Exam 21: Incremental Analysis

Costs that have not yet been incurred and that may vary among different courses of action are called:

When constrained by a limiting resource, managers often seek to produce those products which have:

The net change in operating income resulting from a decision to manufacture EB-2 is (specify whether the change is an increase or a decrease): $_____________

Scrap or rework decision Nielson has 5,000 defective televisions on hand which cost $380,000 to manufacture. Nielson can either sell these defective televisions as scrap for $65 per unit, or spend an additional $120,000 on repairs and then sell the televisions for $135 per unit. Should Nielson repair the defective TVs to sell them as scrap? Show your supporting computations:

What will be the total amount of the loss incurred by K Corp. on the sale of these units if they are repaired and sold for $200 per unit? $_____________ loss

Relevant costs in business decisions (a) Explain what is meant by each of the following terms: opportunity cost, sunk cost, and out-of-pocket cost. (b) Identify which, if any, of the above three types of cost would be considered relevant in making a business decision.

Accounting terminology Listed below are eight technical accounting terms introduced or emphasized in this chapter: Opportunity cost Incremental analysis Sunk cost Split-off point Joint costs Out-of-pocket costs Relevant information Joint products Each of the following statements may (or may not) describe one of these technical terms. In the space provided beside each statement, indicate the accounting term described, or answer "None" if the statement does not correctly describe any of the terms. ______ (a) Data pertaining to future time periods which may vary among alternative courses of action. ______ (b) The point at which manufacturing costs are split between finished goods inventory and work in progress. ______ (c) The benefit foregone by pursuing one course of action over another. ______ (d) Products which emerge from common materials and shared production processes. ______ (e) A cost incurred in the past that will not change as a result of future actions. ______ (f) Costs yet to be incurred which are expected to vary under different courses of action. ______ (g) The examination of differences between future costs and revenue under varying courses of action.

Assuming that the MR Corporation has an inventory of 200 defective motors costing $450,000 to produce and $150,000 to repair, if the company receives an offer to purchase these motors for $325,000 before repairing them, the company's decision should be to sell the motors at the offered price. The $450,000 production costs are sunk costs and therefore irrelevant to the decision. The relevant costs are the repair costs of $150,000 compared to the offer to purchase for $325,000. Since the offer is more than the repair costs, the decision should be to sell the motors at the offered price.

Sunk costs are relevant costs when considering a special order.

What are the total relevant costs of keeping the old equipment?

Which of the following statements is false regarding the defective units?

Aircraft Products, a manufacturer of aircraft landing gear, makes 1,000 units each year of a special valve used in assembling one of its products. The unit cost of producing this valve includes variable costs of $70 and fixed costs of $60. The valves could be purchased from an outside supplier at $77 each. If the valve were purchased from the outside supplier, 40% of the total fixed costs incurred in producing this valve could be eliminated. Buying the valves from the outside supplier instead of making them would cause the company's operating income to:

Seeking creative solutions to problems Explain why it would be irresponsible and short-sighted for managers to base decisions entirely on revenue and cost figures.

Incremental costs can be defined as:

Opportunity costs are recorded in the accounting records.

A sunk cost is an expenditure that has proven to be nonproductive.

If Creative Corporation has an unlimited supply of wood available, which products should it produce?

In determining whether to scrap or to rebuild defective units of product, the cost already incurred in producing the defective units is not relevant.

Sunk costs are relevant to decisions about replacing plant assets.

The term "out-of-pocket cost" is often used to describe costs which have not yet been incurred and which may vary among alternative courses of action.