The Incremental Analysis for the Decision to Make or Buy

Use incremental analysis for special-order decision.

E7.2 (LO 2), AN Gruden Company produces golf discs which it normally sells to retailers for $7 each. The cost of manufacturing 20,000 golf discs is:

Materials $ 10,000

Labor 30,000

Variable overhead 20,000

Fixed overhead 40,000

Total $100,000

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

McGee Corporation offers Gruden $4.80 per disc for 5,000 discs. McGee would sell the discs under its own brand name in foreign markets not yet served by Gruden. If Gruden accepts the offer, it will incur a one-time fixed cost of $6,000 due to the rental of an imprinting machine. No sales commission will result from the special order.

Instructions

Prepare an incremental analysis for the special order.

Should Gruden accept the special order? Why or why not?

What assumptions underlie the decision made in part (b)?

Use incremental analysis for make-or-buy decision.

E7.5 (LO 3), AN Pottery Ranch Inc. has been manufacturing its own finials for its curtain rods. The company is currently operating at 100% of capacity, and variable manufacturing overhead is charged to production at the rate of 70% of direct labor cost. The direct materials and direct labor cost per unit to make a pair of finials are $4 and $5, respectively. Normal production is 30,000 curtain rods per year.

A supplier offers to make a pair of finials at a price of $12.95 per unit. If Pottery Ranch 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 finials will have to be absorbed by other products.

Instructions

Prepare the incremental analysis for the decision to make or buy the finials.

Should Pottery Ranch buy the finials?

Would your answer be different in (b) if the productive capacity released by not making the finials could be used to produce income of $20,000?

Use incremental analysis for further processing of materials decision.

E7.9 (LO 4), AN Anna Garden recently opened her own basketweaving studio. She sells finished baskets in addition to selling the raw materials needed by customers to weave baskets of their own. Unfortunately, owing to space limitations, Anna is unable to carry all the varieties of kits originally assembled and must choose between two basic packages.

The Basic Kit includes undyed, uncut reeds (with dye included) for weaving one basket. This basic package costs Anna $16 and sells for $30. 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. Anna produces the Stage 2 kit by using the materials included in the Basic Kit. Because she is more efficient at cutting and dying reeds than her average customer, Anna is able to produce two Stage 2 kits in one hour from one Basic Kit. (She values her time at $18 per hour.) The Stage 2 kit sells for $36.

Instructions

Determine whether Anna’s basketweaving studio should carry the Basic 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.

Determine whether to sell or process further, joint products.

E7.10 (LO 4), AN Stahl Inc. produces three separate products from a common process costing $100,000. Each of the products can be sold at the split-off point or can be processed further and then sold for a higher price. Shown here are cost and selling price data for a recent period.

Sales Value at Split-Off Point Cost to Process Further Sales Value after Further Processing

Product 10 $60,000 $100,000 $190,000

Product 12 15,000 30,000 35,000

Product 14 55,000 150,000 215,000

Instructions

Determine total net income if all products are sold at the split-off point.

Determine total net income if all products are sold after further processing.

Using incremental analysis, determine which products should be sold at the split-off point and which should be processed further.

Determine total net income using the results from (c) and explain why the net income is different from that determined in (b).

Determine whether to sell or process further, joint products.

E7.13 (LO 5), E An icon reads, Service. On January 2, 2021, Twilight Hospital purchased a $100,000 special radiology scanner from Bella Inc. The scanner had a useful life of 4 years and was estimated to have no disposal value at the end of its useful life. The straight-line method of depreciation is used on this scanner. Annual operating costs with this scanner are $105,000.

Approximately one year later, the hospital is approached by Dyno Technology salesperson, Jacob Cullen, who indicated that purchasing the scanner in 2021 from Bella Inc. was a mistake. He points out that Dyno has a scanner that will save Twilight Hospital $25,000 a year in operating expenses over its 3-year useful life. Jacob notes that the new scanner will cost $110,000 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. Jacob agrees to buy the old scanner from Twilight Hospital for $50,000.

Instructions

If Twilight Hospital sells its old scanner on January 2, 2022, compute the gain or loss on the sale.

Using incremental analysis, determine if Twilight Hospital should purchase the new scanner on January 2, 2022.

Explain why Twilight Hospital might be reluctant to purchase the new scanner, regardless of the results indicated by the incremental analysis in (b).

Use incremental analysis for retaining or replacing equipment decision.

E7.15 (LO 6), AN Veronica Mars, a recent graduate of Bell’s accounting program, evaluated the operating performance of Dunn Company’s six divisions. Veronica made the following presentation to Dunn’s board of directors and suggested the Percy Division be eliminated. “If the Percy Division is eliminated,” she said, “our total profits would increase by $26,000.”

The Other Five Divisions Percy Division Total

Sales $1,664,200 $100,000 $1,764,200

Cost of goods sold 978,520 76,000 1,054,520

Gross profit 685,680 24,000 709,680

Operating expenses 527,940 50,000 577,940

Net income $ 157,740 $ (26,000) $ 131,740

In the Percy Division, cost of goods sold is $61,000 variable and $15,000 fixed, and operating expenses are $30,000 variable and $20,000 fixed. None of the Percy Division’s fixed costs will be eliminated if the division is discontinued.

Instructions

Is Veronica right about eliminating the Percy Division? Prepare a schedule to support your answer.

Use incremental analysis for elimination of a product line.

Chapter 8 exercise

E8.3 (LO 1, 2), AP Leno Company makes swimsuits and sells these suits directly to retailers. Although Leno has a variety of suits, it does not make the Performance suit used by highly skilled swimmers. The market research department believes that a strong market exists for this type of suit. The department indicates that the Performance suit would sell for approximately $100. Given its experience, Leno believes the Performance suit would have the following manufacturing costs.

Direct materials $ 25

Direct labor 30

Manufacturing overhead 45

Total costs $100

Instructions

Assume that Leno uses cost-plus pricing, setting the selling price 25% above its costs. (1) What would be the price charged for the Performance swimsuit? (2) Under what circumstances might Leno consider manufacturing the Performance swimsuit given this approach?

Assume that Leno uses target costing. What is the price that Leno would charge the retailer for the Performance swimsuit?

What is the highest acceptable manufacturing cost Leno would be willing to incur to produce the Performance swimsuit, if it desired a profit of $25 per unit? (Assume target costing.)

Use cost-plus pricing to determine selling price.

E8.6 (LO 2), AP An icon reads, Service. Alma’s Recording Studio rents studio time to musicians in 2-hour blocks. Each session includes the use of the studio facilities, a digital recording of the performance, and a professional music producer/mixer. Anticipated annual volume is 1,000 sessions. The company has invested $2,352,000 in the studio and expects a return on investment (ROI) of 20%. Budgeted costs for the coming year are as follows.

Per Session Total

Direct materials (CDs, etc.) $ 20

Direct labor 400

Variable overhead 50

Fixed overhead $950,000

Variable selling and administrative expenses 40

Fixed selling and administrative expenses 500,000

Instructions

Determine the total cost per session.

Determine the desired ROI per session.

Calculate the markup percentage on the total cost per session.

Calculate the target price per session.

Use cost-plus pricing to determine various amounts.

E8.9 (LO 3), AP An icon reads, Service. Rey Custom Electronics (RCE) sells and installs complete security, computer, audio, and video systems for homes. On newly constructed homes it provides bids using time-and-material pricing. The following budgeted cost data are available.

Time Charges Material Loading Charges

Technicians’ wages and benefits $150,000 —

Parts manager’s salary and benefits — $34,000

Office employee’s salary and benefits 30,000 15,000

Other overhead 15,000 42,000

Total budgeted costs $195,000 $91,000

The company has budgeted for 6,250 hours of technician time during the coming year. It desires a $38 profit margin per hour of labor and an 80% profit on parts. It estimates the total invoice cost of parts and materials in 2022 will be $700,000.

Instructions

Compute the rate charged per hour of labor.

Compute the material loading percentage.

RCE has just received a request for a bid on a security and home entertainment system from Buil Builders on a $1,200,000 new home. The company estimates that the job would require 80 hours of labor and $40,000 of parts. Compute the total estimated bill.

Use time-and-material pricing to determine bill.

E8.12 (LO 4), AN The Cycle Division of Ayala Company has the following unit data related to its most recent cycle, the Roadbuster.

Selling price $2,200

Variable cost of goods sold

Body frame $300

Other variable costs 900 1,200

Contribution margin $1,000

Presently, the Cycle Division buys its body frames from an outside supplier. However, Ayala has another division, FrameBody, that makes body frames for other cycle companies. The Cycle Division believes that FrameBody’s product is suitable for its new Roadbuster cycle. Presently, FrameBody sells its frames for $350 per frame. The variable cost for FrameBody is $270. The Cycle Division is willing to pay $280 to purchase the frames from FrameBody.

Instructions

Assume that FrameBody has excess capacity and is able to meet all of the Cycle Division’s needs. If the Cycle Division buys 1,000 frames from FrameBody, determine the following: (1) effect on the income of the Cycle Division, (2) effect on the income of FrameBody, and (3) effect on the income of Ayala.

Assume that FrameBody does not have excess capacity and therefore would lose sales if the frames were sold to the Cycle Division. If the Cycle Division buys 1,000 frames from FrameBody, determine the following: (1) effect on the income of the Cycle Division, (2) effect on the income of FrameBody, and (3) effect on the income of Ayala.

Determine minimum transfer price.