TEST BANK managerial accounting by 5e kieso weygand ch007

Identify the relevant costs in accepting an order at a special price.. Q7-1 Q7-2 Describe the concept of incre Q7-3 Q7-4 Identify the relevant costs in accepting an order at a special pr

CHAPTER 7 Incremental Analysis

ASSIGNMENT CLASSIFICATION TABLE

Brief

A Problems

B Problems

1 Identify the steps in

management’s

decision-making process

1, 2 1 1

2 Describe the concept

of incremental analysis

3, 4 2 1

3 Identify the relevant

costs in accepting an

order at a special price

5 3 2, 3, 4, 14 1A 1B

4 Identify the relevant

costs in a make-or-buy

decision

6, 7 4 5, 6, 14 2A 2B

5 Identify the relevant costs

in determining whether to

sell or process materials

further

8, 9, 10 5, 6 7, 8, 9, 14 3A 3B

6 Identify the relevant costs

to be considered in

retaining or replacing

equipment

11 7 10, 11, 14 4A 4B

7 Identify the relevant costs

in deciding whether to

eliminate an unprofitable

segment

12 8 12, 13, 14 5A 5B

ASSIGNMENT CHARACTERISTICS TABLE

Problem

Difficulty Level

Time Allotted (min.)

1A Make incremental analysis for special order and identify

nonfinancial factors in the decision

Simple 20–30

2A Make incremental analysis related to make or buy,

consider opportunity cost, and identify nonfinancial

factors

Moderate 30–40

3A Determine if product should be sold or processed further Moderate 30–40 4A Compute gain or loss, and determine if equipment should

be replaced

Moderate 30–40

5A Compute contribution margin and prepare incremental

analysis concerning elimination of divisions

Moderate 30–40

1B Make incremental analysis for special order and identify

nonfinancial factors in the decision

Simple 20–30

2B Make incremental analysis related to make or buy,

consider opportunity cost, and identify nonfinancial

factors

Moderate 30–40

3B Determine if product should be sold or processed further Moderate 30–40 4B Compute gain or loss, and determine if equipment should

be replaced

Moderate 30–40

5B Compute contribution margin and prepare incremental

analysis concerning elimination of divisions

Moderate 20–30

BLOOM’S TAXONOMY TABLE

Identify the steps in management’s decision-making process.

Q7-1 Q7-2

Describe the concept of incre

Q7-3 Q7-4

Identify the relevant costs in accepting an order at a special price.

E7-2 E7-3 E7-4 E7-14 P7-1A P7-1B

Identify the relevant costs in a make-or-buy decision.

Q7-6 Q7-7

E7-5 E7-6 E7-14 P7-2A P7-2B

Identify the relevant costs in determining whether to sell or process mate

Q7-8 Q7-9 Q7-10

BE7-5 BE7-6

E7-7 E7-8 E7-9 E7-14 P7-3A P7-3B

Identify the relevant costs to be considered in retaining or re placing equipment.

E7-10 E7-11 E7-14 P7-4A P7-4B

Identify the relevant costs in deciding whether to eliminate an unprofitable segment.

E7-12 E7-13 E7-14 P7-5A P7-5B

Real-World Focus Exploring the Web Decision Ma

All About You A

Organization Ethics Case Communication

STUDY OBJECTIVES

1 IDENTIFY THE STEPS IN MANAGEMENT’S DECISION-MAKING PROCESS.

2 DESCRIBE THE CONCEPT OF INCREMENTAL ANALYSIS.

3 IDENTIFY THE RELEVANT COSTS IN ACCEPTING AN ORDER AT A SPECIAL PRICE.

4 IDENTIFY THE RELEVANT COSTS IN A MAKE OR BUY DECISION.

5 IDENTIFY THE RELEVANT COSTS IN DETERMINING WHETHER TO SELL OR PROCESS MATERIALS FURTHER.

6 IDENTIFY THE RELEVANT COSTS TO BE CON-SIDERED IN RETAINING OR REPLACING EQUIPMENT.

7 IDENTIFY THE RELEVANT COSTS IN DECIDING WHETHER TO ELIMINATE AN UNPROFITABLE SEGMENT.

CHAPTER REVIEW

Incremental Analysis

1 (S.O 1) Management’s decision-making process frequently involves the following steps:

a Identify the problem and assign responsibility

b Determine and evaluate possible courses of action

c Make a decision

d Review the results of the decision

Accounting’s contribution to the decision-making process occurs primarily in steps (b) and (d)

2 (S.O 2) Business decisions involve a choice among alternative courses of action In making such decisions, management ordinarily considers both financial and nonfinancial information The process used to identify the financial data that change under alternative courses of action is called

incremental analysis.

a Incremental analysis involves not only identifying relevant revenues and costs, but also

determining the probable effects of the decision on future earnings.

b Data for incremental analysis involves estimates and uncertainty

c Gathering data may involve market analysts, engineers, and accountants

3 In incremental analysis, both costs and revenues may change However, in some cases

(1) variable costs may not change under the alternative courses of action, and (2) fixed costs may change

Accept an Order at a Special Price

4 (S.O 3) An order at a special price should be accepted when the incremental revenue from the

order exceeds the incremental costs

a It is assumed that sales in other markets will not be affected by the special order

b If the units can be produced within existing plant capacity, generally only variable costs will

be affected

Make or Buy

5 (S.O 4) In a make or buy decision, management must determine the costs which are different

under the two alternatives If there is an opportunity to use the productive capacity for another

purpose, opportunity cost should be considered Opportunity cost is the potential benefit that

may be obtained by following an alternative course of action This cost is an additional cost of making the component

Sell or Process Further

6 (S.O 5) The basic decision rule in a sell or process further decision is: Process further as long

as the incremental revenue from such processing exceeds the incremental processing costs Incremental revenue is the increase in sales which results from processing the product further

Retain or Replace Equipment

7 (S.O 6) In a decision to retain or replace equipment, management compares the costs which

are affected by the two alternatives Generally, these are variable manufacturing costs and the cost of the new equipment

a The book value of the old machine is a sunk cost which does not affect the decision A sunk

cost is a cost that cannot be changed by any present or future decision.

b However, any trade-in allowance or cash disposal value of the existing asset must be

considered

Eliminate an Unprofitable Segment

8 (S.O 7) In deciding whether to eliminate an unprofitable segment, management should

choose the alternative which results in the highest net income Often fixed costs allocated to the unprofitable segment must be absorbed by the other segments It is possible, therefore, for net

income to decrease when what appears to be an unprofitable segment is eliminated.

9 Many of the decisions involving incremental analysis also have important qualitative features

LECTURE OUTLINE

A Management’s Decision-Making Process.

Use ILLUSTRATION 7-1 to discuss the management decision-making process.

Emphasize that accountants are mainly involved in developing quantitative data that is relevant for alternative courses of action and preparing reports that review the results of decisions.

1 The steps are:

2 Accounting’s contribution to the decision-making process occurs primarily

in steps (b) and (d)—evaluating possible courses of action, and reviewing results.

B Incremental Analysis.

1 The process used to identify the financial data that change under alternative courses of action is called incremental analysis.

ILLUSTRATION 7-2 presents a list of the most common types of decision

situations that utilize incremental analysis.

TEACHING TIP

TEACHING TIP

2 These data are relevant to the decision because they will vary in the future among the possible alternatives.

3 Incremental analysis sometimes involves changes that might seem contrary to your intuition For example, sometimes:

action.

4 Accept an order at a special price.

ILLUSTRATION 7-3 provides an in-class example of a decision situation involving

an order at a special price Emphasize that if fixed costs do not change, the special price must be greater than the unit variable cost of the product in order for the proposal to be profitable.

Also available as teaching transparency.

manufacturing costs to produce the special order and expected revenues.

the lost sales in making the decision.

order would be rejected.

TEACHING TIP

5 Make or buy.

ILLUSTRATION 7-4 provides an in-class example of a make or buy decision.

Point out that if resources have alternative uses, there is an opportunity cost that must be included in the analysis.

Also available as teaching transparencies.

by following an alternative course of action.

6 Sell or process further.

point in the production cycle or continuing to process with the expectation of selling them at a later point at a higher price.

incre-mental revenue from such processing exceeds the increincre-mental processing costs.

single raw material and a common production process These multiple end-products are referred to as joint products.

separately identifiable (the split-off point) are called joint costs.

TEACHING TIP

frequently done based on the relative sales value of the joint products.

of product cost but is irrelevant for any sell-or-process-further decisions since these joint costs are sunk costs They have already been incurred and cannot be avoided by any subsequent decision.

7 Retain or replace equipment.

or replace it.

value is a sunk cost, which is a cost that cannot be changed by any present or future decision.

8 Eliminate an unprofitable segment.

information is the contribution margin produced by the segment and the disposition of the segment’s fixed expenses.

manage-ment should consider the effect of elimination on related segmanage-ments.

seg-ment on employees who may have to be discharged or retrained.

20 MINUTE QUIZ

Circle the correct answer.

True/False

1 Determining and evaluating possible courses of action is a step in management’s decision-making process.

2 In incremental analysis fixed costs may not change under alternative courses of action, while variable costs may change.

3 The relevant information to consider in accepting an order at a special price are the additional manufacturing costs incurred and expected revenues.

4 The basic decision rule to sell or process further is: process further as long as the incremental revenue from such processing exceeds the incremental processing costs.

5 Book value is a sunk cost and is therefore relevant in incremental analysis of retain or replace equipment.

6 Fixed manufacturing costs will never be relevant in a make or buy decision.

7 Opportunity costs are costs that have already been incurred and will not be avoided by any future decision.

8 In deciding on the future status of an unprofitable segment, management should consider the effect of elimination on related product lines.

9 Joint product costs are relevant for any sell-or-process further decisions.

10 Any trade-in allowance or cash disposal value of the old asset is relevant in a retain or replace equipment decision.

Multiple Choice

1 Which of the following is not a step in management’s decision-making process?

a Identify the problem and assign responsibility.

b Determine and evaluate possible courses of action.

c Make a decision.

d Prepare financial statements.

2 If revenues are $315,000 under alternative A and $324,000 under alternative B, and costs are $285,000 for A and $306,000 for B, then using the basic approach in incremental analysis, incremental revenues, costs, and net income, in comparing B to A are respectively

a $9,000, $(21,000), $(12,000).

b $(9,000), $21,000, $12,000.

c $9,000, $21,000, $12,000.

d $(9,000), $(21,000), $(12,000).

3 The cost to manufacture an unfinished unit is $120 ($90 variable, $30 fixed) The selling price per unit is $150 The company has unused productive capacity and has determined that units could be finished and sold for $195 with an increase in variable costs of 40% What is the additional net income per unit to be gained by finishing the unit?

a $9.

b $30.

c $45.

d $36.

4 The potential benefit that may be obtained from following an alternative course of action

is called

a opportunity benefit.

b opportunity cost.

c relevant cost.

d sunk cost.

5 In a make or buy decision, the relevant costs include each of the following except the

a variable manufacturing costs that will be saved.

b fixed manufacturing costs that can be eliminated.

c opportunity costs.

d each of the above is a relevant cost.

ANSWERS TO QUIZ

True/False

Multiple Choice

1 d.

2 a.

3 a.

4 b.

5 d.

ILLUSTRATION 7-1

MANAGEMENT’S DECISION-MAKING PROCESS

Identify the problem and

assign responsibility

possible courses of action 2

Review the results

of the decision

ILLUSTRATION 7-2

TYPES OF INCREMENTAL ANALYSIS

1 Accept an order at a special price.

2 Make or buy.

3 Sell or process further.

4 Retain or replace equipment.

5 Eliminate an unprofitable segment.

ILLUSTRATION 7-3

INCREMENTAL ANALYSIS—SPECIAL ORDER PROPOSAL

Your company produces 10,000 units which is 80% of capacity and its normal selling price is $25/unit.

The following cost data are provided at 10,000 units:

Variable cost per unit Fixed cost per unit

$16 4

• Will you accept a special order from a foreign company for an additional 2,000 units at a price of $22/unit ?

• Those of you who said "yes," would you

accept the order at $19/unit ?

• Those of you who said "yes," would you

accept the order at $15/unit ?

Yes Yes Yes

No No No

Sales

Variable costs

Fixed costs

Net income

Change in revenue

Change in costs

Change in net income

$250,000 (160,000 (40,000

$ 50,000

) )

With Special Order

$294,000 (192,000 (40,000

$ 62,000

$44,000 32,000

$12,000

) )

$288,000 (192,000 (40,000

$ 56,000

$38,000 32,000

$ 6,000

) )

$280,000 (192,000 (40,000

$ 48,000

$30,000 32,000

$ (2,000

) )

)

ILLUSTRATION 7-4

INCREMENTAL ANALYSIS—MAKE OR BUY

Your company manufactures a certain part Another company will provide this part to your company for $50.

Provide the incremental analysis given the following cost data:

Fixed costs of $55,000 will continue if the parts are purchased.

a Would you make or buy this part ?

b The productive capacity not used if the parts are purchased may

be rented for $36,000/year Make or buy ?

Direct materials

Direct labor

Manufacturing overhead

Variable

Fixed

$ 60,000 85,000

40,000 90,000

$275,000

$12 17

8 18

$55 Current Production

of 5,000 Units Unit Cost

ILLUSTRATION 7-4 (Continued)

INCREMENTAL ANALYSIS—MAKE OR BUY

Direct materials

Direct labor

Variable manufacturing overhead

Fixed manufacturing overhead

Buy units (5,000 at $50/unit)

Total annual costs

Buy Make

Net Income Increase (Decrease)

$ 60,000 85,000 40,000 90,000 –0–

$275,000

$ –0–

–0–

–0–

55,000 250,000

$305,000

$ 60,000 85,000 40,000 35,000 (250,000

$ (30,000

a "Make" and save $30,000.

) )

Total annual costs

Opportunity cost

Buy Make

Increase (Decrease)

$275,000 36,000

$311,000

$305,000

–0–

$305,000

$ (30,000 36,000

$ 6,000

Opportunity costs are additional costs added to "make" or reduction of costs subtracted from "buy."

)

b "Buy" and save $6,000.