CHAPTER 25 DIFFERENTIAL ANALYSIS, PRODUCT PRICING, AND ACTIVITY-BASED COSTING DISCUSSION QUESTIONS 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 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 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 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 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 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 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 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 © 2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing DISCUSSION QUESTIONS (Continued) 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 PRACTICE EXERCISES PE 25–1A Differential Analysis Lease Machine (Alt 1) or Sell Machine (Alt 2) January 12, 2014 Differential Revenues Costs Lease Sell Effect Machine (Alternative 1) Machine (Alternative 2) on Income (Alternative 2) $243,000 –16,900 $226,100 Income (Loss) $231,000 –11,550 * $219,450 –$12,000 5,350 –$ 6,650 * $231,000 × 5% Jerrod Company should lease the machine PE 25–1B Differential Analysis Lease Equipment (Alt 1) or Sell Equipment (Alt 2) March 23, 2014 Differential Lease Revenues Costs Income (Loss) Sell Effect Equipment Equipment on Income (Alternative 1) (Alternative 2) (Alternative 2) $84,600 –7,950 $76,650 * $82,000 × 6% Timberlake Company should sell the equipment $82,000 –4,920* $77,080 –$2,600 3,030 $ 430 PE 25–2A Differential Analysis Continue Product S (Alt 1) or Discontinue Product S (Alt 2) September 12, 2014 Continue Product S (Alternative 1) Revenue Costs: Variable cost of goods sold Variable selling and admin expenses Fixed costs Income (Loss) $149,000 Discontinue Product S (Alternative 2) $ Differential Effect on Income (Alternative 2) –$149,000 –88,500 88,500 –24,500 –40,000 –$ 4,000 –40,000 –$40,000 24,500 –$ 36,000 Product S should be continued PE 25–2B Differential Analysis Continue Product B (Alt 1) or Discontinue Product B (Alt 2) May 9, 2014 Differential Revenue Costs: Variable cost of goods sold Variable selling and admin expenses Fixed costs Income (Loss) Product B should be discontinued Continue Discontinue Effect Product B (Alternative 1) Product B (Alternative 2) on Income (Alternative 2) $39,500 $ –$39,500 –25,500 25,500 –16,500 –15,000 –$17,500 –$15,000 –$15,000 16,500 $ 2,500 PE 25–3A Differential Analysis Make Bread (Alt 1) or Buy Bread (Alt 2) August 16, 2014 Differential Make Bread (Alternative 1) Unit costs: Purchase price Delivery Variable costs ($152 – $39) Fixed factory overhead Income (Loss) Buy Bread (Alternative 2) $ 0 –113 –39 –$152 –$105 –12 –39 –$156 Effect on Income (Alternative 2) –$105 –12 113 –$ The company should make the bread PE 25–3B Differential Analysis Make Bottles (Alt 1) or Buy Bottles (Alt 2) March 30, 2014 Differential Unit costs: Purchase price Freight Variable costs ($67 – $22) Fixed factory overhead Income (Loss) The company should buy the bottles Make Buy Effect Bottles (Alternative 1) Bottles (Alternative 2) on Income (Alternative 2) $ 0 –45 –22 –$67 –$35 –5 –22 –$62 –$35 –5 45 $ PE 25–4A Differential Analysis Continue with Old Machine (Alt 1) or Replace Old Machine (Alt 2) February 18, 2014 Continue with Replace Differential Old Machine (Alternative 1) Old Machine (Alternative 2) Effect on Income (Alternative 2) $ 98,000 $ 98,000 –155,000 –348,0002 –$405,000 –155,000 60,000 $ 3,000 Revenues: Proceeds from sale of old machine Costs: Purchase price Direct labor (6 years) Income (Loss) $ 0 –408,0001 –$408,000 $68,000 × years $58,000 × years The company should replace the old machine PE 25–4B Differential Analysis Continue with Old Machine (Alt 1) or Replace Old Machine (Alt 2) April 11, 2014 Continue with Old Machine (Alternative 1) Revenues: Proceeds from sale of old machine Costs: Purchase price Direct labor (5 years) Income (Loss) $ 0 –56,0001 –$56,000 $11,200 × years $7,400 × years The company should continue with the old machine Replace Old Machine (Alternative 2) Differential Effect on Income (Alternative 2) $50,500 $50,500 –75,000 –37,0002 –$61,500 –75,000 19,000 –$ 5,500 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) Revenues, per unit Costs, per unit Income (Loss), per unit Process Differential Further into Product U (Alternative 2) Effect on Income (Alternative 2) $4.65 –3.90 $0.75 $5.30 –4.48 * $0.82 $0.65 –0.58 $0.07 * $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 Process Revenues, per unit Costs, per unit Income (Loss), per unit Differential Sell Further into Effect Product D (Alternative 1) Product E (Alternative 2) on Income (Alternative 2) $36 –24 $12 * $24 + $9 The company should sell Product D without further processing $43 –33* $10 $7 –9 –$2 PE 25–6A Differential Analysis Reject Order (Alt 1) or Accept Order (Alt 2) October 23, 2014 Differential Reject Order (Alternative 1) Revenues, per unit Costs: Variable manufacturing costs, per unit Export tariff, per unit Income (Loss), per unit Accept Order (Alternative 2) Effect on Income (Alternative 2) $0.00 $39.00 $39.00 0.00 0.00 $0.00 –31.00 –9.75* –$ 1.75 –31.00 –9.75 –$ 1.75 * $39.00 × 25% The company should not accept the special order PE 25–6B Differential Analysis Reject Order (Alt 1) or Accept Order (Alt 2) March 16, 2014 Differential Revenues, per unit Costs: Variable manufacturing costs, per unit Export tariff, per unit Income (Loss), per unit * $7.20 × 15% The company should accept the special order Reject Accept Effect Order (Alternative 1) Order (Alternative 2) on Income (Alternative 2) $0.00 $7.20 $7.20 0.00 0.00 $0.00 –5.00 –1.08 * $1.12 –5.00 –1.08 $1.12 PE 25–7A Markup percentage on product cost: Markup percentage on product cost: Desired Profit + Selling and Admin Exp Total Product Cost $55 + $26 $54* = 150% * $80 – $26 PE 25–7B Markup percentage on product cost: Markup percentage on product cost: Desired Profit + Selling and Admin Exp Total Product Cost $58 + $70 $160* = 80% * $230 – $70 PE 25–8A Unit contribution margin……………………………………………… ÷ Testing hours per unit……………………………………………… Unit contribution margin per production bottleneck hour……… Product A $24 $ Product B $30 $ Product A is the most profitable in using bottleneck resources PE 25–8B Unit contribution margin……………………………………………… ÷ Furnace hours per unit……………………………………………… Unit contribution margin per production bottleneck hour……… Product L is the most profitable in using bottleneck resources Product K $120 $ 24 Product L $100 $ 25 CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing PE 25–9A a Fabrication: Assembly: Setup: Inspection: $450,000 ÷ 2,000 direct labor hours = $225 per dlh $210,000 ÷ 2,000 direct labor hours = $105 per dlh $240,000 ÷ 160 setups = $1,500 per setup $300,000 ÷ 800 inspections = $375 per inspection b Speedboat Bass Boat ActivityActivity Base Usage Fabrication 800 dlh Assembly 1,200 dlh Setup 60 setups 600 insp Inspection Total ÷ Budgeted units to be produced Factory overhead per unit Activity× Activity Rate $225 $105 $1,500 $375 /dlh /dlh /setup /insp = Activity Cost $180,000 126,000 90,000 225,000 $621,000 200 ÷ $ 3,105 Base Usage 1,200 800 100 200 dlh dlh setups insp × Activity Rate $225 $105 $1,500 $375 /dlh /dlh /setup /insp 25-10 © 2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part = Activity Cost $270,000 84,000 150,000 75,000 $579,000 200 ÷ $ 2,895 CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing Prob 25–2B Differential Analysis Continue with Old Machine (Alt 1) or Replace Old Machine (Alt 2) November 8, 2014 Continue with Old Machine (Alternative 1) Revenues: Proceeds from sale of old machine Costs: Purchase price Annual manufacturing costs (6 yrs.) Income (Loss) $ Replace Differential Old Effect Machine (Alternative 2) on Income (Alternative 2) $12,900 $12,900 –57,000 –57,000 –20,400 –$64,500 54,000 $ 9,900 –74,400 –$74,400 $12,400 × years $3,400 × years Note: Revenues and nonmanufacturing operating expenses are not affected by the decision to replace the old machine, and thus are not included in the analysis If they were, both alternatives would include them, causing the differential effect on income to net to zero for both items Depreciation is ignored because it is a sunk cost for the old machine and is incorporated in the purchase price for the new machine Flint Tooling Co should replace the old machine with the new machine Other factors to be considered include the following: a Are there any improvements in the quality of work turned out by the new machine? b What effect does the federal income tax have on the decision? c What opportunities are available for the use of the $44,100 of funds ($57,000 less $12,900 proceeds from the old machine) that are required to purchase the new machine? After considering such factors as those listed above, the net cost reduction anticipated over the six-year period may not be sufficient to justify the replacement For example, if there is an opportunity to invest the $44,100 ($57,000 – $12,900) of additional funds required for the replacement in a project that earns a return of 3% (assumed for illustration), the amount of the return over the six-year period would be $7,938 ($44,100 × 3% × 6) However, this is less than differential income determined in part (1), suggesting the proposal to replace is still preferred CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing Prob 25–3B Differential Analysis Promote Tennis Shoe (Alt 1) or Promote Walking Shoe (Alt 2) June 19, 2014 Differential Revenues Costs:* Direct materials Direct labor Variable factory overhead Variable operating expenses Sales promotion Income (Loss) Promote Promote Effect Tennis Shoe (Alternative 1) Walking Shoe (Alternative 2) on Income (Alternative 2) $595,000 $700,000 –133,000 –56,000 –49,000 –42,000 –100,000 $215,000 –224,000 –84,000 –35,000 –70,000 –100,000 $187,000 $105,000 –91,000 –28,000 14,000 –28,000 –$ 28,000 7,000 shoes × $85 7,000 shoes × $100 * Costs, except sales promotion, are the costs per unit multiplied by the increase in unit volume for each shoe Fixed costs are not relevant to the decision, so are not included Sole Mates Inc should promote tennis shoes The sales manager’s tentative decision should be opposed The sales manager erroneously considered the full unit costs instead of the differential (additional) revenue and differential (additional) costs An analysis similar to that presented in part (1) would lead to the selection of tennis shoes for the promotional campaign, since this alternative will contribute $28,000 ($215,000 – $187,000) more to operating income than would be contributed by promoting walking shoes CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing Prob 25–4B Differential Analysis Sell Ingot (Alt 1) or Process Further into Rolled Aluminum (Alt 2) February 5, 2014 Process Revenues, per ton Costs, per ton Income (Loss), per ton Further into Differential Sell Rolled Effect Ingot (Alternative 1) Aluminum (Alternative 2) on Income (Alternative 2) $140,800 –102,100 $ 38,700 $88,000 –52,500 $35,500 $52,800 –49,600 $ 3,200 $1,100 per ton × 80 tons $2,200 per ton ì (80 tons ữ 1.25) $105 per ton × 500 tons $52,500 + ($620 per ton × 80 tons) International Aluminum Co should decide to process aluminum ingot further, rather than sell aluminum ingot, since profits would be increased by $3,200 per batch if ingot was processed further into rolled aluminum CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing Prob 25–5B $60,000 ($600,000 × 10%) a Total manufacturing costs: Variable ($52* × 10,000 units)………………………………………………… Fixed factory overhead………………………………………………………… Total………………………………………………………………………………… $520,000 180,000 Cost amount per unit: $700,000 ÷ 10,000 units…………………………… $ $700,000 70 * $32 + $12 + $8 b Desired Profit + Total Selling and Administrative Expenses Total Manufacturing Costs Markup Percentage = Markup Percentage = $60,000 + $80,000 + ($7 × 10,000 units) $520,000 + $180,000 Markup Percentage = Markup Percentage = $60,000 + $80,000 + $70,000 $700,000 $210,000 $700,000 Markup Percentage = 30% c Cost amount per unit…………………………………………………………… Markup ($70 × 30%)……………………………………………………………… Selling price……………………………………………………………………… $70 21 $91 Prob 25–5B (Continued) (Appendix) a Total costs: Variable ($59 × 10,000 units)………………………………………………… Fixed ($180,000 + $80,000)……………………………………………………… Total………………………………………………………………………………… Cost amount per unit: $850,000 ÷ 10,000 units…………………………… b Markup Percentage = Desired Profit Total Costs Markup Percentage = $60,000 $850,000 Markup Percentage = $590,000 260,000 $850,000 $85.00 7.06% c Cost amount per unit…………………………………………………………… Markup ($85.00 × 7.06%)………………………………………………………… Selling price……………………………………………………………………… $85 $91 (Appendix) a Variable cost amount per unit: $59.00 Total variable costs: $59 × 10,000 units = $590,000 b Desired Profit + Total Fixed Costs Total Variable Costs Markup Percentage = Markup Percentage = Markup Percentage = Markup Percentage = 54.24% (rounded) $60,000 + $180,000 + $80,000 $590,000 $320,000 $590,000 c Cost amount per unit…………………………………………………………… Markup ($59 × 54.24%)…………………………………………………………… Selling price……………………………………………………………………… The cost-plus approach price of $91 should be viewed as a general guideline for establishing long-run normal prices Other considerations, such as the price of competing products and general economic conditions of the marketplace, could lead management to establish a short-run price more or less than $91 $59 32 $91 Prob 25–5B (Concluded) a Differential Analysis Reject Order (Alt 1) or Accept Order (Alt 2) September 5, 2014 Reject Order (Alternative 1) Revenues Costs Variable manufacturing costs Income (Loss), per unit $0 $91,200 $91,200 $0 –83,2002 $ 8,000 –83,200 $ 8,000 1,600 units × $57 1,600 units × ($59 – $7*) * Excluding variable selling and administrative expenses b The proposal should be accepted Accept Order (Alternative 2) Differential Effect on Income (Alternative 2) Prob 25–6B Ethylene Butane Ester Selling price……………………………………………… $170 $155 $130 Variable conversion cost per unit…………………… $ 40 * Direct materials cost per unit………………………… 115 $155 $ 40 * 88 $128 $ 30 ** 85 $115 Contribution margin per unit………………………… $ 15 $ 27 $ 15 * $10 × process hours = $40 ** $10 × process hours = $30 The contribution margin per unit may give false signals when an organization has production bottlenecks Instead, Wilmington Chemical Company should use the contribution margin per bottleneck hour to determine relative product profitability as follows: Contribution margin per unit………………………… ÷ Reactor (bottleneck) hours per unit……………… Contribution margin per reactor hour……………… Ethylene Butane $15 1.50 $27 1.0 $15 0.5 $10 $27 $30 Unlike the analysis in part (1), this analysis shows ester to be the most profitable product, rather than butane The reason is that ester delivers more contribution margin per bottleneck hour than does ethylene or butane ($30 vs $10 and $27) Ester CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing Prob 25–7B Production Setup Total activity cost…………… $220,000 1,100 mh ÷ Total activity base……… Activity rate………………… $ Moving $117,000 260 setups 200 /mh $ $21,000 600 moves 450 /setup 35 /move $ Shipping Product Engineering $105,000 $102,000 1,000 cust ord $ 170 test runs 105 /cust ord Computer Paper Activity Production Setup Moving Shipping Product engineering ActivityBase Usage 400 80 230 310 50 × mh setups moves cust ord test runs Activity Rate $200 $450 $35 $105 $600 $ 600 /test run Newsprint = /mh /setup /move /cust ord /test run Activity Cost $ 80,000 36,000 8,050 32,550 30,000 ActivityBase Usage 500 30 70 140 15 × mh setups moves cust ord test runs Activity Rate $200 $450 $35 $105 $600 $186,600 1,000 ÷ $ 186.60 Total ÷ Number of units Activity cost per unit Specialty Paper Activity Production Setup Moving Shipping Product engineering Total ÷ Number of units Activity cost per unit ActivityBase Usage 200 150 300 550 105 × mh setups moves cust ord test runs Activity Rate $200 $450 $35 $105 $600 = /mh /setup /move /cust ord /test run Activity Cost $ 40,000 67,500 10,500 57,750 63,000 $238,750 500 ÷ $ 477.50 25-51 © 2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part = /mh /setup /move /cust ord /test run Activity Cost $100,000 13,500 2,450 14,700 9,000 $139,650 1,250 ÷ $ 111.72 CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing Prob 25–7B (Concluded) The unit costs are different, even though each product requires 0.4 machine hour because the products consume many activities in ratios different from the volume For example, the specialty paper consumes setup, moving, shipping, and product engineering activities proportionately greater than its volume, while the newsprint consumes the same activities proportionately less than its volume This can be seen from the activity cost per unit If costs were proportional to volume, then the activity cost per unit would be equal for all three products 25-52 © 2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing CASES & PROJECTS CP 25–1 No, it would be unethical for Aaron to attend the meeting Such a meeting would be considered price fixing and would be a violation of federal law Thus, Aaron’s attendance would be a criminal act His actions would also discredit his reputation and that of the profession CP 25–2 The contribution margin is $4 ($22 – $18) per dozen on the special order Thus, Varden’s manager can contribute to fixed costs by accepting the order However, there are some additional considerations the manager must consider before accepting this order Have we ever done business overseas? Exports require additional administrative activities Have these additional administrative costs been considered in the differential analysis? Will the customer sell the golf balls overseas, or will they re-label the golf balls and have them imported back into the United States? Such a situation would cause Varden to be competing against itself Is it likely that other customers will learn of the “special deal” the overseas company received and demand equal treatment? That is, is there a risk that we’ll spoil the pricing structure in the domestic market? Will the overseas customer want to business in the future, or is this just a single sale? If the overseas customer is expected to purchase more golf balls in the future, then it is likely that the customer will come to expect the $22 price in the future Is there a possibility of another customer being willing to purchase the golf balls at the $35 price? If so, Varden may not want to commit capacity to the overseas customer Once the capacity is committed, it will be difficult to sell to anyone else Will we help the overseas customer establish a presence in the overseas golf ball market where we may wish to compete in the future? CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing CP 25–3 First, Marriott has excess capacity for this day, so it should be willing to accept additional customers The Priceline.com customer generates incremental revenue that will not reduce other business Given this, however, the price must at least cover variable cost, or else Marriott will incur a loss The variable cost per room night is shown below Housekeeping labor cost………………………………………………………………… Cost of room supplies (soap, paper, etc.)……………………………………………… Laundry labor and material cost………………………………………………………… Utility cost (mostly air conditioning)…………………………………………………… Total variable cost per day per room…………………………………………………… These costs are mostly avoidable, or variable to room nights This answer assumes that the maid and laundry staff hours are highly flexible and can be staffed to demand Likewise, the air conditioning and lights can be turned off if the room is not rented for the night, saving most of the utility cost The desk staff and hotel depreciation are either sunk (depreciation) or mostly fixed to the number of room nights Therefore, they are not relevant to accepting this business The total variable costs are $61 per night, so the $85 customer bid should be accepted Note to Instructors: There could be some discussion about the degree that some of these costs are fully variable For example, it’s likely that some utility cost must be incurred for the room, whether it is occupied or not Likewise, the housekeeping and laundry staff hours may not be as flexible to demand as assumed here There should be very little question about the room supplies (full variable) or the hotel depreciation (sunk) Regardless of the assumptions, the decision would remain the same $38 10 $61 CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing CP 25–4 a Juanita believes that the fixed costs should be treated as a sunk cost and ignored in the pricing decision In essence, Juanita is suggesting that the new computer model be treated as an incremental decision However, the new model is not a special incremental decision It is a core product that must contribute to covering fixed costs If the product price does not cover fixed costs and provide a profit, then Diamond Computer Company will not be competitive in the long term In the long term, the price must cover all costs, plus a profit markup Thus, Juanita’s solution to the pricing decision is not a good one b Target costing provides a different perspective to the pricing issue Under target costing, Diamond Computer Company should begin with the price the market is willing to pay, which is $1,250 This price should then be reduced by the required profit markup This would yield a target cost of $1,000 ($1,250 ÷ 1.25), which is $200 lower than the present product cost The new target cost should be established as a cost reduction target The company should vigorously improve the product design and processes in order to achieve a $1,000 product cost In this way, the company can compete profitably Target costing takes the market price as given and adjusts the cost in order to yield the required profitability This approach is best used in highly competitive product markets where declining prices require cost reduction in order to compete CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing CP 25–5 a This activity is designed to have students access a number of products and services on the Internet to see their commercial potential Each of the listed sites will provide product descriptions and pricing The list of costs in the products will not be determined at the Internet site but must be assumed Some examples include: Delta Air Lines—Airline tickets Fixed or Variable? Fuel Crew salaries Plane depreciation V F F Landing fees V Travel agent commissions V Lease costs (gates) F Ground salaries F Equipment depreciation F Assume that the activity base is the number of passenger miles for determining fixed and variable costs Employee salaries for an airline are relatively fixed, and only become variable when there are significant changes to the flight schedule Amazon.com—Books Fixed or Variable? Cost of books (purchased for resale) Web page design and programming Computer depreciation V F F Order handling and packing wages V Freight V Assume that the activity base is the number of books sold for determining fixed and variable costs Dell Inc.—Personal computers Fixed or Variable? Cost of computers (dl, dm, and foh) Web page design and programming Advertising V (mostly) F F Order handling and packing wages V Freight V Bundled software* V * Depends on contract terms with software vendor Assume that the activity base is the number of PCs sold for determining fixed and variable costs One could argue that advertising might be variable CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing CP 25–5 (Concluded) b The product with the largest markup on variable cost is the airline ticket The portion of variable cost to total cost for an airline flight will be much smaller (more fixed cost) than the other two products Thus, the markup on variable cost will be a greater percent As a result, the airline product has a larger contribution margin, but it also has a larger fixed cost to cover This creates larger operating leverage (and risk) than the other two products CP 25–6 The product profitability report indicates that the two products are equal in terms of profitability (on a per-case basis) However, the additional information indicates that there will be more activities required for Jamaican Punch than for King Kola Apparently, the factory overhead costs are being allocated on the basis of a single activity base that does not capture these product differences Since the direct labor costs are equal for producing a case of each product, the factory overhead allocated to each case would also be the same under the single factory overhead rate method Thus, they would appear to have similar cost and profitability An activity-based costing approach would likely demonstrate that the Jamaican Punch is less profitable and the King Kola more profitable than indicated by the single plantwide factory overhead rate method In addition, activity-based costing information would guide management in more accurate pricing decisions based on markup on product cost ... 2) on Income (Alternative 2) $ 0.00 –30.00 25. 00 –3.75 –6 .25 –$65.00 –$65.00 0.00 0.00 0.00 –6 .25 –$71 .25 –$65.00 30.00 25. 00 3.75 0.00 –$ 6 .25 $25. 00 × 15% $10.00 – $3.75 Assuming there were... Income (Alternative 2) $1, 025, 000 $1, 025, 000 –360,000 255 ,000 25, 000 –7,500 –180,000 –360,000 –90,000 –20,000 –180,000 255 ,000 –65,000 –12,500 – 225, 000 $ 152,500 – 225, 000 $ 150,000 2,500 $ –$... L $100 $ 25 CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based Costing PE 25 9A a Fabrication: Assembly: Setup: Inspection: $450,000 ÷ 2,000 direct labor hours = $ 225 per dlh