Chapter 21 Chat Problems

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Opportunity cost Sunk cost Out-of-pocket cost Split-off point Joint products Relevant information Incremental analysis a. Examination of differences between costs to be incurred and revenue to be earned under different courses b. A cost incurred in the past that cannot be changed as a result of future actions. c. Costs and revenue that are expected to vary, depending on the course of action decided on. d. The benefit foregone by not pursuing an alternative course of action. e. Products made from common raw materials and shared production processes. f. A cost yet to be incurred that will require future payment and may vary among alternative courses of action g. Let's use this first qualitative exercise to help build our theoretical foundation for this chapter: Each of the following statements may (or may not) describe one of these technical terms. For each statement, indicate the accounting term described, or answer “None” if the statement does not correctly describe any of the terms. The point at which manufacturing costs are split equally between ending inventory and cost of goods sold.

s of action. Incremental Analysis Sunk cost relevant information opportunity cost joint products n. out-of pockets cost none

Special Order: Direct materials $ 5 Direct labor $ 2 Variable factory overhead $ 4 Fixed factory overhead (average cost per unit) $ 3 Total $ 14 Visionary Game Company sells 600,000 units per year of a particular video game at $20 each. The current unit cost of the game is broken down as follows. At the beginning of the current year, Visionary received a special order for 12,000 of these games per month, for one year only, at a sales price of $11 per unit. To fill the order, Visionary will have to rent additional assembly space at a cost of $18,000 ($1,500 per month). Compute the estimated increase or decrease in annual operating income that will result from accepting this special order.

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Incremental revenue $ 1,584,000 Less: incremental cost Direct material $ 720,000 Direct labor $ 288,000 variabke overhead $ 576,000 additional space $ 18,000 Incremental profit/loss $ (18,000) Reject because we would have 18000 l DR. LITT'S ADDITION: Instead of renting the additional space, the company can choose to give up 2,000 of regular video game sales per month to have the capacity to meet this special order. Incremental revenue $ 1,584,000 Less: incremental cost Direct material $ 720,000 Direct labor $ 288,000 variabke overhead $ 576,000 opportunity cost (taking special order) $ 216,000 incremental profit/loss $ (216,000) Reject SPECIAL ORDERS: Compare additional/incremental revenues with additional/incremental costs

loss

Make or Buy: Direct materials $ 156,000 Direct labor $ 132,000 Manufacturing Overhead Variable $ 168,000 Fixed $ 144,000 Total $ 600,000 Cost per unit ($600,000/80,000 units) $ 7.50 OR Parsons Plumbing & Heating manufactures thermostats that it uses in several of its products. Management is considering whether to continue manufacturing the thermostats or to buy them from an outside source. The following information is available. 1. The company needs 80,000 thermostats per year. Thermostats can be purchased from an outside supplier at a cost of $6 per unit. 2. The cost of manufacturing thermostats is $7.50 per unit, computed as follows. 3. Discontinuing the manufacture of the thermostats will eliminate all of the direct materials and direct labor costs but will eliminate only 60 percent of the variable overhead costs. 4. If the thermostats are purchased from an outside source, certain machinery used in the production process would no longer have to be leased. Accordingly, $9,200 of fixed overhead costs could be avoided. No other reductions will result from discontinuing production of the thermostats.

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Costs Make Buy Incremental Cost/Benefit Direct material $ 156,000 $ - direct labor $ 132,000 $ - variable overhead $ 168,000 $ 67,200 fixed overhead $ 144,000 $ 134,800 purchasing $ - $ 480,000 Total cost $ 600,000 $ 682,000 $ (82,000) Continue to make Incremental Cost of Buying $ (82,000) Additional CM of Regulators $ 108,000 Incremental Benefit of Buying $ 26,000 Buy Costs Make Buy Incremental Cost/Benefit Direct material $ 156,000 0 direct labor $ 132,000 $ - variable overhead $ 168,000 $ 67,200 fixed overhead $ 144,000 $ 134,800 purchasing $ - $ 480,000 opportunity cost of making 108000 $ - Total cost $ 708,000 $ 682,000 $ 26,000 buy a. Prepare a schedule to determine the incremental cost or benefit of buying thermostats from the outside su the company manufacture or buy the thermostats? b. Now assume that if thermostats are purchased from the outside source, the factory space previously used thermostats can be used to manufacture an additional 6,000 heat-flow regulators per year. These regulators h estimated contribution margin of $18 per unit. The manufacture of the additional heat-flow regulators would effect on fixed overhead. Now should the company manufacture or buy the thermostats?

upplier. Should to produce have an d have no

Scarce Resources: What combination of products will maximize the profits of Texteriles? CM per unit MH per unit CM/MH PRIORITY Denim $ 14 0.5 $ 28 2 Chenille $ 22 1.0 $ 22 3 Gauze $ 9 0.3 $ 30 1 Production: Units MH used MH remaining Total CM Gauze 1,200 360.0 3,240 10800 Denim 6,000 3000 240 $ 84,000 Chenille 240 240 - 5280 $ 100,080 Texteriles Company creates different types of bolts of cloth. These bolts of cloth are made on the same machinery. The textile machines have the capacity of 3,600 hours per month. Texteriles is considering producing three different types of cloth: denim, chenille, and gauze, with contribution margins per bolt of $14, $22, and $9, respectively. Texteriles knows it can sell only a total of 6,000 bolts of denim, 2,000 bolts of chenille, and/or 1,200 bolts of gauze. A bolt of each type of cloth requires a different amount of machine time as follows: denim takes 0.5 machine-hours, chenille takes 1 machine-hour, and gauze takes 0.3 machine- hours.

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What combination of products will maximize the pro CM per unit MH per unit Denim $ 36 4.0 Chenille $ 24 2.0 Gauze $ 40 5.0 Production: Units MH used Gauze 1,200 6,000.0 Denim 6,000 24000 Chenille 240 480

ofits of Texteriles? CM/MH PRIORITY $ 9 2 $ 12 3 $ 8 1 MH remaining Total CM (2,400) 48000 (26,400) $ 216,000 26,880 5760 $ 269,760

Sell or Rebuild: Direct materials $ 10 Direct labor $ 2 Variable factory overhead $ 3 Fixed factory overhead (average cost per unit) $ 1 Total $ 16 Silent Sentry is currently evaluating three options regarding the 50,000 detectors: Silent Sentry manufactures gas leak detectors that are sold to homeowners throughout the United States at $25 apiece. Each detector is equipped with a sensory cell that is guaranteed to last two full years before needing to be replaced. The company currently has 50,000 gas leak detectors in its inventory that contain sensory cells that had been purchased from a discount vendor. Silent Sentry engineers estimate that these sensory cells will last only 18 months before needing to be replaced. The company has incurred the following unit costs related to the 50,000 detectors. 1. Scrap the inferior sensory cell in each unit and replace it with a new one at a cost of $8 each. The units could then be sold at their full unit price of $25. involve changing the packaging of each unit to inform the buyer that the estimated life of the sensory cell is 18 months. The estimated out-of-pocket cost associated with the packaging changes is $3 per unit. 3. Sell each unit “as is” with its current packaging to a discount buyer in a foreign country. The buyer has offered to pay Silent Sentry a unit price of $22.

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Option 1 Option 2 Option 3 Incremental Revenue/Unit $ 1,250,000 $ 1,200,000 $ 1,100,000.00 Incremental Cost/Unit $ 400,000 $ 150,000 $ - Total Incremental Benefit $ 850,000 $ 1,050,000 $ 1,100,000 Perform an incremental analysis of these options. Based on the analysis, which option should choose?

d Silent Sentry