Ch 6.1, 6.2, 6.3, 6.4, 6.5

Harcourt Manufacturing (HM) has the capacity to produce 10,000 fax machines per year. HM currently produces and sells 7,000 units per year. The fax machines normally sell for $100 each. Modem Products has offered to buy 2,000 fax machines from HM for $60 each. Unit-level costs associated with manufacturing the fax machines are $15 each for direct labor and $40 each for direct materials. Product-level and facility-level costs are $50,000 and $65,000, respectively. How much would profit increase (decrease) if HM accepted this special order? $10,000 $112,000 ($10,000) ($112,000)

$10,000 Revenue (2,000 x $60) = $120,000 Unit-Level Costs (2,000 x ($15 + $40)) = ($110,000) Profit = $10,000

Tom's Toolery is operating at 80% of its productive capacity. It is currently paying $20 per unit for a part used in its manufacturing operation. Tom's estimates it could make the part internally for a total cost of $24 per unit, consisting of $18 of unit-level production costs and $6 of facility-level costs that are currently attributed to other products. Tom's usually purchases 50,000 units of the part each year. These units could be manufactured using Tom's excess capacity. What is the effect on cost if the company decides to start making the part? $100,000 cost decrease $100,000 cost increase $200,000 cost increase $1,000,000 cost increase

$100,000 cost decrease Cost to purchase $20 Relevant cost to make* 18 Decrease in cost per unit - $2

Gilbert's management is considering whether to eliminate manufacturing product G at the beginning of the next year. The elimination will have no effect on the sales or unit-level costs of products F and H. The change in income that would result from eliminating product G is $30,000 increase $20,000 decrease $10,000 increase $10,000 decrease

$20,000 decrease Product G is currently contributing $20,000 to profitability ($180,000 Revenue - $160,000 avoidable cost). The facility-level costs are not avoidable regardless of whether Product G is eliminated. If the Product G is eliminated, company-wide profitability will decrease by $20,000.

Jason Company is considering replacing equipment which originally cost $600,000. New equipment costs $500,000 and the old equipment can be sold for $400,000. What is the sunk cost in this situation? $600,000 $200,000 $400,000 $500,000

$600,000 The original cost of the old equipment is the result of a historical event that cannot be changed by current or future action. In other words, you cannot change the past. Therefore the original cost of old equipment is a sunk cost that is not relevant to current or future decisions.

Krauss Company purchased a construction crane three years ago for $180,000. The crane has a current book value of $100,000 and operating expenses excluding depreciation of $12,000 per year. The current market value of this crane is $85,000. If the old crane is kept five more years, its salvage value would be $10,000. A new crane would cost $70,000, have a useful life of five years, and would require $13,000 per year in operating expenses excluding depreciation. The new crane has a salvage value of $20,000 after five years. Based on this information, Krauss should acquire the new crane because it has the lower relevant cost. acquire the new crane because it is newer and has a longer useful life. retain the old crane because it has lower operating expenses. retain the old crane because it has a higher market value.

Acquire the new crane because it has the lower relevant cost As shown in the following table the relevant cost of acquiring and operating the new crane is lower than the cost of retaining and operating the old crane. Therefore Krauss should acquire the new crane. Old Crane: OC ($85k market - 10k salvage) = 75k Operating expense (12k x 5) = 60k New crane: OC (70k - 20k) = 50k Operating expense = 13k x 5 = 65k

Which of the following statements is true regarding potential qualitative issues affecting outsourcing decisions? Outsourcing reduces a manufacturer's vertical integration. Low balling refers to the practice of offering lower prices initially and then raising prices when the buyer becomes dependent. Outsourcing can cause morale issues for the employees who are not directly affected by the practice. All of the answers describe potential qualitative factors associated with outsourcing decisions.

All of the answers describe potential qualitative factors associated with outsourcing decisions.

A segment elimination decision involves a comparison between revenue that will be lost through the elimination and the total cost of operating the segment. fixed cost of operating the segment. outsourcing costs of operating the segment. avoidable cost of operating the segment.

Avoidable cost of operating the segment Only the costs that can be avoided or saved by the decision to eliminate are relevant to the revenue versus cost comparison.

To be relevant, information must: Differ among the alternatives. Affect present or future conditions. Both of the answers are characteristics of relevant information. None of the answers are characteristics of relevant information.

Both of the answers are characteristics of relevant information.

U-RIDE, Inc. currently produces the electric engines that are used in golf carts made and sold by the Company. Electco has offered to sell the electric engines to U-RIDE at a price of $200 each. U-RIDE is currently operating profitably producing and selling 2,000 engines a year using 90% of its manufacturing capacity. Which of the following is true? U-RIDE should make the engines for cost savings of $25 per unit. Buying the units would increase U-RIDE's cost by $13 per unit. U-RIDE has avoidable costs of greater than $200 per unit and should therefore buy the engines. Buying the units would increase profitability by $38 per unit.

Buying the units would increase U-RIDE's cost by $13 per unit. Unit-level material cost - $175 Product-level Cost [($2,000 x 12 months) ÷ 2,000 engines] -12 Total - $187 *The depreciation is a sunk cost that is not relevant. The facility-level utility cost will be incurred regardless of whether the motors are made or outsourced and are therefore, not relevant. If URIDE outsources the engines the company will incur additional cost of $13 per unit ($200 to buy - $187 to make).

Which of the following is least likely to be classified as a unit-level cost? Cost of direct materials Cost of plant security Cost of inspecting items produced Cost of direct labor

Cost of plant security The cost of providing security for the plant facility does not change when increases or decreases in the number of units made occur.

If Barbecue Division were eliminated, profitability would increase $25,000. increase $525,000. decrease $100,000. decrease $25,000.

Decrease $100,000 Rev from sales - $500,000 Avoidable costs: Salaries for workers - ($100,000) Direct materials - ($300,000) Contribution to profit - $100,000

Harcourt Manufacturing (HM) has the capacity to produce 10,000 fax machines per year. HM currently produces and sells 7,000 units per year. HM currently leases its excess capacity for a rental fee of $12,000. The fax machines normally sell for $100 each. Modem Products has offered to buy 2,000 fax machines from HM for $60 each. Unit-level costs associated with manufacturing the fax machines are $15 each for direct labor and $40 each for direct materials. Product-level and facility-level costs are $50,000 and $65,000, respectively. Based on this information (ignore qualitative characteristics) HM should reject the offer because accepting it will reduce profitability by $2,000. HM should accept the offer because accepting it will contribute $10,000 to profit. HM should reject the offer because accepting it will reduce profitability by $10,000. HM should accept the offer because accepting it will contribute $12,000 to profit.

HM should reject the offer because accepting it will reduce profitability by $2,000.

What is total avoidable cost?

If the Division is eliminated Chips, Inc. could avoid paying for the salaries and direct materials incurred to make the barbecue chips. The sunk cost and the facility-level cost cannot be avoided regardless of whether the Division is eliminated. Total avoidable cost is $400,000 ($100,000 salaries + $300,000 materials).

The Lamp Company (TLC) currently makes and sells approximately 5,000 lamps per year. TLC recently received an offer from a new customer to purchase 500 lamps. TLC has the capacity to make the additional lamps but is reluctant to accept the offer because the price offered is significantly below the normal selling price. Based on this information TLC if faced with a(n) special order decision. asset replacement decision. outsourcing decision. segment elimination decision.

Special order decision

Which of the following are not relevant to decision making? Replacement cost Incremental cost Opportunity cost Sunk cost

Sunk cost Sunk costs are based on historical events that cannot be changed by current or future events. In other words, you cannot change the past. In other words, the past is the same regardless of which alternatives are selected in a current decision. Since sunk costs do not differ between the alternatives and do not affect present or future conditions they are not relevant for decision making purposes.

Steel City Company (SCC) paid $120,000 to purchase land that it planned to use as a future building site. A short time later the Company was approached with an opportunity to purchase a better property. The new property cost $125,000. After considering the alternative SCC decided to reject the offer because the Company would be required to sell the original site for $119,000 thereby incurring a $1,000 loss on the disposal of the land ($120,000 - $119,000).Based on this information the $1,000 loss is relevant to the decision. the $119,00 current market value of original site is relevant to the decision. the $125,000 cost of the replacement property is not relevant to the decision. the $5,000 difference between the cost of the two properties ($125,000 - $120,000) is relevant to the decision.

The $119,00 current market value of original site is relevant to the decision. The $1,000 loss ($120,000 - $119,000) and the $5,000 dollar difference between the cost of the original site and the cost of the replacement property are not relevant because these items are based on the historical cost of original site which is a sunk cost. The current market value of the old property ($119,000) and the cost of the replacement property ($125,000) are both relevant to the decision because they impact the current or future condition of the Company.

Which of the following items would not be relevant to an asset replacement decision? The market value of the new asset. The salvage value of the asset being replaced. The book value of the asset being replaced. The cost of operating the new asset.

The book value of the asset being replaced The book value is the original cost of the asset minus accumulated depreciation. These are historical facts that cannot be changed by present or future events. In other words, the book value of the old asset is a sunk cost that is not relevant to the decision.

Buying the engines will free up manufacturing capacity that could be used to make a new economy line golf cart that would produce an additional $36,000 profit per year. U-RIDE is currently operating profitably producing and selling 2,000 engines annually. Based on this information, which of the following is true? The $36,000 is not relevant because it is an estimate. Buying the units would increase U-RIDE's cost by $13 per unit. U-RIDE has avoidable costs of less than $200 per unit and should therefore buy engines. The cost of buying the engines is $5 per unit less than the relevant cost of making the units.

The cost of buying the engines is $5 per unit less than the relevant cost of making the units. Unit-level material cost - $175 Product-level Cost [($2,000 x 12 months) ÷ 2,000 engines] - $12 Opportunity Cost ($36,000 ÷ 2,000 engines) - $18 Total - $205 *The depreciation is a sunk cost that is not relevant. The facility-level utility cost will be incurred regardless of whether the motors are made or outsourced and are therefore, not relevant. If U-RIDE continues to make the engines, the Company loses the opportunity to develop the new line of economy carts and therefore incurs a $36,000 annual opportunity cost. Under these circumstances it is $5 cheaper to buy the engines than it is to make them ($200 purchase price versus $205 relevant cost to make).

Which of the following is a facility-level cost? Cost of direct materials The cost of the salary for the company president. Cost of designing a new product The cost of setting up the production line to make a batch of products.

The cost of the salary for the company president. The cost of direct materials is a unit-level cost. The cost of designing a product is a product-level cost. Generally, set-up costs are batch-level costs. They are incurred each time a new batch is produced. They may include the cost of setting up the production machines, training employees, paperwork and ordering cost to provide materials for the batch.

Should HM accept the special order? Yes, unequivocally. No. Yes, but only if qualitative factors are favorable. No, because GAAP requires all costs to be included in the product.

Yes To be accepted a special order decision must provide both favorable quantitative and qualitative results.

What are sunk costs

a cost that has already been incurred and cannot be recovered.

A company should accept a special order if additional revenue is greater than relevant costs. the avoidable cost of making the products is less than the sunk cost. the company is operating at full capacity. qualitative features are unfavorable.

additional revenue is greater than relevant costs

What is salvage value

is the estimated resale value of an asset at the end of its useful life. Salvage value is subtracted from the cost of a fixed asset to determine the amount of the asset cost that will be depreciated.

Hector, Inc. currently makes and sells approximately 5,000 shovels per year. Hector has an offer to buy the shovels it currently makes at a price that is below its cost of making them. Based on this information Hector is faced with a(n) special order decision. asset replacement decision. outsourcing decision. segment elimination decision.

outsourcing decision.

Interrelated sales transactions (sales of one product affects the sales of another product) is a qualitative characteristic most commonly examined in a special order decision. segment elimination decision. make or buy decision. Interrelated sales analysis is not used in any of the decisions identified in the answers provided.

segment elimination decision. Segment elimination decisions frequently include an analysis of interrelated sales transactions. For example, eliminating children's clothing could affect the sales of women's clothing. Women who previously bought something for themselves while shopping for their children may no longer visit the store.

Tucker Company is considering replacing a machine. The machine had originally cost $12,000. It has accumulated depreciation of $4,000. The current market value of the machine is $7,000. Based on this information alone the original cost of the asset is relevant to a replacement decision. the Company should not replace the machine because doing so would require the recognition of a $1,000 loss on the disposal of the machine. the market value of the machine is relevant to a replacement decision. the book value of the machine is relevant to a replacement decision.

the market value of the machine is relevant to a replacement decision. The original cost, book value and the loss are all based on past transactions that cannot be changed by current or future action. They represent sunk costs that are not relevant to a replacement decision.