Chapter 6 - Learn Smart

Grady Corporation is evaluating two decision alternatives. Alternative One has costs of $2,000 and revenues of $3,000 while Alternative Two has costs of $3,200 and revenues of $4,000. What is the amount of differential revenue?

$1,000, because $4,000 - $3,000 = $1,000

Grady Corporation is evaluating two decision alternatives. Alternative One has costs of $2,000 and revenues of $5,000 while Alternative Two has costs of $3,200 and revenues of $7,000. Identify the amount of differential revenue.

$2,000, because differential revenue is the difference in revenue between two alternatives. In this case, the difference between $5,000 and $7,000 results in $2,000 differential revenue.

Chris Co. produces sports equipment and is currently producing 1,000 surfboards annually. A supplier has offered to produce the boards for Chris Co. for $300 per board. Chris Co. incurs unit-level costs of $280 per unit. Chris also spends $25,000 on product design each year and incurs $50,000 of facility-level costs. Calculate the avoidable production cost for Chris Co. to produce 1 board.

$305, because unit level cost = $280 and product level cost is $25,000/1,000 units = $25 Avoidable cost to produce one unit= $305.

Wilson Co. has three segments -- Tennis, Golf, and Fishing. The Tennis segment is currently producing 2,000 units annually. The units sell for $200 each. The cost of each unit is $110. The Tennis segment spends $100,000 on product design each year. The segment also is allocated $200,000 of annual facility-level costs. Calculate the avoidable cost if Wilson Co. were to eliminate the Tennis segment.

$320,000, because unit cost is $110 x 2,000 units = $220,000 and product design = $100,000. Therefore avoidable cost = $320,000.

Wilson Co. produces sports equipment and is currently producing 2,000 tennis rackets annually. A supplier has offered to produce the rackets for Wilson Co. for $370 per racket. Wilson incurs unit-level costs of $360 per unit. Wilson also spends $10,000 on product design each year and incurs $100,000 of facility-level costs. Calculate the avoidable production cost for Wilson to produce 1 racket.

$365, because Unit level cost = $360 Product level cost is $10,000/2,000 units = $5. Therefore, avoidable cost to produce one racket = $365.

Wilson Co. has three segments -- Tennis, Golf, and Fishing. The Tennis segment is currently producing 2,000 units annually. The units sell for $200 each. The cost of each unit Wilson produces is $110. The Tennis segment spends $100,000 on product design each year. The segment also is allocated $200,000 of annual facility-level costs. Calculate the differential revenue if Wilson Co. were to eliminate the Tennis segment.

$400,000, because differential revenue is $200 x 2,000 units = $400,000. This is the amount of relevant revenue that pertains to eliminating the Tennis segment. If the Tennis segment is eliminated, then $400,000 of differential revenue will be lost.

Premier Co. has three segments -- Park Benches, Swings, and Lighting. The Bench segment is currently producing 5,000 units annually. The units sell for $100 each. The cost of each unit is $90. The Bench segment spends $40,000 on product design each year. The segment also is allocated $100,000 of annual facility-level costs. Calculate the avoidable cost if Premier Co. were to eliminate the Bench segment.

$490,000, because unit cost is 5,000 units x $90 = $450,000 and product design = $40,000. Therefore, avoidable cost = $490,000.

Premier Co. produces park equipment and is currently producing 10,000 park benches annually. A supplier has offered to produce the bench for Premier Co. for $500 per bench. Premier Co. incurs unit-level costs of $490 per unit. Premier also spends $50,000 on product design each year and incurs $100,000 of facility-level costs. Calculate the avoidable production cost for Premier Co. to produce 1 bench.

$495, because unit level cost = $490 and product level cost is $50,000/10,000 units = $5. Therefore, avoidable cost to produce one unit= $495

Oliver Company owns a machine with a current book value of $50,000. The market value of the machine is $20,000. The operating expenses are $9,000. Oliver is evaluating whether to sell the machine for $20,000 and purchase a new machine that will have lower operating expenses. In this scenario, what is the sunk cost related to Oliver's decision?

$50,000, because the market value of the machine represents the sacrifice Oliver must make if it keeps using the existing machine which is known as an opportunity cost. The sunk cost is the current book value of $50,000. It is a cost that was incurred in a prior period and represents an irrelevant sunk cost.

Premier Co. has three segments -- Park Benches, Swings, and Lighting. The Bench segment is currently producing 5,000 units annually. The units sell for $100 each. The cost of each unit is $90. The Bench segment spends $40,000 on product design each year. The segment also is allocated $100,000 of annual facility-level costs. Calculate the differential revenue if Premier Co. were to eliminate the Bench segment.

$500,000, because the differential revenue is $100 x 5,000 units = $500,000. This is the amount of relevant revenue that pertains to eliminating the Bench segment. If the Bench segment is eliminated, the $500,000 of differential revenue will be lost.

Wilson Co. produces tennis rackets. A customer has offered Wilson Co. $400 per unit for 200 units. To fill the order, Wilson would incur unit-level costs of $300 per unit and batch-level costs of $1,000. Wilson also incurred $10,000 of product-level costs to design the racket and $100,000 of facility-level costs. Calculate the amount of differential cost.

$61,000, because the differential costs for the special order include the unit level cost and batch level costs for the special order. The unit level costs would be 200 units x $300 = $60,000. The batch level cost would be $1,000. Therefore, total differential cost is $61,000.

Outdoor Living Company has just received a special order for 500 tents. Outdoor Living has sufficient idle capacity to accept the order. Accepting the order will increase Outdoor Living's variable manufacturing costs. Which type of cost is considered a sunk cost to Outdoor Living's decision of whether to accept or reject the special order.

$7,000 depreciation costs on equipment used to make the tents. Labor and raw material costs to manufacture the tents is relevant to the special order decision. A sunk cost represents a cost that was incurred in a prior period and is irrelevant to the decision.

Premium Co. produces park benches. A customer has offered Premium Co. $800 per unit for 100 units. To fill the order, Chris would incur unit-level costs of $600 per unit and batch-level costs of $15,000. Premium Co. also incurred $20,000 of product-level costs to design the bench and $200,000 of facility-level costs. Calculate the amount of differential cost.

$75,000 because unit-level costs = $60,000 and batch-level costs = 15,000 giving a total of $75,000.

Wilson Co. produces tennis rackets. A customer has offered Wilson Co. $400 per unit for 200 units. To fill the order, Wilson would incur unit-level costs of $300 per unit and batch-level costs of $1,000. Wilson also incurred $10,000 of product-level costs to design the racket and $100,000 of facility-level costs. Calculate the amount of differential revenue.

$80,000 because $200 x 400 units = $80,000.

Premium Co. produces park benches. A customer has offered Premium Co. $800 per unit for 100 units. To fill the order, Chris would incur unit-level costs of $600 per unit and batch-level costs of $15,000. Premium Co. also incurred $20,000 of product-level costs to design the bench and $200,000 of facility-level costs. Calculate the amount of differential revenue.

$80,000, because differential revenue = $80,000 ($800 x 100 units)

Which of following characteristics are qualitative?

1. Employee satisfaction 2. Appearance 3. Customer satisfaction

Which of following characteristics are quantitative?

1. Net income 2. Employee wages 3. Allocated overhead cost

Which of the following should be considered when making a special order decision?

1. Unit-level costs 2. Batch-level costs

Which of the following should be considered when making an outsourcing decision?

1. Unit-level costs 2. Product-level costs 3. Batch-level costs

To be relevant, information must

1. be future oriented. 2. differ among alternatives.

Which of the following is a product-level cost?

Engineering design costs

True or false: Only variable costs are relevant to decision making.

False Both variable and fixed costs can be relevant.

Chris Co. produces surfboards. A customer has offered Chris Co. $400 a unit for 100 units. To fill the order, Chris would incur unit-level costs of $350 a unit and batch-level costs of $5,500. Chris Co. also incurred $70,000 of product-level costs to design the board and $10,000 of facility-level costs. Based on your quantitative analysis, should Chris Co. accept the special order?

No, because differential revenue $400 x 100 units = $40,000. Avoidable unit level cost 350 x 100 units = $35,000. Avoidable batch level cost = $5,500. Total Differential costs = $40,500 Since differential revenue is less than the differential cost, the company should not accept the special order.

Wilson Co. produces sports equipment and is currently producing 2,000 tennis rackets annually. A supplier has offered to produce the rackets for Wilson Co. for $370 per racket. Wilson incurs unit-level costs of $360 per unit. Wilson also spends $10,000 on product design each year and incurs $100,000 of facility-level costs. Based on your quantitative analysis, should Wilson Co. outsource the rackets? What is the effect on profit?

No, because unit cost 2,000 units x $360 = $720,000 and product level cost = $10,000. Total Relevant cost for production = $730,000 Cost to outsource 2,000 units x $370 = $740,000. In this case, the cost of outsourcing is greater than the cost of producing. Wilson Co. would be better off to continue producing the rackets than to outsource.

Chris Co. produces surfboards. A customer has offered Chris Co. $400 per unit for 100 units. To fill the order, Chris would incur unit-level costs of $350 per unit and batch-level costs of $5,500. Chris Co. also incurred $70,000 of product-level costs to design the board and $10,000 of facility-level costs. Chris Co. can rent out its excess capacity for $2,000 if it does not accept the special order. Based on your quantitative analysis, should Chris Co. accept the special order? What is the effect on profit?

No, Chris Co. should not accept the special order because it will decrease profit by $2,500

Premier Co. produces park equipment and is currently producing 10,000 park benches annually. A supplier has offered to produce the benches for Premier Co. for $500 per bench. Premier Co. incurs unit-level costs of $490 per unit. Premier also spends $50,000 on product design each year and incurs $100,000 of facility-level costs. If Premier Co. outsources the benches, they can lease their manufacturing space for $40,000. Based on your quantitative analysis, should Premier Co. outsource the benches?

No, Premier Co. should not outsource park benches because outsourcing will decrease profit by $10,000.

Premier Co. produces park equipment and is currently producing 10,000 park benches annually. A supplier has offered to produce the benches for Premier Co. for $500 per bench. Premier Co. incurs unit-level costs of $490 per unit. Premier also spends $50,000 on product design each year and incurs $100,000 of facility-level costs. Based on your quantitative analysis, should Premier Co. outsource the benches?

No, Premier Co. should not outsource park benches because outsourcing will decrease profit by $50,000. Unit cost is 10,000 units x $490 = $4,900,000. Product level costs are $50,000. Total Relevant cost for production= $4,950,000 Cost to outsource is 10,000 units x $500 = $5,000,000. In this case, the cost of outsourcing is more expensive than the cost of producing. Premier Co. would be better off to produce the benches.

Premium Co. produces park benches. A customer has offered Premium Co. $800 per unit for 100 units. To fill the order, Premium would incur unit-level costs of $600 per unit and batch-level costs of $15,000. Premium Co. also incurred $20,000 of product-level costs to design the bench and $200,000 of facility-level costs. Premium Co. can rent out its excess capacity for $12,000 if it does not accept the special order. Based on your quantitative analysis, should Premium Co. accept the special order? What is the effect on profit?

No, Premium Co. should not accept the special order because it will decrease profit by $7,000. Because the differential costs for the special order include the unit level cost, batch level cost, and the opportunity cost for the special order. The unit level costs would be 100 units x $600 = $60,000. The batch level cost would be $15,000. The opportunity cost is $12,000 due to the potential leasing opportunity. Therefore, total differential cost is $87,000. The differential revenue is 100 units x $800 = $80,000. Since the differential cost exceeds the differential revenue the special order should not be accepted.

Wilson Co. has three segments -- Tennis, Golf, and Fishing. The Tennis segment is currently producing 2,000 units annually. The units sell for $200 each. The cost of each unit is $110. The Tennis segment spends $100,000 on product design each year. The segment also is allocated $200,000 of annual facility-level costs. Using quantitative analysis, should Wilson eliminate the Tennis segment? What would be the effect on profit?

No, Wilson Co. should not eliminate the Tennis segment because eliminating the segment will decrease profit by $80,000. Unit cost is $110 x 2,000 units = $220,000 and product design = $100,000. Differential cost = $320,000. Differential revenue is $200 x 2,000 units = $400,000. Since the differential revenue that would be lost is greater than the differential cost, the segment should not be eliminated.

Chris Co. is considering replacing an old machine. The old machine was purchased for $100,000 and has a book value of $40,000 and should last four more years. Chris Co. believes that it can sell the old machine for $20,000. The new machine cost $80,000 and will have a 4-year life and a $10,000 salvage value. Currently, it cost $20,000 annually to operate the old machine. The new machine is more efficient and should reduce operating cost by 50%. Based on quantitative analysis, calculate the relevant costs and indicate if Chris Co. should replace the old machine?

No, because the relevant cost of the new machine is $10,000 more than the old machine. Opportunity cost = $20,000, Salvage value = $0, Operating expenses are $20,000 x 4 years = $80,000. Total Relevant cost = $100,000 for old machine. Cost of new machine = $80,000 Salvage value = $10,000 Operating expenses = $40,000 Total Relevant cost = $110,000 for new machine. Chris Co. should not acquire the new machine. In this case, keeping the old machine produces the lower relevant costs.

Which of the following is a batch-level cost?

Shipping cost of sending 100 units.

Premium Co. produces park benches. A customer has offered Premium Co. $800 a unit for 100 units. To fill the order, Chris would incur unit-level costs of $600 a unit and batch-level costs of $15,000. Premium Co. also incurred $20,000 of product-level costs to design the bench and $200,000 of facility-level costs. Based on your quantitative analysis, should Premier Co. accept the special order?

Yes, because differential revenue equals 100 units x $800 = $80,000. Avoidable unit level costs equal 100 units x $600 = $60,000. Avoidable batch level cost = $15,000. Total Differential costs = $75,000. Since differential revenue is greater than the differential cost, the company should accept the special order.

Chris Co. has three segments -- Surfing, Mountain Biking, and Fly Fishing. The Surfing segment is currently producing 1,000 units annually. The units sell for $500 each. The cost of each unit is $400. The Surfing segment spends $110,000 on product design each year. The segment also is allocated $100,000 of annual facility-level costs. Using quantitative analysis, should Chris eliminate the Surfing segment? What would be the effect on profit?

Yes, Chris Co. should eliminate the Surfing segment, because eliminating it will increase profit by $10,000. Unit cost is $400 x 1,000 units = $400,000 and product design = $110,000. Differential cost = $510,000. Differential revenue is $500 x 1,000 units = $500,000. Since the differential cost that could be avoided is greater than the differential revenue, the segment should be eliminated.

Chris Co. produces sports equipment and is currently producing 1,000 surfboards annually. A supplier has offered to produce the boards for Chris Co. for $300 per board. Chris Co. incurs unit-level costs of $280 per unit. Chris also spends $25,000 on product design each year and incurs $50,000 of facility-level costs. Based on your quantitative analysis, should Chris Co. outsource the board? What is the effect on profit?

Yes, Chris Co. should outsource the board because outsourcing will increase profit by $5,000.

Chris Co. produces sports equipment and is currently producing 1,000 surfboards annually. A supplier has offered to produce the boards for Chris Co. for $300 per board. Chris Co. incurs unit-level costs of $280 per unit. Chris also spends $25,000 on product design each year and incurs $50,000 of facility-level costs. If Chris Co. outsources the boards, they can lease their manufacturing space for $1,000. Based on your quantitative analysis, should Chris Co. outsource the board? What is the effect on profit?

Yes, Chris Co. should outsource the board because outsourcing will increase profit by $6,000.

Wilson Co. produces tennis rackets. A customer has offered Wilson Co. $400 per unit for 200 units. To fill the order, Wilson would incur unit-level costs of $300 per unit and batch-level costs of $1,000. Wilson also incurred $10,000 of product-level costs to design the racket and $100,000 of facility-level costs. Wilson Co. can rent out its excess capacity for $10,000 if it does not accept the special order. Based on your quantitative analysis, should Wilson Co. accept the special order? What is the effect on profit?

Yes, Wilson Co. should accept the special order because it will increase profit by $9,000. because the differential costs for the special order include the unit level cost, batch level cost, and the opportunity cost for the special order. The unit level costs would be 200 units x $300 = $60,000. The batch level cost would be $1,000. The opportunity cost is $10,000 due to the potential leasing opportunity. Therefore, total differential cost is $71,000. The differential revenue is 200 units x $400 = $80,000. Since the differential revenue exceeds the differential cost the special order should be accepted.

Wilson Co. produces sports equipment and is currently producing 2,000 tennis rackets annually. A supplier has offered to produce the rackets for Wilson Co. for $370 per racket. Wilson incurs unit-level costs of $360 per unit. Wilson also spends $10,000 on product design each year and incurs $100,000 of facility-level costs. If Wilson outsources the rackets, they can lease their manufacturing space for $20,000. Based on your quantitative analysis, should Wilson Co. outsource the rackets? What is the effect on profit?

Yes, Wilson Co. should outsource the rackets because outsourcing will increase profits by $10,000. Because Unit cost 2,000 units x $360 = $720,000. Product level cost = $10,000 Opportunity cost = $20,000 Total Relevant cost for production = $750,000 Cost to outsource 2,000 units x $370 = $740,000. In this case, the cost of outsourcing is cheaper than the cost of producing, Wilson Co. would be better off to outsource the rackets and lease the space.

Chris Co. is considering replacing an old machine. The old machine was purchased for $100,000 and has a book value of $40,000 and should last four more years. Chris Co. believes that it can sell the old machine for $20,000. The new machine costs $70,000 and will have a 4-year life and a $30,000 salvage value. Currently, it cost $20,000 annually to operate the old machine. The new machine is more efficient and should reduce operating cost by 50%. Based on quantitative analysis, calculate the relevant costs and indicate if Chris Co. should replace the old machine?

Yes, because the relevant cost of the new machine is $20,000 less than the old machine.

Costs that can be eliminated by making specific choices are called costs.

avoidable

Costs incurred each time a company generates a set quantity of goods produced at one time are called _______________-level costs.

batch

Outsourcing involves a decision about whether to

buy goods and services from other companies rather than producing them internally.

To evaluate an outsourcing decision, a manager should compare the avoidable cost of making an item to the cost of it.

buying

Revenue that differs among two alternatives is called _______________ _______________.

differential revenue

Relevant revenue is also called

differential revenue.

Unit-level costs are

incurred each time a company generates one individual item of product.

The practice of enticing clients with a low price and then increasing prices once clients are dependent is called

low-ball pricing.

Qualitative information about a segment elimination decision is relevant when it

makes a difference in the decision and it differs among alternatives.

Cost information

may or may not be relevant, depending on the context.

Costs incurred to support specific goods or services are called

product-level costs.

Managers should base equipment replacement decisions on _______________ analysis rather than physical deterioration.

profitability

Equipment replacement decisions should be made based on

profitability analysis, because equipment may become technologically obsolete long before it fails physically. Managers should base equipment replacement decisions on profitability analysis rather than physical deterioration.

The fact that some customers prefer one stop shopping and may stop buying items from Segment A if Segment B is eliminated is an example of a _______________ factor that should be considered in making the segment elimination decision.

qualitative

In decision-making, relevant information is

relevant but not necessarily exact.

Avoidable costs are

relevant.

Differential _______________ are expected future sales that vary between the alternatives under consideration.

revenues

Costs incurred each time a company generates one individual item of product are called _______________-level costs.

unit

Companies that have control over the full range of activities from acquiring raw materials to distributing goods and services use _______________ integration.

vertical