660,000 )

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g. The company will only save money by shutting down operations if it can save the direct fixed costs. Even then, laying off workers for half a year, only to try to get them back at the beginning of next year, is not a viable option. Workers will try to find other jobs, replacement hires will need to be trained, and the community outcry is likely to add to the company’s woes. It would be best to keep operating and work on a long-term solution to the company’s financial problems.

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Case 8-34

Wilson is not necessarily faced with an ethical conflict, as his advisory committee has not asked him to participate in any unethical behavior. The committee’s disagreement with Wilson primarily concerns prudent business practice. Nevertheless, Wilson can find direction in the IMA’s Statement of Ethical Professional Practice.

In section 3 of the statement, members are instructed to mitigate actual conflicts of interest. Wilson’s bonus based on cost savings is such a conflict of interest, though it is not necessarily one that prejudices his judgment. However, the appearance of a conflict may be enough to prevent Wilson from credibly carrying out his responsibilities. Though it is not uncommon for upper management to receive bonuses based on financial performance, no part of the bonus mentions the necessary trade-off between cost savings and quality care. It may be time for Wilson to review with his bosses a change to his incentive package, recognizing that his decisions can appear to be self-serving.

If Wilson truly believes this outsourcing arrangement is in the best interest of the organization and shareholders, he needs to investigate the outsourcing arrangement with respect to the issues the committee raised: privacy and accuracy. If the committee has concerns, Wilson can be assured that patients and the community will have concerns as well. Section 1 of the statement requires members to provide decision support information that is accurate, clear, concise and timely. Wilson has more work to do in gathering information, testing the proposed system without using private information, and benchmarking against other hospitals.

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