Solution manual accounting 25th edition warren chapter 25

2 January 12, 2014 Lease Machine Alternative 1 Sell Machine Alternative 2 Differential Effect on Income Alternative 2 March 23, 2014 Lease Equipment Alternative 1 Sell Equipment Alternat

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CHAPTER 25 DIFFERENTIAL ANALYSIS, PRODUCT PRICING,

AND ACTIVITY-BASED COSTING

DISCUSSION QUESTIONS

1 a Differential revenue is the amount of increase or decrease in revenue expected from a

particular course of action compared with an alternative

b Differential cost is the amount of increase or decrease in cost expected from a particular

course of action compared with an alternative

c Differential income is the difference between differential revenue and differential cost

2 The differential income and costs of the lease option should be compared against selling the building.

The differential revenue would be the lease revenue compared to the proceeds from sale The

differential expenses would be the costs associated with leasing the building, including maintenance, property tax, and insurance, compared to the expenses of selling, such as sales commissions The opportunity cost of money should also be considered in the analysis

3 If there is demand for the premium-grade product, the differential revenue (premium less commodity)

may exceed the differential cost to process the product to premium grade

4 A business should only accept business at a special price if the lower price will not contaminate the

regular pricing for other customers or induce other customers to demand the special price In addition, the business must be careful not to violate the Robinson-Patman Act, which prohibits uncompetitive price differences across different markets for the same product Lastly, the business must consider the longer-term ramifications of offering discount business to a customer that may wish to order in the future

5 It would be reasonable to purchase from the supplier if the fixed cost per unit was less than 50 cents.

That is, if the fixed cost is less than 50 cents per unit, then the variable cost per unit would exceed the supplier’s price, making the supplier price more attractive

6 Some of the financial considerations include the profitability of the store, including all the revenues

and the variable and fixed costs associated with the store, since they would all be differential to the decision In addition, any costs of closing the store and preparing the store for disposal would need

to be considered (legal costs, demolition costs, employee severance costs) Lastly, the opportunity cost of the value of the equipment and land (either in cash or rental income) should be considered.For example, if the opportunity value of the assets were $500 per month, then the store would need to have a profitability exceeding this amount to remain an attractive alternative

7 In the long run, the normal selling price must be set high enough to cover all costs (both fixed and

variable) and provide a reasonable amount for profit

8 In setting prices, managers should also consider such factors as the prices of competing products and

the general economic conditions of the marketplace

25-1

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DISCUSSION QUESTIONS (Continued)

9 The target cost concept begins with a price that can be sustained in the marketplace, then

subtracts a target profit, thus determining the target cost The cost is made to conform to the price required in the market In contrast, under cost plus, a markup is added to the cost The resulting price is assumed to be acceptable in the market

10 The proper measure of product value in a bottlenecked process is the contribution margin per

bottleneck hour

11 Activity-based costing should be used when a business has a combination of wide product

variety and complex production and support processes In these circumstances, activity-based costing will more accurately allocate factory overhead to products This occurs because factory overhead allocated by a single predetermined rate assumes all factory overhead is associated with products using a single allocation base In complex environments, however, factory overhead may be associated with products according to how they consume activities Thus, multiple activity rates are needed to more closely capture how factory overhead is actually used by products

CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing

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PRACTICE EXERCISES

PE 25–1A

Differential Analysis Lease Machine (Alt 1) or Sell Machine (Alt 2)

January 12, 2014

Lease Machine (Alternative 1)

Sell Machine (Alternative 2)

Differential Effect

on Income (Alternative 2)

March 23, 2014

Lease Equipment (Alternative 1)

Sell Equipment (Alternative 2)

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PE 25–2A

Differential Analysis Continue Product S (Alt 1) or Discontinue Product S (Alt 2)

September 12, 2014

Continue Product S (Alternative 1)

Discontinue Product S (Alternative 2)

Costs:

Variable selling and admin.

May 9, 2014

Continue Product B (Alternative 1)

Discontinue Product B (Alternative 2)

Costs:

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PE 25–3A

Differential Analysis Make Bread (Alt 1) or Buy Bread (Alt 2)

August 16, 2014

Make Bread (Alternative 1)

Buy Bread (Alternative 2)

on Income (Alternative 2) Unit costs:

March 30, 2014

Make Bottles (Alternative 1)

Buy Bottles (Alternative 2)

on Income (Alternative 2) Unit costs:

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PE 25–4A

Differential Analysis Continue with Old Machine (Alt 1) or Replace Old Machine (Alt 2)

February 18, 2014

Continue with Old Machine (Alternative 1)

Replace Old Machine (Alternative 2)

on Income (Alternative 2) Revenues:

April 11, 2014

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PE 25–5A

Differential Analysis Sell Product T (Alt 1) or Process Further into Product U (Alt 2)

August 2, 2014

Sell Product T (Alternative 1)

Process Further into Product U (Alternative 2)

* $3.90 + $0.58

The company should process further into Product U.

PE 25–5B

Differential Analysis Sell Product D (Alt 1) or Process Further into Product E (Alt 2)

February 26, 2014

Sell Product D (Alternative 1)

Process Further into Product E (Alternative 2)

* $24 + $9

The company should sell Product D without further processing.

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PE 25–6A

Differential Analysis Reject Order (Alt 1) or Accept Order (Alt 2)

October 23, 2014

Reject Order (Alternative 1)

Accept Order (Alternative 2)

Costs:

* $39.00 × 25%

The company should not accept the special order.

PE 25–6B

March 16, 2014

Costs:

* $7.20 × 15%

The company should accept the special order.

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PE 25–7A

Markup percentage on product cost:

Desired Profit + Selling and Admin Exp.

Total Product Cost

Desired Profit + Selling and Admin Exp.

Total Product Cost

Unit contribution margin per production bottleneck hour……… $ 6 $ 5 Product A is the most profitable in using bottleneck resources.

PE 25–8B

Product K Product L

Unit contribution margin per production bottleneck hour……… $ 24 $ 25 Product L is the most profitable in using bottleneck resources.

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PE 25–9A

a Fabrication: $450,000 ÷ 2,000 direct labor hours = $225 per dlh

Assembly: $210,000 ÷ 2,000 direct labor hours = $105 per dlh

Setup: $240,000 ÷ 160 setups = $1,500 per setup

Inspection: $300,000 ÷ 800 inspections = $375 per inspection

b.

Activity

25-10

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PE 25–9B

a Cutting: $90,000 ÷ 1,500 direct labor hours = $60 per dlh

Sewing: $22,500 ÷ 1,500 direct labor hours = $15 per dlh

Setup: $80,000 ÷ 1,000 setups = $80 per setup

Inspection: $32,500 ÷ 500 inspections = $65 per inspection

b.

Activity

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equipment owner Thus, the analysis is similar to the text examples, but must be

set up from the user’s, rather than the owner’s, perspective.

Differential Analysis Lease Equipment (Alt 1) or Buy Equipment (Alt 2)

August 4, 2014

Lease Equipment (Alternative 1)

Buy Equipment (Alternative 2)

on Income (Alternative 2) Costs:

April 16, 2014

Lease Machinery (Alternative 1)

Sell Machinery (Alternative 2)

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b Star Cola should be retained As indicated by the differential analysis in part

(a), the income would decrease by $3,000 if the product is discontinued.

Differential Analysis Continue Star Cola (Alt 1) or Discontinue Star Cola (Alt 2)

January 21, 2014

Continue Star Cola (Alternative 1)

Discontinue Star Cola (Alternative 2)

Costs:

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March 31, 2014

Continue Cups (Alternative 1)

Discontinue Cups (Alternative 2)

Costs:

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Ex 25–5

Note to Instructors: Many students may be unfamiliar with the financial services

industry This exercise provides an opportunity to introduce students to some

basic terms and concepts used within the industry.

a The “Investor Services” segment serves the retail customer, you and me.

These are the brokerage, Internet, and mutual fund services used by individual investors The “Institutional Services” segment includes the same services

provided for financial institutions, such as banks, mutual fund managers,

insurance companies, and pension plan administrators.

b Variable costs in the “Investor Services” segment include:

1 Commissions to brokers

2 Fees paid to exchanges for executing trades

3 Transaction fees incurred by Schwab mutual funds to purchase and sell

shares

4 Advertising

Fixed costs in the “Investor Services” segment include:

1 Depreciation on brokerage offices

2 Depreciation on brokerage office equipment, such as computers and

computer networks

3 Property taxes on brokerage offices

(in millions) (in millions)

Plus depreciation……… 93 52

d If one assumes that the fixed costs that serve institutional investors (computers, servers, and facilities) would not be sold but would be used by the other sector, then the contribution margin of $495 million would be an estimate of the reduced profitability If the fixed assets were sold, then the operating income decline

would approach $443 million Since the institutional and retail investors use

nearly the same assets, the $495 million answer is probably the better estimate.

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Ex 25–6

The flaw in the decision is the failure to focus on the differential revenues and

costs, which indicate that operating income would be reduced by $59,000 if

Children’s Shoes were discontinued This differential income from sales of

Children’s Shoes can be determined from the following differential analysis:

Differential Analysis Continue Children’s Shoes (Alt 1) or Discontinue Children’s Shoes (Alt 2)

Continue Children’s Shoes (Alternative 1)

Discontinue Children’s Shoes (Alternative 2)

Costs:

b Assuming there were no better alternative uses for the spare capacity, it would

be advisable to manufacture the carrying cases because the cost savings would

be $6.25 per unit Fixed factory overhead is irrelevant, since it will continue

whether the carrying cases are purchased or manufactured.

Differential Analysis Make Carrying Case (Alt 1) or Buy Carrying Case (Alt 2)

July 19, 2014

Make Carrying Case (Alternative 1)

Buy Carrying Case (Alternative 2)

on Income (Alternative 2) Costs:

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* 25,000 pages × $13 per page

b The benefit from using an outside service is shown to be $4,000 greater than

performing the layout work internally The fixed costs (depreciation

expenses) in the budget are irrelevant to the decision Thus, the work should

be purchased from the outside on a strictly financial basis.

c Before electing to terminate the five employees, the guild should consider

the long-run impact of the decision Specifically, future page layout rates

may grow faster than the cost of internal salaries, thus favoring the use of

employees over the long term This would especially be the case if the

outside company provided a low bid in order to win the initial business In

addition, the guild may wish to consider noneconomic factors, such as the

ability to more directly control the quality and timing of the layout work by

internal employees.

Differential Analysis Lay Out Pages Internally (Alt 1) or Purchase Layout Services (Alt 2)

February 22, 2014

Lay Out Pages Internally (Alternative 1)

Purchase Layout Services (Alternative 2)

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The company should replace the old machine.

b The sunk cost is the $250,000 book value ($600,000 cost less $350,000 accumulated

depreciation) of the present machine The original cost and accumulated depreciation

were incurred in the past and are irrelevant to the decision to replace the machine.

September 11, 2014

Proceeds from sale of old

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Ex 25–10

a.

* Each annual revenue and cost is multiplied by five years.

b The proposal should not be accepted.

c In addition to the factors given, consideration should be given to such factors

as: Do both present and proposed operations provide the same capacity?

What opportunity costs are associated with alternative uses of the $180,000

outlay required to purchase the automatic machine? Is the product improved

by using automatic machinery? Does the federal income tax have an effect on

the decision?

May 4, 2014 Continue with Old Machine (Alternative 1)

Costs:

Selling and admin expenses

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Ex 25–11

Differential Analysis Sell Rough Cut (Alt 1) or Process Further into Finished Cut (Alt 2)

June 14, 2014

Sell Rough Cut (Alternative 1)

Process Further into Finished Cut (Alternative 2)

Oakridge Lumber Company should process further and sell finished-cut lumber.

Ex 25–12

a.

Differential Analysis Sell Regular Columbian (Alt 1) or Process Further into Decaf Columbian (Alt 2)

October 6, 2014

Sell Regular Columbian (Alternative 1)

Process Further into Decaf Columbian (Alternative 2)

b The differential revenue from processing further to Decaf Columbian is more

than the differential cost of processing further by $2,166 Thus, Rise N’ Shine

Coffee Company should sell and process further to Decaf Columbian.

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Ex 25–12 (Concluded)

c The price of Decaf Columbian would need to decrease to $11.50 per pound

in order for the differential analysis to yield neither an advantage nor a

disadvantage (indifference) This is determined as follows:

Net Advantage of Further Processing Volume of Decaf Columbian

$2,166 = $0.38 per lb.

= 5,700 lbs.

The price of Decaf Columbian would need to be $0.38 lower, or $11.50, to

yield no net differential income or loss This is verified by the following

differential analysis:

Differential Analysis Sell Regular Columbian (Alt 1) or Process Further into Decaf Columbian (Alt 2)

October 6, 2014

Sell Regular Columbian (Alternative 1)

Process Further into Decaf Columbian (Alternative 2)

* $11.50 × (6,000 lbs × 95%)

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Ex 25–13

November 12, 2014

18,000 units × $29 per unit

b The additional units can be sold for $32 each, and since unused capacity is

available, the only costs that would be added if this additional production were accepted are the variable costs of $29 per unit The differential revenue is

therefore $32 per unit, and the differential cost is $29 per unit Thus, the net

gain is $3 per unit × 18,000 units, or $54,000.

c $29.01 Any selling price above $29 (variable costs per unit) will produce a

positive contribution margin.

Ex 25–14

Total variable costs……… $262,500 Variable cost per unit:

$262,500 ÷ 25,000 batteries = $10.50

The lowest bid should be sufficient to cover the variable cost of $10.50 per unit.

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20,000 tires × $6.50 per tire

* 5% × $125 The avoided sales commission should not be computed on the basis

of the $92 price to Euro Motors, but on the existing domestic sales price of $125.

Goodman should accept the special order from Euro Motors.

b $92 – $145,000

20,000

= $92.00 – $7.25 = $84.75

January 21, 2014

Costs:

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Total Manufacturing Costs

$30,000 + $24,000

$27,000 Markup Percentage = 200%

d Cost amount (product cost) per unit……… $ 33.75 Markup ($33.75 × 200%)……… 67.50 Selling price……… $101.25

Ex 25–17

a Desired profit = $1,200,000 × 30% = $360,000

b Cost amount (product cost) per unit: $2,500,000* ÷ 10,000 units = $250

* ($215 manufacturing variable cost per unit × 10,000 units) + $350,000

manufacturing fixed cost

c Markup Percentage =

Markup Percentage =

Desired Profit + Total Selling and Administrative Expenses

Total Manufacturing Costs

d Cost amount per unit……… $250 Markup ($250 × 30%)……… 75 Selling price……… $325

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Ex 25–18

a The price will be set at the estimated market price required to remain

competitive, or $28,000 Under the target cost concept, the market dictates the price, not the markup on cost.

b The required profit margin of 20% of the estimated $28,000 price implies a

$22,400 target product cost as follows:

Target Product Cost = $28,000 – ($28,000 × 20%)

Target Product Cost = $28,000 – $5,600

Target Product Cost = $22,400

Since the estimated manufacturing cost of $23,200 exceeds the target cost

of $22,400, Toyota must reduce $800 from its total costs in order to

maintain competitive pricing within its profit objectives.

Note to Instructors: Target costing provides pressure to keep costs competitive

The method assumes that the company may not be able to successfully add

a markup to its costs because the resulting price may be too high in the

marketplace For example, merely adding the 25% markup on the $23,200

product cost would result in an uncompetitive price of $29,000 The target cost concept moves backward by taking the price as given and then determining the cost that is required for a given profit objective.

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$400 selling price – $200 markup = $200 target product cost

(Also, $200 × 100% = $200 markup on product cost; $200 + $200 = $400 selling price)

b Required cost reduction: $230 – $200 = $30

3 Injection molding productivity improvement:

Direct labor improvement (25%* × 40% × $40) $4.00

Factory overhead improvement (25%* × 48% × $15) 1.80 5.80 Total savings per unit

* Improving the cycle time from four minutes to three minutes is a 25% reduction.

The total savings exceeds the required target cost reduction by $0.30 Thus,

these improvements are sufficient to meet the target cost.

$30.30

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Ex 25–20

Determine the contribution margin per furnace hour as follows:

per furnace hour*……… $ 0.30 $ 0.70 $ 0.50

* Calculated as follows:

$1.80 Type 5: = $0.30 per furnace hour

6 hours

12 hours Emphasize Type 10 In a production-constrained environment, Type 10 generates

the most unit contribution margin per hour of furnace resource and, thus, is the

most profitable While Type 20 has the largest profit per unit ($4.40) and unit

contribution margin ($6.00), these would not be the correct metrics for determining the product to emphasize in the marketing campaign, assuming the furnace is a

bottleneck resource.

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b The Small glass product is the most profitable in a bottleneck operation,

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Ex 25–22

Activity

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