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Self-Study Questions 315

Solution to Comprehensive Do it! Action Plan

(a) Relevant costs per unit would be:
• Determine the relevant cost per
Materials $500,000/5,000  $100 unit of the special order.
Labor 250,000/5,000  50 • Identify the relevant costs and
Variable overhead 100,000/5,000  20 revenues for the units to be
Selling expenses 5 produced.
Total relevant cost per unit $175 • Compare the results related
Net Income to accepting the special order
Reject Order Accept Order Increase (Decrease) versus rejecting the special
Revenues $0 $165,000 $165,000
order.
Costs 0 175,000 (175,000)
Net income $0 $ (10,000) $ (10,000)
(b) Walston should reject the offer. The incremental benefit of $165 per cabinet is less
than the incremental cost of $175. By accepting the order, Walston’s net income
would actually decline by $10,000.

Self-Study Questions
Answers are at the end of the chapter. (c) Variable costs only.
(SO 1) 1. Three of the steps in management’s decision-making (d) Fixed costs only.
process are (1) review results of decision, (2) deter- 5. It costs a company $14 of variable costs and $6 of (SO 3)
mine and evaluate possible courses of action, and fixed costs to produce product Z200 that sells for $30.
(3) make the decision. The steps are prepared in the A foreign buyer offers to purchase 3,000 units at $18
following order: each. If the special offer is accepted and produced
(a) (1), (2), (3). with unused capacity, net income will:
(b) (3), (2), (1). (a) decrease $6,000.
(c) (2), (1), (3). (b) increase $6,000.
(d) (2), (3), (1). (c) increase $12,000.
(SO 2) 2. Incremental analysis is the process of identifying the (d) increase $9,000.
financial data that: 6. It costs a company $14 of variable costs and $6 of (SO 3)
(a) do not change under alternative courses of action. fixed costs to produce product Z200. Product Z200
(b) change under alternative courses of action. sells for $30. A buyer offers to purchase 3,000 units
(c) are mixed under alternative courses of action. at $18 each. The seller will incur special shipping
(d) No correct answer is given. costs of $5 per unit. If the special offer is accepted
and produced with unused capacity, net income will:
(SO 1, 3. In making business decisions, management ordinarily
(a) increase $3,000.
2) considers:
(b) increase $12,000.
(a) quantitative factors but not qualitative factors.
(c) decrease $12,000.
(b) financial information only.
(d) decrease $3,000.
(c) both financial and nonfinancial information.
(d) relevant costs, opportunity costs, and sunk costs. 7. Jobart Company is currently operating at full capacity. (SO 3)
It is considering buying a part from an outside supplier
(SO 2) 4. A company is considering the following alternatives: rather than making it in-house. If Jobart purchases the
Alternative A Alternative B part, it can use the released productive capacity to gen-
erate additional income of $30,000 from producing a
Revenues $50,000 $50,000
different product. When conducting incremental analy-
Variable costs 24,000 24,000
sis in this make-or-buy decision, the company should:
Fixed costs 12,000 15,000
(a) ignore the $30,000.
Which of the following are relevant in choosing be- (b) add $30,000 to other costs in the “Make” column.
tween alternatives? (c) add $30,000 to other costs in the “Buy” column.
(a) Revenues, variable costs, and fixed costs. (d) subtract $30,000 from the other costs in the
(b) Variable costs and fixed costs. “Make” column.
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316 chapter 7 Incremental Analysis

(SO 4) 8. In a make-or-buy decision, relevant costs are: (d) Process further; net income per unit will be $1
(a) manufacturing costs that will be saved. greater.
(b) the purchase price of the units. 12. In a decision to retain or replace equipment, the book (SO 6)
(c) opportunity costs. value of the old equipment is a (an):
(d) all of the above. (a) opportunity cost.
(SO 4) 9. Derek is performing incremental analysis in a make- (b) sunk cost.
or-buy decision for Item X. If Derek buys Item X, he (c) incremental cost.
can use its released productive capacity to produce (d) marginal cost.
Item Z. Derek will sell Item Z for $12,000 and incur 13. If an unprofitable segment is eliminated: (SO 7)
production costs of $8,000. Derek’s incremental (a) net income will always increase.
analysis should include an opportunity cost of: (b) variable expenses of the eliminated segment will
(a) $12,000. have to be absorbed by other segments.
(b) $8,000. (c) fixed expenses allocated to the eliminated seg-
(c) $4,000. ment will have to be absorbed by other segments.
(d) $0. (d) net income will always decrease.
(SO 5) 10. The decision rule in a sell-or-process-further decision 14. A segment of Hazard Inc. has the following data. (SO 7)
is: process further as long as the incremental revenue
Sales $200,000
from processing exceeds:
Variable expenses 140,000
(a) incremental processing costs.
Fixed expenses 100,000
(b) variable processing costs.
(c) fixed processing costs. If this segment is eliminated, what will be the effect
(d) No correct answer is given. on the remaining company? Assume that 50% of the
fixed expenses will be eliminated and the rest will be
(SO 5) 11. Walton, Inc. makes an unassembled product that it
allocated to the segments of the remaining company.
currently sells for $55. Production costs are $20.
(a) $120,000 increase.
Walton is considering assembling the product and
(b) $10,000 decrease.
selling it for $68. The cost to assemble the product is
(c) $50,000 increase.
estimated at $12. What decision should Walton make?
(d) $10,000 increase.
(a) Sell before assembly; net income per unit will
be $12 greater.
(b) Sell before assembly; net income per unit will
be $1 greater. Go to the book’s companion website,
(c) Process further; net income per unit will be $13 www.wiley.com/college/weygandt,
greater. for Additional Self-Study Questions.

Questions
1. What steps are frequently involved in management’s 7. Define the term “opportunity cost.” How may this
decision-making process? cost be relevant in a make-or-buy decision?
2. Your roommate, Mike Myer, contends that account- 8. What is the decision rule in deciding whether to sell
ing contributes to most of the steps in management’s a product or process it further?
decision-making process. Is your roommate correct? 9. What are joint products? What accounting issue re-
Explain. sults from the production process that creates joint
3. “Incremental analysis involves the accumulation of products?
information concerning a single course of action.” Do 10. How are allocated joint costs treated when making a
you agree? Why? sell-or-process-further decision?
4. Sara Gura asks for your help concerning the rele- 11. Your roommate, Vanessa Hunt, is confused about
vance of variable and fixed costs in incremental sunk costs. Explain to your roommate the meaning of
analysis. Help Sara with her problem. sunk costs and their relevance to a decision to retain
5. What data are relevant in deciding whether to accept or replace equipment.
an order at a special price? 12. Erm Paris Inc. has one product line that is unprofitable.
6. Son Ly Company has an opportunity to buy parts at $7 What circumstances may cause overall company net
each that currently cost $10 to make. What manufac- income to be lower if the unprofitable product line is
turing costs are relevant to this make-or-buy decision? eliminated?
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Do it! Review 317

Brief Exercises
BE7-1 The steps in management’s decision-making process are listed in random order Identify the steps in
below. Indicate the order in which the steps should be executed. management’s decision-
making process.
________ Make a decision ________ Review results of the decision
________ Identify the problem and assign ________ Determine and evaluate possible (SO 1)
responsibility courses of action
BE7-2 Marlowe Company is considering two alternatives. Alternative A will have rev- Determine incremental
enues of $150,000 and costs of $100,000. Alternative B will have revenues of $185,000 changes.
and costs of $125,000. Compare Alternative A to Alternative B showing incremental rev- (SO 2)
enues, costs, and net income.
BE7-3 In Caan Company it costs $30 per unit ($20 variable and $10 fixed) to make a Determine whether to accept
product at full capacity that normally sells for $45. A foreign wholesaler offers to buy a special order.
3,000 units at $24 each. Caan will incur special shipping costs of $2 per unit. Assuming (SO 3)
that Caan has excess operating capacity, indicate the net income (loss) Caan would real-
ize by accepting the special order.
BE7-4 Lafluer Manufacturing incurs unit costs of $7.50 ($4.50 variable and $3 fixed) Determine whether to make
in making a sub-assembly part for its finished product. A supplier offers to make 10,000 or buy a part.
of the assembly part at $5 per unit. If the offer is accepted, Lafluer will save all variable (SO 4)
costs but no fixed costs. Prepare an analysis showing the total cost saving, if any, Lafluer
will realize by buying the part.
BE7-5 Bolus Inc. makes unfinished bookcases that it sells for $60. Production costs are Determine whether to sell or
$35 variable and $10 fixed. Because it has unused capacity, Bolus is considering finish- process further.
ing the bookcases and selling them for $70. Variable finishing costs are expected to be (SO 5)
$8 per unit with no increase in fixed costs. Prepare an analysis on a per unit basis show-
ing whether Bolus should sell unfinished or finished bookcases.
BE7-6 Each day, Zapp Corporation processes 1 ton of a secret raw material into two Determine whether to sell or
resulting products, AB1 and XY1. When it processes 1 ton of the raw material the com- process further, joint products.
pany incurs joint processing costs of $60,000. It allocates $25,000 of these costs to AB1 (SO 5)
and $35,000 of these costs to XY1. The resulting AB1 can be sold for $90,000. Alterna-
tively, it can be processed further to make AB2 at an additional processing cost of $50,000,
and sold for $150,000. Each day’s batch of XY1 can be sold for $90,000. Alternatively, it
can be processed further to create XY2, at an additional processing cost of $50,000, and
sold for $130,000. Discuss what products Zapp Corporation should make.
BE7-7 Russel Company has a factory machine with a book value of $90,000 and a Determine whether to retain
remaining useful life of 4 years. A new machine is available at a cost of $250,000. This or replace equipment.
machine will have a 4-year useful life with no salvage value. The new machine will lower (SO 6)
annual variable manufacturing costs from $600,000 to $500,000. Prepare an analysis
showing whether the old machine should be retained or replaced.
BE7-8 Gruner, Inc., manufactures golf clubs in three models. For the year, the Big Bart Determine whether to
line has a net loss of $5,000 from sales $200,000, variable costs $175,000, and fixed costs eliminate an unprofitable
$30,000. If the Big Bart line is eliminated, $20,000 of fixed costs will remain. Prepare an segment.
analysis showing whether the Big Bart line should be eliminated. (SO 7)

Do it! Review
Do it! 7-1 Corn Company incurs a cost of $35 per unit, of which $20 is variable, to Evaluate special order.
make a product that normally sells for $58. A foreign wholesaler offers to buy 6,000 units (SO 3)
at $31 each. Corn will incur additional costs of $2 per unit to imprint a logo and to pay
for shipping. Compute the increase or decrease in net income Corn will realize by ac-
cepting the special order, assuming Corn has sufficient excess operating capacity. Should
Corn Company accept the special order?
Do it! 7-2 Barney Company must decide whether to make or buy some of its com- Evaluate make-or-buy
ponents. The costs of producing 60,000 switches for its generators are as follows. opportunity.
Direct materials $30,000 Variable overhead $45,000 (SO 4)
Direct labor $42,000 Fixed overhead $60,000
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318 chapter 7 Incremental Analysis

Instead of making the switches at an average cost of $2.95 ($177,000  60,000), the com-
pany has an opportunity to buy the switches at $2.75 per unit. If the company purchases
the switches, all the variable costs and one-third of the fixed costs will be eliminated.
(a) Prepare an incremental analysis showing whether the company should make or buy
the switches. (b) Would your answer be different if the released productive capacity will
generate additional income of $30,000?
Sell or process further. Do it! 7-3 La Mesa manufactures unpainted furniture for the do-it-yourself (DIY)
(SO 5) market. It currently sells a table for $75. Production costs are $39 variable and $10 fixed.
La Mesa is considering staining and sealing the table to sell it for $99. Variable costs to
finish each table are expected to be $18, and fixed costs are expected to be $3.
Prepare an analysis showing whether La Mesa should sell unpainted or finished tables.
Analyze whether to eliminate Do it! 7-4 Lion Corporation manufactures several types of accessories. For the year,
unprofitable segment. the gloves and mittens line had sales of $500,000, variable expenses of $375,000, and fixed
(SO 7) expenses of $150,000. Therefore, the gloves and mittens line had a net loss of $25,000. If
Lion eliminates the line, $40,000 of fixed costs will remain.
Prepare an analysis showing whether the company should eliminate the gloves and
mittens line.

Exercises
Analyze statements about E7-1 Derauf has prepared the following list of statements about decision making and
decision making and incremental analysis.
incremental analysis. 1. The first step in management’s decision-making process is, “Determine and evaluate
(SO 1, 2) possible courses of action.”
2. The final step in management’s decision-making process is to actually make the
decision.
3. Accounting’s contribution to management’s decision-making process occurs primarily
in evaluating possible courses of action and in reviewing the results.
4. In making business decisions, management ordinarily considers only financial infor-
mation because it is objectively determined.
5. Decisions involve a choice among alternative courses of action.
6. The process used to identify the financial data that change under alternative courses
of action is called incremental analysis.
7. Costs that are the same under all alternative courses of action sometimes affect the
decision.
8. When using incremental analysis, some costs will always change under alternative
courses of action, but revenues will not.
9. Variable costs will change under alternative courses of action, but fixed costs will not.

Instructions
Identify each statement as true or false. If false, indicate how to correct the statement.
Use incremental analysis E7-2 Gruner Company produces golf discs which it normally sells to retailers for $7
for special-order decision. each. The cost of manufacturing 20,000 golf discs is:
(SO 3) Materials $ 10,000
Labor 30,000
Variable overhead 20,000
Fixed overhead 40,000
Total $100,000

Gruner also incurs 5% sales commission ($0.35) on each disc sold.

Travis Corporation offers Gruner $4.75 per disc for 5,000 discs. Travis would sell the
discs under its own brand name in foreign markets not yet served by Gruner. If Gruner
accepts the offer, its fixed overhead will increase from $40,000 to $45,000 due to the
purchase of a new imprinting machine. No sales commission will result from the special
order.
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Exercises 319

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Gruner accept the special order? Why or why not?
(c) What assumptions underlie the decision made in part (b)?

E7-3 Shandling Company manufactures toasters. For the first 8 months of 2011, the com- Use incremental analysis for
pany reported the following operating results while operating at 75% of plant capacity: special order.
(SO 3)
Sales (350,000 units) $4,375,000
Cost of goods sold 2,500,000
Gross profit 1,875,000
Operating expenses 875,000
Net income $1,000,000

Cost of goods sold was 70% variable and 30% fixed; operating expenses were also 70%
variable and 30% fixed.
In September, Shandling Company receives a special order for 15,000 toasters at
$7.50 each from Bierko Company of Mexico City. Acceptance of the order would result
in an additional $3,000 of shipping costs but no increase in fixed operating expenses.

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Shandling Company accept the special order? Why or why not?

E7-4 Tough Fiber Company is the creator of Y-Go, a technology that weaves silver Use incremental analysis
into its fabrics to kill bacteria and odor on clothing while managing heat. Y-Go has be- for special order.
come very popular as an undergarment for sports activities. Operating at capacity, the (SO 3)
company can produce 1,000,000 undergarments of Y-Go a year. The per unit and the
total costs for an individual garment when the company operates at full capacity are
as follows.
Per Undergarment Total
Direct materials $2.00 $2,000,000
Direct labor 0.50 500,000
Variable manufacturing overhead 1.00 1,000,000
Fixed manufacturing overhead 1.50 1,500,000
Variable selling expenses 0.25 250,000
Totals $5.25 $5,250,000

The U.S. Army has approached Tough Fiber and expressed an interest in purchasing
200,000 Y-Go undergarments for soldiers in extremely warm climates. The Army would
pay the unit cost for direct materials, direct labor, and variable manufacturing overhead
costs. In addition, the Army has agreed to pay an additional $1 per undergarment to cover
all other costs and provide a profit. Presently, Tough Fiber is operating at 70 percent ca-
pacity and does not have any other potential buyers for Y-Go. If Tough Fiber accepts the
Army’s offer, it will not incur any variable selling expenses related to this order.

Instructions
Using incremental analysis, determine whether Tough Fiber should accept the Army’s
offer.

E7-5 Swayze Inc. has been manufacturing its own shades for its table lamps. The com- Use incremental analysis for
pany is currently operating at 100% of capacity, and variable manufacturing overhead is make-or-buy decision.
charged to production at the rate of 70% of direct labor cost. The direct materials and (SO 4)
direct labor cost per unit to make the lamp shades are $5 and $6, respectively. Normal
production is 30,000 table lamps per year.
A supplier offers to make the lamp shades at a price of $15.50 per unit. If Swayze
Inc. accepts the supplier’s offer, all variable manufacturing costs will be eliminated, but
the $45,000 of fixed manufacturing overhead currently being charged to the lamp shades
will have to be absorbed by other products.
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320 chapter 7 Incremental Analysis

Instructions
(a) Prepare the incremental analysis for the decision to make or buy the lamp shades.
(b) Should Swayze Inc. buy the lamp shades?
(c) Would your answer be different in (b) if the productive capacity released
by not making the lamp shades could be used to produce income of $35,000?

Use incremental analysis for E7-6 Selleck has recently started the manufacture of RecRobo, a three-wheeled robot
make-or-buy decision. that can scan a home for fires and gas leaks and then transmit this information to a mobile
(SO 4) phone. The cost structure to manufacture 20,000 RecRobo’s is as follows.
Cost
Direct materials ($40 per robot) $ 800,000
Direct labor ($30 per robot) 600,000
Variable overhead ($6 per robot) 120,000
Allocated fixed overhead ($25 per robot) 500,000
Total $2,020,000

Selleck is approached by Padong Inc., which offers to make RecRobo for $90 per unit
or $1,800,000.
Instructions
(a) Using incremental analysis, determine whether Selleck should accept this offer under
each of the following independent assumptions.
(1) Assume that $300,000 of the fixed overhead cost can be reduced (avoided).
(2) Assume that none of the fixed overhead can be reduced (avoided). However, if
the robots are purchased from Padong Inc., Selleck can use the released produc-
tive resources to generate additional income of $300,000.
(b) Describe the qualitative factors that might affect the decision to purchase the robots
from an outside supplier.

Prepare incremental analysis E7-7 Harmon Company purchases sails and produces sailboats. It currently produces
for make-or-buy decision. 1,200 sailboats per year, operating at normal capacity, which is about 80% of full capacity.
(SO 4) Harmon purchases sails at $260 each, but the company is considering using the excess
capacity to manufacture the sails instead. The manufacturing cost per sail would be $100
for materials, $80 for direct labor, and $100 for overhead. The $100 overhead is based
on $72,000 of annual fixed overhead that is allocated using normal capacity.
The president of Harmon has come to you for advice. “It would cost me $280 to make
the sails,” she says, “but only $260 to buy them. Should I continue buying them, or have
I missed something?”
Instructions
(a) Prepare a per unit analysis of the differential costs. Briefly explain whether Harmon
should make or buy the sales.
(b) If Harmon suddenly finds an opportunity to rent out the unused capacity of its fac-
tory for $80,000 per year, would your answer to part (a) change? Briefly explain.
(c) Identify three qualitative factors that should be considered by Harmon in this make-
or-buy decision.
(CGA adapted)

Prepare incremental analysis E7-8 Interdesign uses 1,000 units of the component IMC2 every month to manufacture
concerning make-or-buy one of its products. The unit costs incurred to manufacture the component are as follows:
decision.
(SO 4) Direct materials $ 65.00
Direct labor 48.00
Overhead 126.50
Total $239.50

Overhead costs include variable material handling costs of $6.50, which are applied to
products on the basis of direct material costs. The remainder of the overhead costs are
applied on the basis of direct labor dollars and consist of 50% variable costs and 50%
fixed costs.
A vendor has offered to supply the IMC2 component at a price of $200 per unit.
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Exercises 321

Instructions
(a) Should Interdesign purchase the component from the outside vendor if Interdesign’s
capacity remains idle?
(b) Should Interdesign purchase the component from the outside vendor if it can use its
facilities to manufacture another product? What information will Interdesign need
to make an accurate decision? Show your calculations.
(c) What are the qualitative factors that Interdesign will have to consider when making
this decision?
(CGA adapted)
E7-9 Lori Luthen recently opened her own basketweaving studio. She sells finished Use incremental analysis
baskets in addition to the raw materials needed by customers to weave baskets of their own. for further processing of
Lori has put together a variety of raw material kits, each including materials at various materials decision.
stages of completion. Unfortunately, owing to space limitations, Lori is unable to carry all (SO 5)
varieties of kits originally assembled and must choose between two basic packages.
The basic introductory kit includes undyed, uncut reeds (with dye included) for weav-
ing one basket. This basic package costs Lori $14 and sells for $28. The second kit, called
Stage 2, includes cut reeds that have already been dyed. With this kit the customer need
only soak the reeds and weave the basket. Lori is able to produce the second kit by using
the basic materials included in the first kit and adding one hour of her own time, which
she values at $20 per hour. Because she is more efficient at cutting and dying reeds than
her average customer, Lori is able to make two kits of the dyed reeds, in one hour, from
one kit of undyed reeds. The Stage 2 kit sells for $35.
Instructions
Determine whether Lori’s basketweaving shop should carry the basic introductory kit
with undyed and uncut reeds or the Stage 2 kit with reeds already dyed and cut. Prepare
an incremental analysis to support your answer.
E7-10 Schultz, Inc. produces three separate products from a common process costing Determine whether to sell
$100,000. Each of the products can be sold at the split-off point or can be processed further or process further, joint
and then sold for a higher price. Shown below are cost and selling price data for a recent products.
period. (SO 5)

Sales Value Cost to Sales Value

at Split-off Process after Further
Point Further Processing
Product 12 $50,000 $100,000 $190,000
Product 14 10,000 30,000 35,000
Product 16 60,000 150,000 220,000
Instructions
(a) Determine total net income if all products are sold at the split-off point.
(b) Determine total net income if all products are sold after further processing.
(c) Using incremental analysis, determine which products should be sold at the split-off
point and which should be processed further.
(d) Determine total net income using the results from (c) and explain why the net in-
come is different from that determined in (b).
E7-11 Chan Minerals processes materials extracted from mines. The most common raw Determine whether to sell or
material that it processes results in three joint products: Sarco, Barco, and Larco. Each process further, joint
of these products can be sold as is, or it can be processed further and sold for a higher products.
price. The company incurs joint costs of $180,000 to process one batch of the raw ma- (SO 5)
terial that produces the three joint products. The following cost and sales information is
available for one batch of each product.
Sales Value at Allocated Cost to Process Sales Value of
Split-off Point Joint Costs Further Processed Product
Sarco $200,000 $40,000 $120,000 $300,000
Barco 300,000 60,000 89,000 400,000
Larco 400,000 80,000 250,000 800,000
Instructions
Determine whether each of the three joint products should be sold as is, or processed further.
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322 chapter 7 Incremental Analysis

Prepare incremental analysis E7-12 A company manufactures three products using the same production process. The
for whether to sell or process costs incurred up to the split-off point are $200,000. These costs are allocated to the prod-
materials further. ucts on the basis of their sales value at the split-off point. The number of units produced,
(SO 5) the selling prices per unit of the three products at the split-off point and after further
processing, and the additional processing costs are as follows:
Number of Selling Price Selling Price Additional
Product Units Produced at Split-off after Processing Processing Costs
A 3,000 $10.00 $15.00 $14,000
B 6,000 11.60 16.20 16,000
C 2,000 19.40 21.60 9,000
Instructions
(a) Which information is relevant to the decision on whether or not to process the prod-
ucts further? Explain why this information is relevant.
(b) Which product(s) should be processed further and which should be sold at the split-
off point?
(c) Would your decision be different if the company was using the quantity of output to
allocate joint costs? Explain.
(CGA adapted)
Use incremental analysis E7-13 On January 2, 2011, Kinnaird Hospital purchased a $100,000 special radiology
for retaining or replacing scanner from Rickard Inc. The scanner has a useful life of 5 years and will have no dis-
equipment decision. posal value at the end of its useful life. The straight-line method of depreciation is used
(SO 6) on this scanner. Annual operating costs with this scanner are $105,000.
Approximately one year later, the hospital is approached by Harmon Technology sales-
person, Jane Black, who indicated that purchasing the scanner in 2011 from Rickard Inc.
was a mistake. She points out that Harmon has a scanner that will save Kinnaird Hos-
pital $27,000 a year in operating expenses over its 4-year useful life. She notes that the
new scanner will cost $120,000 and has the same capabilities as the scanner purchased
last year. The hospital agrees that both scanners are of equal quality. The new scanner
will have no disposal value. Black agrees to buy the old scanner from Kinnaird Hospital
for $30,000.
Instructions
(a) If Kinnaird Hospital sells its old scanner on January 2, 2012, compute the gain or
loss on the sale.
(b) Using incremental analysis, determine if Kinnaird Hospital should purchase the new
scanner on January 2, 2012.
(c) Explain why Kinnaird Hospital might be reluctant to purchase the new scanner, re-
gardless of the results indicated by the incremental analysis in (b).
Use incremental analysis E7-14 Huckeby Enterprises uses a computer to handle its sales invoices. Lately, busi-
for retaining or replacing ness has been so good that it takes an extra 3 hours per night, plus every third Saturday,
equipment decision. to keep up with the volume of sales invoices. Management is considering updating its
(SO 6) computer with a faster model that would eliminate all of the overtime processing.
Current Machine New Machine
Original purchase cost $15,000 $25,000
Accumulated depreciation $ 6,000 —
Estimated annual operating costs $24,000 $18,000
Useful life 5 years 5 years
If sold now, the current machine would have a salvage value of $5,000. If operated for
the remainder of its useful life, the current machine would have zero salvage value. The
new machine is expected to have zero salvage value after five years.
Instructions
Should the current machine be replaced?
Use incremental analysis E7-15 Mary Myers, a recent graduate of Rolling’s accounting program, evaluated the
concerning elimination of operating performance of Shaw Company’s six divisions. Mary made the following pres-
division. entation to Shaw’s Board of Directors and suggested the Erie Division be eliminated. “If
(SO 7) the Erie Division is eliminated,” she said, “our total profits would increase by $24,500.”
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Exercises 323

The Other Erie

Five Divisions Division Total
Sales $1,664,200 $100,000 $1,764,200
Cost of goods sold 978,520 76,500 1,055,020
Gross profit 685,680 23,500 709,180
Operating expenses 527,940 48,000 575,940
Net income $ 157,740 $ (24,500) $ 133,240

In the Erie Division, cost of goods sold is $60,000 variable and $16,500 fixed, and operat-
ing expenses are $25,000 variable and $23,000 fixed. None of the Erie Division’s fixed
costs will be eliminated if the division is discontinued.
Instructions
Is Mary right about eliminating the Erie Division? Prepare a schedule to sup-
port your answer.
E7-16 Nichols Company makes three models of phasers. Information on the three prod- Use incremental analysis for
ucts is given below. elimination of a product line.
(SO 7)
Stunner Double-Set Mega-Power
Sales $300,000 $500,000 $200,000
Variable expenses 150,000 200,000 140,000
Contribution margin 150,000 300,000 60,000
Fixed expenses 120,000 225,000 90,000
Net income $ 30,000 $ 75,000 $ (30,000)

Fixed expenses consist of $300,000 of common costs allocated to the three products based
on relative sales, and additional fixed expenses of $30,000 (Stunner), $75,000 (Double-
Set), and $30,000 (Mega-Power). The common costs will be incurred regardless of how
many models are produced. The other fixed expenses would be eliminated if a model is
phased out.
Ralph Port, an executive with the company, feels the Mega-Power line should be dis-
continued to increase the company’s net income.
Instructions
(a) Compute current net income for Nichols Company.
(b) Compute net income by product line and in total for Nichols Company if the com-
pany discontinues the Mega-Power product line. (Hint: Allocate the $300,000 com-
mon costs to the two remaining product lines based on their relative sales.)
(c) Should Nichols eliminate the Mega-Power product line? Why or why not?
E7-17 Straus Company operates a small factory in which it manufactures two prod- Prepare incremental analysis
ucts: A and B. Production and sales results for last year were as follows: concerning keeping or
dropping a product to
A B maximize operating income.
Units sold 8,000 20,000 (SO 2, 7)
Selling price per unit $95 $78
Variable costs per unit 50 45
Fixed costs per unit 22 22
For purposes of simplicity, the firm averages total fixed costs over the total number of
units of A and B produced and sold.
The research department has developed a new product (C) as a replacement for prod-
uct B. Market studies show that Straus Company could sell 11,000 units of C next year
at a price of $120; the variable costs per unit of C are $42. The introduction of product C
will lead to a 10% increase in demand for product A and discontinuation of product B.
If the company does not introduce the new product, it expects next year’s results to be the
same as last year’s.
Instructions
Should Straus Company introduce product C next year? Explain why or why not. Show
calculations to support your decision.
(CMA-Canada adapted)
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324 chapter 7 Incremental Analysis

Identify relevant costs for E7-18 The costs listed below relate to a variety of different decision situations.
different decisions.
Cost Decision
(SO 3, 4, 5, 6, 7)
1. Unavoidable fixed overhead Eliminate an unprofitable segment
2. Direct labor Make or buy
3. Original cost of old equipment Equipment replacement
4. Joint production costs Sell or process further
5. Opportunity cost Accepting a special order
6. Segment manager’s salary Eliminate an unprofitable segment.
Manager will be terminated.
7. Cost of new equipment Equipment replacement
8. Incremental production costs Sell or process further
9. Direct materials Equipment replacement. The amount
of materials required does not change.
10. Rent expense Purchase or lease a building
Instructions
For each cost listed above, indicate if it is relevant or not to the related decision. For
those costs determined to be irrelevant, briefly explain why.

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Exercises: Set B

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Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the

Student Companion site, to access Exercise Set B.

Problems: Set A
Use incremental analysis for P7-1A Hyper Sports Inc. manufactures basketballs for the National Basketball Associa-
special order and identify tion (NBA). For the first 6 months of 2011, the company reported the following operating
nonfinancial factors in the results while operating at 90% of plant capacity and producing 112,500 units.
decision.
(SO 3) Amount
Sales $4,500,000
Cost of goods sold 3,600,000
Selling and administrative expenses 450,000
Net income $ 450,000

Fixed costs for the period were: cost of goods sold $1,080,000, and selling and adminis-
trative expenses $225,000.
In July, normally a slack manufacturing month, Hyper Sports receives a special order
for 10,000 basketballs at $28 each from the Italian Basketball Association (IBA). Accep-
tance of the order would increase variable selling and administrative expenses $0.50 per
unit because of shipping costs but would not increase fixed costs and expenses.

Instructions
(a) NI increase $31,000 (a) Prepare an incremental analysis for the special order.
(b) Should Hyper Sports Inc. accept the special order? Explain your answer.
(c) What is the minimum selling price on the special order to produce net income of
$4.10 per ball?
(d) What nonfinancial factors should management consider in making its
decision?
Use incremental analysis
related to make or buy, P7-2A The management of Sherrer Manufacturing Company is trying to decide whether
consider opportunity cost, to continue manufacturing a part or to buy it from an outside supplier. The part, called
and identify nonfinancial WISCO, is a component of the company’s finished product.
factors. The following information was collected from the accounting records and produc-
(SO 4) tion data for the year ending December 31, 2011.
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Problems: Set A 325

1. 7,000 units of WISCO were produced in the Machining Department.

2. Variable manufacturing costs applicable to the production of each WISCO unit were:
direct materials $4.80, direct labor $4.30, indirect labor $0.43, utilities $0.40.
3. Fixed manufacturing costs applicable to the production of WISCO were:
Cost Item Direct Allocated
Depreciation $2,100 $ 900
Property taxes 500 200
Insurance 900 600
$3,500 $1,700

All variable manufacturing and direct fixed costs will be eliminated if WISCO is pur-
chased. Allocated costs will have to be absorbed by other production departments.
4. The lowest quotation for 7,000 WISCO units from a supplier is $70,000.
5. If WISCO units are purchased, freight and inspection costs would be $0.40 per unit, and
receiving costs totaling $1,250 per year would be incurred by the Machining Department.

Instructions
(a) Prepare an incremental analysis for WISCO. Your analysis should have columns for (a) NI (decrease) $(1,040)
(1) Make WISCO, (2) Buy WISCO, and (3) Net Income Increase/(Decrease).
(b) Based on your analysis, what decision should management make?
(c) Would the decision be different if Sherrer Company has the opportunity to produce (c) NI increase $3,960
$5,000 of net income with the facilities currently being used to manufacture WISCO?
Show computations.
(d) What nonfinancial factors should management consider in making its
decision?
P7-3A Milton Industrial Products Co. (MIPC) is a diversified industrial-cleaner process- Determine if product should
ing company. The company’s Verde plant produces two products: a table cleaner and a be sold or processed further.
floor cleaner from a common set of chemical inputs (CDG). Each week 900,000 ounces (SO 5)
of chemical input are processed at a cost of $210,000 into 600,000 ounces of floor cleaner
and 300,000 ounces of table cleaner. The floor cleaner has no market value until it is con-
verted into a polish with the trade name FloorShine. The additional processing costs for
this conversion amount to $250,000.
FloorShine sells at $20 per 30-ounce bottle. The table cleaner can be sold for $25 per
30-ounce bottle. However, the table cleaner can be converted into two other products by
adding 300,000 ounces of another compound (TCP) to the 300,000 ounces of table cleaner.
This joint process will yield 300,000 ounces each of table stain remover (TSR) and table
polish (TP). The additional processing costs for this process amount to $100,000. Both
table products can be sold for $18 per 30-ounce bottle.
The company decided not to process the table cleaner into TSR and TP based on the
following analysis.
Process Further
Table Stain
Table Remover Table Polish
Cleaner (TSR) (TP) Total
Production in ounces 300,000 300,000 300,000
Revenue $250,000 $180,000 $180,000 $360,000
Costs:
CDG costs 70,000* 52,500 52,500 105,000**
TCP costs 0 50,000 50,000 100,000
Total costs 70,000 102,500 102,500 205,000
Weekly gross profit $180,000 $ 77,500 $ 77,500 $155,000

*If table cleaner is not processed further, it is allocated 1/3 of the $210,000 of CDG cost,
which is equal to 1/3 of the total physical output.
**If table cleaner is processed further, total physical output is 1,200,000 ounces. TSR and
TP combined account for 50% of the total physical output and are each allocated 25%
of the CDG cost.
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326 chapter 7 Incremental Analysis

Instructions
(a) Determine if management made the correct decision to not process the table cleaner
further by doing the following.
(1) Calculate the company’s total weekly gross profit assuming the table cleaner is
not processed further.
(2) Gross profit $200,000 (2) Calculate the company’s total weekly gross profit assuming the table cleaner is
processed further.
(3) Compare the resulting net incomes and comment on management’s decision.
(b) Using incremental analysis, determine if the table cleaner should be processed further.
(CMA adapted)
Compute gain or loss, and P7-4A Last year (2011) Solomon Condos installed a mechanized elevator for its tenants.
determine if equipment The owner of the company, Sam Solomon, recently returned from an industry equip-
should be replaced. ment exhibition where he watched a computerized elevator demonstrated. He was im-
(SO 6) pressed with the elevator’s speed, comfort of ride, and cost efficiency. Upon returning
from the exhibition, he asked his purchasing agent to collect price and operating cost
data on the new elevator. In addition, he asked the company’s accountant to provide
him with cost data on the company’s elevator. This information is presented below.

Old Elevator New Elevator

Purchase price $120,000 $180,000
Estimated salvage value 0 0
Estimated useful life 6 years 5 years
Depreciation method Straight-line Straight-line
Annual operating costs
other than depreciation:
Variable $ 35,000 $ 12,000
Fixed 23,000 8,400

Annual revenues are $240,000, and selling and administrative expenses are $29,000,
regardless of which elevator is used. If the old elevator is replaced now, at the beginning
of 2012, Solomon Condos will be able to sell it for $25,000.
Instructions
(a) Determine any gain or loss if the old elevator is replaced.
(b) Prepare a 5-year summarized income statement for each of the following assumptions:
(1) The old elevator is retained.
(b)(2) NI $698,000 (2) The old elevator is replaced.
(c) NI increase $33,000 (c) Using incremental analysis, determine if the old elevator should be replaced.
(d) Write a memo to Sam Solomon explaining why any gain or loss should be
ignored in the decision to replace the old elevator.
Prepare incremental analysis P7-5A Moreno Manufacturing Company has four operating divisions. During the first
concerning elimination quarter of 2011, the company reported aggregate income from operations of $176,000
of divisions. and the following divisional results.
(SO 7)
Division
I II III IV
Sales $250,000 $200,000 $500,000 $400,000
Cost of goods sold 200,000 189,000 300,000 250,000
Selling and administrative expenses 65,000 60,000 60,000 50,000
Income (loss) from operations $ (15,000) $ (49,000) $140,000 $100,000

Analysis reveals the following percentages of variable costs in each division.

I II III IV
Cost of goods sold 70% 90% 80% 75%
Selling and administrative expenses 40 70 50 60

Discontinuance of any division would save 50% of the fixed costs and expenses for that
division.
Top management is very concerned about the unprofitable divisions (I and II). Con-
sensus is that one or both of the divisions should be discontinued.
JWCL162_c07_296-335.qxd 7/30/09 7:07 PM Page 327

Problems: Set B 327

Instructions
(a) Compute the contribution margin for Divisions I and II. (a) I $84,000
(b) Prepare an incremental analysis concerning the possible discontinuance of (1) Division
I and (2) Division II. What course of action do you recommend for each division?
(c) Prepare a columnar condensed income statement for Moreno Manufacturing, assum- (c) Income III $133,850
ing Division II is eliminated. Use the CVP format. Division II’s unavoidable fixed costs
are allocated equally to the continuing divisions.
(d) Reconcile the total income from operations ($176,000) with the total income from
operations without Division II.

Problems: Set B
P7-1B Haslett Inc. manufactures basketballs for the National Basketball Association Use incremental analysis for
(NBA). For the first 6 months of 2011, the company reported the following operating re- special order and identify
sults while operating at 90% of plant capacity. nonfinancial factors in
decision.
Amount Per Unit (SO 3)
Sales $4,500,000 $50
Cost of goods sold 3,150,000 35
Selling and administrative expenses 360,000 4
Net income $ 990,000 $11

Fixed costs for the period were: cost of goods sold $900,000, and selling and administra-
tive expenses $135,000.
In July, normally a slack manufacturing month, Haslett receives a special order for
9,000 basketballs at $32 each from the European Basketball Association (EBA). Accep-
tance of the order would increase variable selling and administrative expenses $0.50 per
unit because of shipping costs but would not increase fixed costs and expenses.

Instructions
(a) Prepare an incremental analysis for the special order. (a) NI increase $36,000
(b) Should Haslett Inc. accept the special order?
(c) What is the minimum selling price on the special order to produce net income of
$5.00 per ball?
(d) What nonfinancial factors should management consider in making its
decision?

P7-2B The management of Finnigan Manufacturing Company is trying to decide whether Use incremental analysis
to continue manufacturing a part or to buy it from an outside supplier. The part, called related to make or buy;
BIZBE, is a component of the company’s finished product. consider opportunity cost
The following information was collected from the accounting records and produc- and identify nonfinancial
tion data for the year ending December 31, 2011. factors.
(SO 4)
1. 6,000 units of BIZBE were produced in the Machining Department.
2. Variable manufacturing costs applicable to the production of each BIZBE unit were:
direct materials $4.75, direct labor $4.60, indirect labor $0.45, utilities $0.35.
3. Fixed manufacturing costs applicable to the production of BIZBE were:

Cost Item Direct Allocated

Depreciation $1,100 $ 900
Property taxes 500 200
Insurance 900 600
$2,500 $1,700

All variable manufacturing and direct fixed costs will be eliminated if BIZBE is pur-
chased. Allocated costs will have to be absorbed by other production departments.
4. The lowest quotation for 6,000 BIZBE units from a supplier is $66,000.
5. If BIZBE units are purchased, freight and inspection costs would be $0.30 per unit,
and receiving costs totaling $750 per year would be incurred by the Machining
Department.
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328 chapter 7 Incremental Analysis

Instructions
(a) NI (decrease) ($5,150) (a) Prepare an incremental analysis for BIZBE. Your analysis should have columns for
(1) Make BIZBE, (2) Buy BIZBE, and (3) Net Income Increase/Decrease.
(b) Based on your analysis, what decision should management make?
(c) NI increase $850 (c) Would the decision be different if Finnegan Company has the opportunity to pro-
duce $6,000 of net income with the facilities currently being used to manufacture
BIZBE? Show computations.
(d) What nonfinancial factors should management consider in making its
decision?

Determine if product should P7-3B Indiana Household Products Co. (IHPC) is a diversified household-cleaner pro-
be sold or processed further. cessing company. The company’s Mishawaka plant produces two products: an appliance
(SO 5) cleaner and a general-purpose cleaner from a common set of chemical inputs (NPR).
Each week 1,000,000 ounces of chemical input are processed at a cost of $200,000 into
750,000 ounces of appliance cleaner and 250,000 ounces of general-purpose cleaner.
The appliance cleaner has no market value until it is converted into a polish with the
trade name Shine Brite. The additional processing costs for this conversion amount to
$270,000. Shine Brite sells at $15 per 25-ounce bottle. The general-purpose cleaner can
be sold for $24 per 25-ounce bottle. However, the general-purpose cleaner can be con-
verted into two other products by adding 250,000 ounces of another compound (PST) to
the 250,000 ounces of general-purpose cleaner. This joint process will yield 250,000 ounces
each of premium cleaner (PC) and premium stain remover (PSR). The additional pro-
cessing costs for this process amount to $140,000. Both premium products can be sold
for $20 per 25-ounce bottle.
The company decided not to process the general-purpose cleaner into PC and PSR
based on the following analysis.

Process Further
General- Premium Premium Stain
Purpose Cleaner Remover
Cleaner (PC) (PSR) Total
Production in ounces 250,000 250,000 250,000
Revenue $240,000 $200,000 $200,000 $400,000
Costs:
NPR costs 50,000* 40,000 40,000 80,000**
PST costs 0 70,000 70,000 140,000
Total costs 50,000 110,000 110,000 220,000
Weekly gross profit $190,000 $ 90,000 $ 90,000 $180,000

*If general-purpose cleaner is not processed further, it is allocated 1/4 of the $200,000 of
NPR cost, which is equal to 1/4 of the total physical output.
**If general-purpose cleaner is processed further, total physical output is 1,250,000
ounces. PC and PSR combined account for 40% of the total output and are each allo-
cated 20% of the NPR cost.

Instructions
(a) Determine if management made the correct decision to not process the general-
purpose cleaner further by doing the following.
(1) Calculate the company’s total weekly gross profit assuming the general-purpose
cleaner is not processed further.
(a)(2) Gross profit $240,000 (2) Calculate the company’s total weekly gross profit assuming the general-purpose
cleaner is processed further.
(3) Compare the resulting net incomes and comment on management’s decision.
(b) Using incremental analysis, determine if the general-purpose cleaner should be
Compute gain or loss, processed further.
and determine if (CMA adapted)
equipment should
be replaced. P7-4B Last year (2011) Bourne Company installed new factory equipment. The owner
(SO 6) of the company, Jason Bourne, recently returned from an industry equipment exhibition
JWCL162_c07_296-335.qxd 7/30/09 7:07 PM Page 329

Problems: Set B 329

where he watched computerized equipment demonstrated. He was impressed with the

equipment’s speed and cost efficiency. Upon returning from the exhibition, he asked his
purchasing agent to collect price and operating cost data on the new equipment. In ad-
dition, he asked the company’s accountant to provide him with cost data on the com-
pany’s equipment. This information is presented below.

Old Equipment New Equipment

Purchase price $210,000 $270,000
Estimated salvage value 0 0
Estimated useful life 6 years 5 years
Depreciation method Straight-line Straight-line
Annual operating costs
other than depreciation:
Variable $50,000 $15,000
Fixed 30,000 8,000

Annual revenues are $360,000, and selling and administrative expenses are $45,000,
regardless of which equipment is used. If the old equipment is replaced now, at the be-
ginning of 2012, Bourne Company will be able to sell it for $38,000.

Instructions
(a) Determine any gain or loss if the old equipment is replaced.
(b) Prepare a 5-year summarized income statement for each of the following assumptions:
(1) The old equipment is retained.
(2) The old equipment is replaced. (b) (2) NI $1,053,000
(c) Using incremental analysis, determine if the old equipment should be replaced. (c) NI increase $53,000
(d) Write a memo to Jason Bourne explaining why any gain or loss should be
ignored in the decision to replace the old equipment.

P7-5B Tryon Manufacturing Company has four operating divisions. During the first Prepare incremental analysis
quarter of 2011, the company reported aggregate income from operations of $135,000 concerning elimination
and the divisional results shown below. of divisions.
(SO 7)
Division
I II III IV
Sales $510,000 $390,000 $310,000 $170,000
Cost of goods sold 300,000 250,000 270,000 150,000
Selling and administrative expenses 60,000 80,000 65,000 70,000
Income (loss) from operations $150,000 $ 60,000 $ (25,000) $ (50,000)

Analysis reveals the following percentages of variable costs in each division.

I II III IV
Cost of goods sold 70% 80% 75% 90%
Selling and administrative expenses 40 50 60 70

Discontinuance of any division would save 50% of the fixed costs and expenses for that
division.
Top management is very concerned about the unprofitable divisions (III and IV). Con-
sensus is that one or both of the divisions should be discontinued.

Instructions
(a) Compute the contribution margin for Divisions III and IV. (a) III $68,500
(b) Prepare an incremental analysis concerning the possible discontinuance of (1) Divi-
sion III and (2) Division IV. What course of action do you recommend for each
division?
(c) Prepare a columnar condensed income statement for Tryon Manufacturing, assum- (c) II $54,000
ing Division IV is eliminated. Use the CVP format. Division IV’s unavoidable fixed
costs are allocated equally to the continuing divisions.
(d) Reconcile the total income from operations ($135,000) with the total income from
operations without Division IV.