Chapter 13, Problem 2ATC

ATC 6-2 Group Assignment Relevance and cost behavior

Maccoa Soft, a division of Zayer Software Company, produces and distributes an automated payroll software system. A contribution margin format income statement for Maccoa Soft for the past year follows:

Revenue (12,000 units × $1,200)	$14,400,000
Unit-level variable costs
Product materials cost (12,000 × $60)	(720,000)
Installation labor cost (12,000 × $200)	(2,400,000)
Manufacturing overhead (12,000 × $2)	(24,000)
Shipping and handling (12,000 × $25)	(300,000)
Sales commissions (12,000 × $300)	(3,600,000)
Nonmanufacturing miscellaneous costs (12,000 × $5)	(60,000)
Contribution margin (12,000 × $608)	7,296,000
Fixed costs
Research and development	(2,700,000)
Legal fees to ensure product protection	(780,000)
Advertising costs	(1,200,000)
Rental cost of manufacturing facility	(600,000)
Depreciation on production equipment (zero market value)	(300,000)
Other manufacturing costs (salaries, utilities, etc.)	(744,000)
Division-level facility sustaining costs	(1,730,000)
Allocated companywide facility-level costs	(1,650,000)
Net loss	$ (2,408,000)

1. a. Divide the class into groups and then organize the groups into three sections. Assign Task 1 to the first section, Task 2 to the second section, and Task 3 to the third section. Each task should be considered independently of the others.

Group Tasks

1. (1) Assume that Maccoa has excess capacity. The sales staff has identified a large franchise company with 200 outlets that is interested in Maccoa’s software system but is willing to pay only $800 for each system. Ignoring qualitative considerations, should Maccoa accept the special order?
2. (2) Maccoa has the opportunity to purchase a comparable payroll system from a competing vendor for $600 per system. Ignoring qualitative considerations, should Maccoa outsource producing the software? Maccoa would continue to sell and install the software if the manufacturing activities were outsourced.
3. (3) Given that Maccoa is generating a loss, should Zayer eliminate it? Would your answer change if Maccoa could increase sales by 1,000 units?
4. b. Have a representative from each section explain its respective conclusions. Discuss the following:
   1. (1) Representatives from Section 1 should respond to the following: The analysis related to the special order (Task 1) suggests that all variable costs are always relevant. Is this conclusion valid? Explain your answer.
   2. (2) Representatives from Section 2 should respond to the following: With respect to the outsourcing decision, identify a relevant fixed cost and a nonrelevant fixed cost. Discuss the criteria for determining whether a cost is or is not relevant.
   3. (3) Representatives from Section 3 should respond to the following: Why did the segment elimination decision change when the volume of production and sales increased?

To determine

Whether Division MS should accept the special order by ignoring the qualitative considerations.

Explanation of Solution

Variable cost: It is also called as production costs that change in extent to the measure of goods that are manufactured. In other words, for each product that is manufactured, variable costs increment by a similar amount.

Opportunity cost: Opportunity cost is the forfeit of certain benefits such as cost savings, incomes, which is surrendered by not picking an option. Opportunity costs are applicable in decisions where the acknowledgment of one option disqualifies the likelihood of selecting different alternatives.

Determine the unit-level incremental costs

$\begin{array}{c}IncrementalCosts=\left[\begin{array}{l}MaterialCosts+LaborCost+ManufacturingOverhead+\\ ShippingCosts+SalesCommission+MiscellaneousCosts\end{array}\right]\\ =\left[\$60+\$200+\$2+\$25+\$300+\$5\right]\\ =\$592\end{array}$

Therefore the unit-level incremental cost is $592.

Conclusion

From the result obtained above, the fixed costs are irrelevant since they will continue the similar irrespective of whether the special order is accepted. The total unit-level incremental costs that will be incurred if the special order is accepted will be $592. Because the incremental cost per unit of $592 is less than the incremental income of $800 per unit, hence the special order should be accepted.

Therefore the special order should be accepted.

To determine

Whether Division MS should outsource producing the software by ignoring the qualitative considerations.

Explanation of Solution

Determine the total avoidable costs

$\begin{array}{c}AvoidableCosts=\left[\begin{array}{l}MaterialCosts+ManufacturingOverhead+\mathrm{R}\&DCosts\\ LegalFees+\mathrm{Re}ntalCosts+OtherManufacturingCosts\end{array}\right]\\ =\left[\begin{array}{l}\$720,000+\$24,000+\$2,700,000+\\ \$780,000+\$600,000+\$744,000\end{array}\right]\\ =\$5,568,000\end{array}$

Therefore the total avoidable cost is $5,568,000.

Determine the total avoidable cost per unit

$\begin{array}{c}AvoidableCosts=\left[\frac{AvoidableCosts}{NumberofUnits}\right]\\ =\left[\frac{\$5,568,000}{12,000}\right]\\ =\$464\end{array}$

Therefore the avoidable cost per unit is $464.

Conclusion

From the result obtained above, the total avoidable expense per unit is $464. Since the avoidable cost is less than the value required to buy of $600, Division MS would be in an ideal situation to keep on producing the software.

Therefore Division MS should produce the software.

To determine

Whether Company Z should eliminate Division MS.

Explanation of Solution

Determine the total avoidable costs at 12,000 units

If the division is eliminated, all expenses with the exception of the assigned companywide facility level expense and the depreciation on manufacturing the equipment or the sunk cost could be avoided.

Table (1)

(Refer excel for workings)

Therefore the total avoidable cost at 12,000 units is -$458,000.

Conclusion

From the result obtained above, the avoidable costs surpass the incremental revenue, the division must be eliminated.

Therefore Division MS should be eliminated.

To determine

Whether the answer changes if the sales increase by 1,000 units.

Explanation of Solution

Determine the total avoidable costs at 13,000 units

The additional selling units of 1,000 units would build add up to the total sales of 13,000 units.

Table (2)

(Refer excel for workings)

Therefore the total avoidable cost at 13,000 units is $150,000.

Conclusion

From the result obtained above, At a sales volume level of 13,000 units, the division must not be eliminated.

Therefore Division MS should not be eliminated.

To determine

Whether the conclusion is valid.

Explanation of Solution

The reason on whether the conclusion is valid is as follows:

All the variable costs are not constantly relevant. For instance, assume that the special order customer move towards the organization openly, in this way eliminating the requirement to pay sales commissions. Under these conditions the sales commissions would not be relevant to a choice with respect to whether the special order should be accepted. The variable costs can be either relevant or irrelevant contingent upon the specific conditions related with the special decision.

To determine

The criteria for determining whether a cost is relevant or not relevant.

Explanation of Solution

The criteria for determining whether a cost is relevant or not relevant are as follows:

The research and development expenditures are applicable on the grounds that they are not incurred if the item is outsourced. The advertising costs are not relevant since they are important to advance the item irrespective of whether it is produced or outsourced. In other words, the costs must vary between the choices and be future arranged.

To determine

The reason on the segment elimination decision changes when the volume of production and sales increased.

Explanation of Solution

The reason on the segment elimination decision changes when the volume of production and sales increased are as follows:

Increases in volume influence the total contribution margin to increment. In like manner, additional margin is accessible to take care of fixed costs or to add to the productivity.