TEST BANK managerial accounting by 5e kieso weygand ch007

CHAPTER Incremental Analysis ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises A Problems B Problems Identify the steps in management’s decisionmaking process 1, 1 Describe the concept of incremental analysis 3, Identify the relevant costs in accepting an order at a special price 2, 3, 4, 14 1A 1B Identify the relevant costs in a make-or-buy decision 6, 5, 6, 14 2A 2B Identify the relevant costs in determining whether to sell or process materials further 8, 9, 10 5, 7, 8, 9, 14 3A 3B Identify the relevant costs to be considered in retaining or replacing equipment 11 10, 11, 14 4A 4B Identify the relevant costs in deciding whether to eliminate an unprofitable segment 12 12, 13, 14 5A 5B 7-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) Simple 20–30 1A Make incremental analysis for special order and identify nonfinancial factors in the decision 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 7-2 7-3 Identify the relevant costs in accepting an order at a special price Identify the relevant costs in a make-or-buy decision Identify the relevant costs in determining whether to sell or process materials further Identify the relevant costs to be considered in retaining or replacing equipment Identify the relevant costs in deciding whether to eliminate an unprofitable segment *3 *4 *5 *6 *7 Broadening Your Perspective Describe the concept of incremental analysis *2 Q7-8 Q7-9 Q7-10 Identify the steps in management’s BE7-1 decision-making process Real-World Focus Decision Making All About Across the You Exploring the Web Decision Making Organization Activity Across the Organization BE7-8 Q7-12 E7-7 E7-8 E7-9 BE7-5 BE7-6 P7-5A P7-5B P7-4A P7-4B E7-14 P7-3A P7-3B P7-2A P7-2B Managerial Analysis Decision Making Across the Organization Ethics Case Communication E7-12 E7-13 E7-14 E7-10 E7-11 E7-14 E7-5 E7-6 E7-14 BE7-4 E7-14 P7-1A P7-1B Evaluation E7-2 E7-3 E7-4 Synthesis BE7-3 BE7-2 Analysis BE7-7 E7-1 E7-1 Application Q7-11 Q7-6 Q7-7 Q7-5 Q7-3 Q7-4 Q7-1 Q7-2 Knowledge Comprehension *1 Study Objective Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems BLOOM’S TAXONOMY TABLE STUDY OBJECTIVES IDENTIFY THE STEPS IN MANAGEMENT’S DECISIONMAKING PROCESS DESCRIBE THE CONCEPT OF INCREMENTAL ANALYSIS IDENTIFY THE RELEVANT COSTS IN ACCEPTING AN ORDER AT A SPECIAL PRICE IDENTIFY THE RELEVANT COSTS IN A MAKE OR BUY DECISION IDENTIFY THE RELEVANT COSTS IN DETERMINING WHETHER TO SELL OR PROCESS MATERIALS FURTHER IDENTIFY THE RELEVANT COSTS TO BE CONSIDERED IN RETAINING OR REPLACING EQUIPMENT IDENTIFY THE RELEVANT COSTS IN DECIDING WHETHER TO ELIMINATE AN UNPROFITABLE SEGMENT 7-4 CHAPTER REVIEW Incremental Analysis (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) (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 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 (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 (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 (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 7-5 Retain or Replace Equipment (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 (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 Many of the decisions involving incremental analysis also have important qualitative features 7-6 LECTURE OUTLINE A Management’s Decision-Making Process TEACHING TIP 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 The steps are: 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)—evaluating possible courses of action, and reviewing results B Incremental Analysis The process used to identify the financial data that change under alternative courses of action is called incremental analysis TEACHING TIP ILLUSTRATION 7-2 presents a list of the most common types of decision situations that utilize incremental analysis 7-7 These data are relevant to the decision because they will vary in the future among the possible alternatives Incremental analysis sometimes involves changes that might seem contrary to your intuition For example, sometimes: a Variable costs not change under the alternative courses of action b Fixed costs change Accept an order at a special price TEACHING TIP ILLUSTRATION 7-3 provides an in-class example of a decision situation involving an order at a special price Emphasize that if fixed costs 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 a The relevant information is the difference between the variable manufacturing costs to produce the special order and expected revenues b If other sales are affected, then the company would have to consider the lost sales in making the decision c If the company is operating at full capacity, it is likely that the special order would be rejected 7-8 Make or buy TEACHING TIP 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 a In a make or buy decision, the relevant costs are: (1) The variable manufacturing costs that will be saved (2) The fixed manufacturing costs that can be eliminated (3) The purchase price (4) Opportunity costs: The potential benefit that may be obtained by following an alternative course of action Sell or process further a Many manufacturers have the option of selling products at a given point in the production cycle or continuing to process with the expectation of selling them at a later point at a higher price b The basic decision rule is: Process further as long as the incremental revenue from such processing exceeds the incremental processing costs c In many industries, a number of end-products are produced from a single raw material and a common production process These multiple end-products are referred to as joint products d All costs incurred prior to the point at which the two products are separately identifiable (the split-off point) are called joint costs 7-9 e Joint product costs must be allocated to individual products, frequently done based on the relative sales value of the joint products f The allocation of joint product costs is important for the determination 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 Retain or replace equipment a Management often has to decide whether to continue using an asset or replace it b The relevant items to be considered are: (1) The effects on variable costs (2) The cost of the new equipment c Any disposal value of the existing asset must also be considered d The book value of the old asset does not affect the decision Book value is a sunk cost, which is a cost that cannot be changed by any present or future decision Eliminate an unprofitable segment a In deciding whether to eliminate an unprofitable segment, the relevant information is the contribution margin produced by the segment and the disposition of the segment’s fixed expenses b In deciding on the future status of an unprofitable segment, management should consider the effect of elimination on related segments c Management should also consider the effect of eliminating the segment on employees who may have to be discharged or retrained 7-10 20 MINUTE QUIZ Circle the correct answer True/False Determining and evaluating possible courses of action is a step in management’s decision-making process True In incremental analysis fixed costs may not change under alternative courses of action, while variable costs may change True False Joint product costs are relevant for any sell-or-process further decisions True 10 False In deciding on the future status of an unprofitable segment, management should consider the effect of elimination on related product lines True False Opportunity costs are costs that have already been incurred and will not be avoided by any future decision True False Fixed manufacturing costs will never be relevant in a make or buy decision True False Book value is a sunk cost and is therefore relevant in incremental analysis of retain or replace equipment True False 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 True False The relevant information to consider in accepting an order at a special price are the additional manufacturing costs incurred and expected revenues True False False Any trade-in allowance or cash disposal value of the old asset is relevant in a retain or replace equipment decision True False 7-11 Multiple Choice 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 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) 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 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 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 7-12 ANSWERS TO QUIZ True/False True True True True False 10 False False True False True Multiple Choice d a a b d 7-13 ILLUSTRATION 7-1 MANAGEMENT’S DECISION-MAKING PROCESS Identify the problem and assign responsibility Determine and evaluate possible courses of action Review the results of the decision Make the decision 7-14 ILLUSTRATION 7-2 TYPES OF INCREMENTAL ANALYSIS Accept an order at a special price Make or buy Sell or process further Retain or replace equipment Eliminate an unprofitable segment 7-15 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 $16 Fixed cost per unit • Will you accept a special order from a foreign company for an additional Yes 2,000 units at a price of $22/unit? No • Those of you who said "yes," would you Yes accept the order at $19/unit? No • Those of you who said "yes," would you Yes accept the order at $15/unit? No With Special Order Without Special Order $22 $294,000 (192,000 ) (40,000 ) $ 62,000 $19 $15 $288,000 (192,000 ) (40,000 ) $ 56,000 $280,000 (192,000 ) (40,000 ) $ 48,000 Change in revenue Change in costs $44,000 32,000 $38,000 32,000 $30,000 32,000 Change in net income $12,000 $ 6,000 $ (2,000 ) Sales Variable costs Fixed costs Net income $250,000 (160,000 ) (40,000 ) $ 50,000 7-16 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: Current Production of 5,000 Units Direct materials Direct labor Manufacturing overhead Variable Fixed Unit Cost $ 60,000 85,000 $12 17 40,000 90,000 $275,000 18 $55 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? 7-17 ILLUSTRATION 7-4 (Continued) INCREMENTAL ANALYSIS—MAKE OR BUY Make Direct materials Buy Net Income Increase (Decrease) $ 60,000 $ –0– $ 60,000 Direct labor 85,000 –0– 85,000 Variable manufacturing overhead 40,000 –0– 40,000 Fixed manufacturing overhead 90,000 55,000 35,000 –0– 250,000 (250,000 ) $275,000 $305,000 $ (30,000 ) Make Buy Increase (Decrease) Total annual costs $275,000 $305,000 $ (30,000 ) Opportunity cost 36,000 –0– 36,000 $311,000 $305,000 $ 6,000 Buy units (5,000 at $50/unit) Total annual costs a "Make" and save $30,000 Opportunity costs are additional costs added to "make" or reduction of costs subtracted from "buy." b "Buy" and save $6,000 7-18 ... changed by any present or future decision Eliminate an unprofitable segment a In deciding whether to eliminate an unprofitable segment, the relevant information is the contribution margin produced by. .. 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) (S.O... 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