Exam 21: Incremental Analysis

Identifying information relevant to a particular business decision requires an understanding of both quantitative and qualitative considerations.

Sunk costs are relevant costs when considering a special order.

The most common method to allocate joint costs is in proportion to the relative sales value of the products.

Limited resources Portable Enterprises produces two lines of mobile homes: double-wide and single-wide.Unit cost and revenue data pertaining to each product are shown below: Each double-wide home requires 350 different labor hours and 125 machine hours.Each single-wide home requires 175 direct labor hours and 150 machine hours.Demand for each line of homes far exceeds the company's total production capacity. (a)If Portable's production capacity is constrained by limited direct labor hours,which line of homes should it produce? ___________________ (b)If Portable's total production capacity is constrained by machine hours,which line of homes should it produce? ____________________ Computations

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.

Even though costs,revenues,and other factors do not vary among possible courses of action,they may be relevant to a decision.

Which of the following types of cost are always relevant to a decision?

An opportunity cost is a relevant cost when making a business decision.

Which factor is not relevant in deciding whether or not to accept a special order?

Sunk costs have already been incurred and cannot be changed by future actions.

Accounting terminology Listed below are eight technical accounting terms introduced or emphasized in this chapter: 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.

Pricing special orders Explain why an American corporation might sell a product in Eastern Europe at a price significantly below that for which it sells the same product in the United States.

Nonfinancial considerations are relevant in decision making.

Perfect Plumbing Corporation currently manufactures a valve for use in water pumps that it produces for sale.The company is considering purchasing the valves from an outside supplier rather than manufacturing them.Which of the following costs is not relevant to the decision?

The Fine Point Company currently produces all of the components for its one product; an electric pencil sharpener.The unit cost of manufacturing the motor for this pencil sharpener is: The company is considering the possibility of buying this motor from a subcontractor and has been quoted a price of $3.60 per unit.The relevant cost of manufacturing the motor to be considered in reaching the decision is:

Maple syrup and pancakes are examples of joint products.

Incremental analysis rarely requires the decision maker to exercise judgment.

Special order decision Prudent Products Corporation manufactures and sells 1,000 motorcycle engines each month.A primary component in each motor is an oil pump used to keep the motor lubricated.Prudent Products has the monthly capacity to produce 1,500 oil pumps.The variable unit costs associated with manufacturing each pump are shown below: Fixed manufacturing overhead per month (for up to 1,500 units of production)averages $46,000.Volk's Autos,Inc.,has offered to purchase 250 oil pumps from Prudent Products per month to be used in its own motorcycles. (a)Prudent Product's average unit cost of manufacturing each oil pump if it rejects Volk's Autos' order is $__________ per unit. (b)The incremental unit cost of producing each additional oil pump is $__________ per unit. (c)If this special order is accepted,the price per unit that Prudent Products could charge Volk's Autos in order to earn a $20,000 monthly pretax profit on the sale is $__________ per unit.

Incremental analysis Information regarding current operations of the Farrell Corporation is given below: A proposed addition to Farrell's factory is estimated by the sales manager to increase sales by a maximum of $750,000.The company's accountants have determined that the proposed addition will add $320,000 to fixed costs each year. (a)Explain why the existing $310,000 of fixed costs is a sunk cost while the $320,000 of fixed costs associated with the proposed addition is an out-of-pocket cost. (b)Calculate by how much the proposed addition will either increase or reduce operating income.

Incremental analysis - accepting a special order Essential Company normally produces and sells 4,000 video monitors for personal computers each month.Variable manufacturing costs amount to $62 per unit,and fixed manufacturing costs are $170,000 per month.The regular sales price of the monitors is $140 per unit.The company is considering a special order from a foreign computer maker to buy an additional 1,000 monitors per month at a special price of $70 per unit.Filling this special order would not affect Essential Company's regular sales volume or fixed manufacturing costs. (a)The average cost per unit at the 4,000-unit-per-month production level is $_______________ per unit. (b)The average cost per unit at the 5,000-unit-per-month production level is $_______________ per unit. (c)The amount of increase or decrease (indicate the correct term)in Essential Company's operating income that would result from accepting the special order is $_______________.