Differential Analysis – The

Key to Decision Making

CHAPTER 13

Managerial
Accounting
Seventeenth edition
 13-2

Identify relevant and

irrelevant costs and
benefits in a
decision.
 13-3

Decision Making – Important Concepts :

Concept #1

Every decision involves choosing from among

at least two alternatives. Therefore, the first
step in decision-making is to define the
alternatives being considered.
Concept #2
Once you have defined the alternatives, you
need to identify the criteria for choosing
Relevant
among costs
them. Irrelevant costs
and relevant and Irrelevant
benefits benefits

Should be considered Should be

ignored
When making a decision When making
a decision
 13-4

Decision Making – Important Concepts

Concept #3

Relevant costs and benefits are:

future costs and benefits that differ
between the alternatives.
 Relevant Costs Irrelevant Costs
Avoidable costs: Sunk costs
An avoidable cost is a A sunk cost is a cost that
cost that can be has already been incurred
eliminated by choosing and cannot be changed
one alternative over regardless of what a
Opportunity costs
another. manager decides to do.
An opportunity cost is Future costs and benefits
the potential benefit that do not differ between
that is given up when alternatives
one alternative is are irrelevant to the
selected over another. decision-making process
 13-4

Decision Making – Important Concepts

Concept #4

The key to effective decision making is

differential analysis—focusing on the future
costs and benefits that differ between the
alternatives. Everything else is irrelevant and
should be ignored.
 Identifying Relevant Costs
13-7

Example
Cynthia, a Boston student, is considering visiting her friend in New York. She
can drive or take the train. By car, it is 230 miles to her friend’s apartment. She
is trying to decide which alternative is less expensive and has gathered the
following information.

Automobile Costs (based on 10,000 miles driven per year)

Annual Cost Cost per
of Fixed Items Mile
1 Annual straight-line depreciation on car $ 2,800 $ 0.280
2 Cost of gasoline 0.100
3 Annual cost of auto insurance and license 1,380 0.138
4 Maintenance and repairs 0.065
5 Parking fees at school 360 0.036
6 Total average cost $ 0.619

$45 per month × 8 months $2.70 per gallon ÷ 27 MPG

$24,000 cost – $10,000 salvage value ÷ 5 years

Identifying Relevant Costs –
13-8

Additional Information
Automobile Costs (based on 10,000 miles driven per year)
Annual Cost Cost per
of Fixed Items Mile
1 Annual straight-line depreciation on car $ 2,800 $ 0.280
2 Cost of gasoline 0.100
3 Annual cost of auto insurance and license 1,380 0.138
4 Maintenance and repairs 0.065
5 Parking fees at school 360 0.036
6 Total average cost $ 0.619

Additional Information
7 Reduction in resale value of car per mile of wear $ 0.026
8 Round-tip train fare $ 104
9 Benefits of relaxing on train trip ????
10 Cost of putting dog in kennel while gone $ 40
11 Benefit of having car in New York ????
12 Hassle of parking car in New York ????
13 Per day cost of parking car in New York $ 25
 Item Relevant Irrelevant Comment

The cost of the car  It is a sunk cost and is not relevant to the current decision.

The annual cost of insurance  It is not relevant. It will remain the same if she drives or takes the train.

the cost of gasoline  It is clearly relevant if she decides to drive. If she takes the train, she would avoid
the cost of the gasoline, so the cost differs between the alternatives

The cost of maintenance and repairs  It is relevant. In the long-run, these costs depend upon miles driven.

The monthly school parking fee  It is not relevant because it must be paid if Cynthia drives or takes the train.

The decline in resale value due to  is relevant due to the additional miles driven
additional miles

The round-trip train fare  If she drives the cost can be avoided.

Relaxing on the train  is relevant even though it is difficult to assign a dollar value to the benefit.

The kennel cost  because Cynthia will incur the cost if she drives or takes the train.

The cost of parking in New York  because it can be avoided if she takes the train.

The benefits of having a car in New York  but are difficult to assign a dollar amount
and the problems of finding a parking
space
 13-13

The Decision
Decision: From a financial standpoint, Cynthia would be
better off taking the train to visit her friend. Some of the
non-financial factors may influence her final decision.

Relevant Financial Cost of Driving

Gasoline (460 @ $0.100 per mile) $ 46.00
Maintenance (460 @ $0.065 per mile) 29.90
Reduction in resale (460 @ $0.026 per mile) 11.96
Parking in New York (2 days @ $25 per day) 50.00
Total $ 137.86

Relevant Financial Cost of Taking the Train

Round-trip ticket $ 104.00
Decision 13-17

# 1:

Whether a product
line or segment
should be added or
dropped.
Exercise 1
A segmented income statement for the digital watches
line is as shown:
Segment Income Statement
Digital Watches
Sales $ 500,000
Less: variable expenses
Variable manufacturing costs $ 120,000
Variable shipping costs 5,000
Commissions 75,000 200,000
Contribution margin $ 300,000
Less: fixed expenses
General factory overhead $ 60,000
Salary of line manager 90,000
Depreciation of equipment 50,000
Advertising - direct 100,000
Rent - factory space 70,000
General admin. expenses 30,000 400,000
Net operating loss $ (100,000)
Exercise 1
 Due to the declining popularity of digital watches, Lovell
Company’s digital watch line has not reported a profit for several
years. Lovell is considering whether to keep this product line or
drop it.

 An investigation has revealed that the fixed general factory

overhead and fixed general administrative expenses will not be
affected by dropping the digital watch line. The fixed general
factory overhead and general administrative expenses assigned to
this product would be reallocated to other product lines. The
equipment used to manufacture digital watches has no resale
value or alternative use.

Required:
Should Lovell retain or drop the digital watch segment?
Answer: using Contribution Margin
13-24

Approach

Losses
Contribution margin lost if digital
watches are dropped $ (300,000)
Gains
Less fixed costs that can be avoided
Salary of the line manager $ 90,000
Advertising - direct 100,000
Rent - factory space 70,000 260,000
Financial disadvantage of dropping
the digital wataches product line $ (40,000)

Decision:
A contribution margin approach reveals that the contribution margin lost
($300,000) exceeds the fixed costs avoided ($260,000) by $40,000. Therefore,
The company should retain the digital watch segment.
Answer: using Comparative Income
13-24

Approach
Comparative Income Approach
Solution
Keep Drop
Digital Digital
Watches Watches Difference
Sales $ 500,000 $ - $ (500,000)
Less variable expenses: -
Manufacturing expenses 120,000 - 120,000
Shipping 5,000 - 5,000
Commissions 75,000 - 75,000
Total variable expenses 200,000 - 200,000
Contribution margin 300,000 - (300,000)
Less fixed expenses:
General factory overhead 60,000 60,000 -
Salary of line manager 90,000 - 90,000
Depreciation 50,000 50,000 -
Advertising - direct 100,000 - 100,000
Rent - factory space 70,000 - 70,000
General admin. expenses 30,000 30,000 -
Total fixed expenses 400,000 140,000 260,000
Net operating loss $ (100,000) $ (140,000) $ (40,000)
 13-24

Analysis:
IfIf the
the digital
digital watch
watch line
line is
is dropped,
dropped, the
the company
company loses
loses
$300,000
$300,000 in in contribution
contribution margin.
margin.
On
On the
the other
other hand,
hand, the
the general
general factory
factory overhead
overhead would would
be
be the
the same
same under
under both
both alternatives,
alternatives, so
so itit is
is irrelevant.
irrelevant.
The
The salary
salary of
of the
the product
product line
line manager
manager would
would disappear,
disappear,
so
so itit is
is relevant
relevant to
to the
the decision.
decision.

The
The depreciation
depreciation is is aa sunk
sunk cost.
cost. Also,
Also, remember
remember that
that
the
the equipment
equipment has has no
no resale
resale value
value or
or alternative
alternative use,
use, so
so
the
the equipment
equipment and and the
the depreciation
depreciation expense
expense associated
associated
with
with itit are
are irrelevant
irrelevant to
to the
the decision.
decision.
 13-24

Decision:
Decision:
The
The complete
complete comparative
comparative income
income statements
statements reveal
reveal that
that Lovell
Lovell
would
would earn
earn $40,000
$40,000 of
of additional
additional profit
profit by
by retaining
retaining the
the digital
digital
watch
watch line.
line. Therefore,
Therefore, The
The company
company should
should retain
retain the
the digital
digital
watch
watch segment.
segment.
 13-31

Further Analysis: Beware of Allocated Fixed Costs

Be aware that allocated fixed costs can distort the
keep/drop decision.

Lovell’s managers may ask: “Why

should we keep the digital watch
segment when it’s showing a
$100,000 loss?”

The answer lies in the way we allocate

common fixed costs to our products.
Including unavoidable common fixed costs makes
the product line appear to be unprofitable, when in
fact dropping the product line would decrease the
company’s overall net operating income.
Exercise 2
Deela Fashions operates three departments: Men’s, Women’s, and
Accessories. Departmental operating income data for the third quarter of
2012 are as follows:

Assume that the fixed expenses assigned to each department include only
direct fixed costs of the department:
● Salary of the department’s manager
● Cost of advertising directly related to that department
If Deela Fashions drops a department, it will not incur these fixed expenses.
19
Required: Under these circumstances, should Deela Fashions drop
Accessories department? Give your reasoning.
Answer
If Accessories Department is Dropped
Losses
CM Lost 100,000 -92,000 (8,000)
Gains:
Avoidable costs 26,000
Financial advantage of dropping the department 18,000

Decision:
Deela Fashions should drop the Accessories Department because
Gains from dropping are greater than losses .which will result in
financial advantage $18,000

20
 Exercise 3
London Cakes company has three products: Product A, Product B and Product
C. Income statements of the three product lines for the latest month are given
below:
Product Line A ($) B ($) C ($)
Sales 467,000 314,000 598,000
Less: Variable Costs 241,000 169,000 321,000
Contribution Margin 226,000 145,000 277,000
Less: Fixed Costs 184,000 148,000 232,000
Net Income 42,000 − 3,000 45,000

London Cakes wants to drop product B as it has a negative profitability (loss). If

London Cakes decides to drop, then it can very well avoid variable costs (in full)
and $ 86,000 only in fixed costs
Required
(a) Suggest whether Product B should be dropped? Explain your rationale.
(b) Will your decision be changed if total fixed costs ($ 148,000) in full are
avoidable?
21
(A) Answer

If Product B is Dropped
Losses
CM Lost 314,000 -169,000 (145,000)
Gains:
Avoidable costs 86,000
Financial Disadvantage of dropping the product (59,000)

Decision:
London cakes should not be dropping product B as it might results in
financial disadvantages for the company of $ 59,000. Since the CM lost is
much higher the gains they will get out of avoiding ,it is not advised that
the company drops the product at this point of time.
22
(B)

If Product B is Dropped
Losses
CM Lost 314,000 -169,000 (145,000)
Gains:
Avoidable costs 148,000
Financial advantage of dropping the product 3,000

Decision: Yes. Now the costs benefits are more than the revenue
lost, thus, product B could be dropped.
Decision 13-34

#2

make or buy
decision
 13-35

The Make or Buy Decision

When a company is involved in more than one activity
in the entire value chain, it is vertically integrated. A
decision to carry out one of the activities in the value
chain internally, rather than to buy externally from a
supplier is called a “make or buy” decision.
 13-38

Exercise 1
Essex Company manufactures part 4A that is used in one of its
products. The unit product cost of this part is:

Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of special equip. 3
Supervisor's salary 2
General factory overhead 10
Unit product cost $ 30
 13-39

Exercise 1
The special equipment used to manufacture part 4A has no
resale value.
The total amount of general factory overhead, which is
allocated on the basis of direct labor hours, would be unaffected
by this decision.
The $30 unit product cost is based on 20,000 parts produced
each year.
An outside supplier has offered to provide the 20,000 parts at a
cost of $25 per part.
Should the company stop making part 4A and buy it from an
outside supplier?
Answer: 13-40

Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
Allocated gen. fact. overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000
Financial advantage of making part 4A $160,000

Decision:
Given that the total avoidable costs are less than the cost of
buying the part, Essex should continue to make the part.
The avoidable costs associated with making part 4A include direct
materials, direct labor, variable overhead, and the supervisor’s salary.
 13-41

Analysis:
Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
Allocated gen. fact. overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

The cost incurred to buy the equipment is a sunk cost; the

depreciation simply spreads this sunk cost over the
equipment’s useful life. Thus the special equipment and its
associated depreciation expense are irrelevant to the decision.
 13-42

Analysis:
Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
Allocated gen. fact. overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

The allocated general factory overhead represents allocated costs

common to all items produced in the factory and would continue
unchanged( Not avoidable). Thus, it is irrelevant to the decision.
 Exercise 2
AAA Systems manufactures a switch that it uses in its final product. The switch has the
following manufacturing costs per unit:

Another company has offered to sell AAA Systems the switch for $20.00 per unit. If AAA
Systems buys the switch from the outside supplier, the idle manufacturing facilities cannot be
used for any other purpose, yet none of the fixed costs are avoidable.
Required:
1- In your opinion, should AAA Systems make or buy the switch? Why? Support you
analysis with required calculations.
2- What are the other factors that should be considered when taking such decisions?
 Answer
Outsource
Make (Buy) Difference
Switch Cost (Make – Buy)
Variable costs:
Direct materials $ 11.00 $ 11.00
Direct labor 4.50 4.50
Variable manufacturing 6.00 6.00

overhead
Purchase cost $ 20.00 (20.00)
Total differential cost per $ 21.50 $ 20.00 $ 1.50
switch
Decision:
AAA Systems should buy the switch because the variable cost of
outsourcing the switch, $20.00 per switch, is less than the variable
cost of making the switch in-house, $21.50 per switch. Fixed costs
are unavoidable and are therefore irrelevant.
2-
The above analysis takes into account only the financial factors.
However, there are a number of non-financial/qualitative factors
that should be considered when taking such decisions. For
example:
 Alternative uses of the capacity that would be used to make
the items.
 The ability of the supplier to meet required delivery
schedules.
 The quality of the items purchased from the supplier.
 The ability of the supplier to supply tubes if volume increases
in future years.
 The problem of finding an alternative source of supply if the
supplier proves to be undependable
 How would the decision affect employees’ morale?
Exercise 3
The Electronics Company can buy a special part from a
vendor at a cost of $ 72 per part, the company estimates the
following costs if it decides to produce the part:
▪ Direct materials $ 22.5
▪ Direct labor $ 31.5
▪ Variable manufacturing overhead $ 13.5
▪ Fixed manufacturing overhead: (depreciation $ 9,000 and
other fixed costs $ 135,000)
Required
If the company has unused (idle) capacity which could be
used in producing this parts (22,500 parts).Do you suggest
buying or making this part?
20-35
 13-44

Opportunity Cost

Opportunity costs are not actual cash outlays and are not
recorded in the formal accounts of an organization.
An opportunity cost is the benefit that is foregone as a
result of pursuing some course of action.
If the space to make Part 4A had an alternative use, the
opportunity cost would have been equal to the segment
margin that could have been derived from the best
alternative use of the space.
 13-45

Decision # 3

Whether a special
order should be
accepted.
 13-46

Special Orders
 Companies sometimes receive special
offers at prices lower than normal selling
price
 This special order is a one-time order that
is not considered part of the company’s
normal ongoing business.

 When analyzing a special order, only the

incremental costs and benefits are
relevant.
 Decision rule: Accept the special offer if
income increases (and reject it if income
decreases).
Exercise 1
Jet, Inc. makes a single product whose normal selling price is $20 per unit.
 A foreign distributor offers to purchase 3,000 units for $10 per unit.
 This is a one-time order that would not affect the company’s regular
business.
 Annual capacity is 10,000 units, but Jet, Inc. is currently producing and
selling only 5,000 units
 Its per unit and annual sales and costs are in the contribution margin
income statement in this exhibit
Jet, Inc.
Contribution Income Statement
Revenue (5,000 × $20) $ 100,000
Variable costs:
Direct materials $ 20,000
Direct labor 5,000
Manufacturing overhead 10,000
Marketing costs 5,000
Total variable costs 40,000
Contribution margin 60,000
Fixed costs:
Manufacturing overhead $ 28,000
Marketing costs 20,000
Total fixed costs 48,000
Net operating income $ 12,000
Required: Should Jet accept the offer?
Answer:
Special Offer Analysis Per Unit Total
Sales (3,000 units) $10 $30,000
Variable costs
Direct materials 4 12,000
Direct labor 1 3,000
Manufacturing overhead 2 6,000
Marketing costs 1 3,000
Contribution margin 2 6,000
Fixed costs
Manufacturing overhead - -
Marketing costs - -
Income $2 $6,000
Decision: 13-49

Jet should accept the order, Because the incremental revenue will
exceed the incremental costs. In other words, net operating income
will increase by $6,000

Incremental revenue (3,000 × $10) $ 30,000

Incremental cost (3,000 × $8 variable cost) 24,000
Financial advantage of accepting the order $ 6,000
 Exercise 2
 FasTrac produces and sells 100,000 units annually. Its per unit and annual sales and
costs are in the contribution margin income statement in this exhibit. Its normal
selling price is $10.00 per unit, and each unit sold generates $2.00 per unit of income.
 A new customer wants to buy 10,000 units at $8.50 each and export them to another
country.
 This order will incur incremental fixed general and administrative costs of $1,000.

Required: Should FasTrac accept the order?

 Answer:

Decision:
FasTrac should accept the order, Because the incremental revenue will
exceed the incremental costs. In other words, net operating income
will increase by $18,000.
 13-53

Decision # 4

Determine the most

profitable use of a
constrained
resource.
 Exercise 1
Ensign Company produces two products and selected data are shown below:
Product
1 2
Selling price per unit $ 60 $ 50
Less variable expenses per unit 36 35
Contribution margin per unit $ 24 $ 15

Current demand per week (units) 2,000 2,200

Contribution margin ratio 40% 30%
Processing time required
on machine A1 per unit 1.00 min. 0.50 min.

 Machine A1 is the constrained resource and is being used at 100% of its

capacity.
 There is excess capacity on all other machines.
 Machine A1 has a capacity of 2,400 minutes per week.
Required:
Should Ensign focus its efforts on Product 1 or Product 2?Why?
 Answer:
Product
1 2
Selling price per unit $ 60 $ 50
Less variable expenses per unit 36 35
Contribution margin per unit $ 24 $ 15
Time required to produce 1 unit ÷ 1 min. ÷ 0.5 min.
Contribution margin per Minute $24 $30

Decision:
Ensign should emphasize Product 2 because it generates a
contribution margin of $30 per minute of the constrained
resource relative to $24 per minute for Product 1.
Exercise 2
Farah produces standard and deluxe sunglasses:
Per Pair
Standard Deluxe
Sale price $20 $30
Variable expenses 16 21
The company has 15,000 machine hours available. In one machine
hours, Farah can produce either 70 pairs of the standard model or
30 pairs of the deluxe model. Which model should Farah
emphasize?

47
 ANSWER
Per Pair
Standard Deluxe
Sale price per pair $20 $30
- Variable expense per pair (16) (21)
= Contribution margin per pair $4 $9
× Units produced each machine hours × 70 × 30
= Contribution margin per machine hours $280 $270

Decision: Farah Company should emphasize the standard model

because it has the higher contribution margin per unit of the
constraint – machine hours – resulting in a higher contribution
margin for the company.

48
Exercise 3
AAA Company produces Toaster Ovens and Bread
Machines:
Toaster Bread
Ovens Machines
Sale price $ 60 $135
Variable costs $ 38 $ 105

The company has 1,500 machine hours available. In one machine

hours, AAA can produce either 5 units of toaster ovens or 3 units
of bread machines .Which model should AAA emphasize?

49
 Answer
Toaster Bread
Ovens Machines
Sale price $ 60 $135
Variable costs $ (38) $ ( 105)
Contribution margin per unit $ 22 $ 30
No. of units per machine hour ×5 ×3
Contribution margin per machine hour $110 $90

Decision: AAA should emphasize the Toaster Ovens because it has

the higher contribution margin per unit of the constraint – machine
hours – resulting in a higher contribution margin for the company.

50
 Exercise 4
The following details relate to ready meals that are prepared by a food
processing company:
K L M
$ per meal $ per meal $ per meal
Selling price 5 3 4.40
Variable conversion costs 3.60 1.80 3.15
Fixed conversion costs 0.50 0.30 0.60
Profit 0.90 0.90 0.65
Oven time (minutes 10 4 8
required per ready meal)

Required
Show which ready meal is the most profitable for the company as per
contribution per limiting factor? (per minute). Comment on the results.
51
 Answer
K L M
$ per $ per $ per
meal meal meal
Selling price 5 3 4.40
Variable conversion costs 3.60 1.80 3.15
Contribution per unit 1.40 1.20 1.25
Oven time (minutes required per ÷ 10 ÷4 ÷8
ready meal)
Contribution per minute 0.14 0.30 0.16
Rank 3 1 2
Comment
The most profitable meal is meal L and the least profitable is meal K.
Contribution per minute is maximum in L and minimum in the case of K.
Organizations need to allocate more resources to the product that gives
maximum contribution per limiting factor. As per this principle, L needs to be
allocated52maximum resources in order to get maximum profit.
Exercise 5
13-74

Chairs Tables
Selling price per unit $80 $400
Variable cost per unit $30 $200
Board feet per unit 2 10
Monthly demand 600 100

The company’s supplier of hardwood will only be able

to supply 2,000 board feet this month. What plan would
maximize profits?
a. 500 chairs and 100 tables
b. 600 chairs and 80 tables
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
 13-75

Chairs Tables
Selling price per unit $80 Chairs Tables
$400
Variable cost per unit price
Selling $30 $200$ 80 $ 400
Board feet per unit 2 10
Monthly demand
Variable cost
600 100
30 200
Contribution margin $ 50 $ 200
The company’s supplierBoard
of hardwood
feet will only be able
2 to 10
supply 2,000 board feetCM
thisper
month.
boardWhat
foot plan$ would
25 $ 20
maximize profits?
a. 500 chairs and 100 tables
Production of chairs 600
Board feet required
b. 600 chairs and 80 tables 1,200
Board feet remaining 800
c. 500 chairs and 80 tables
Board feet per table 10
d. 600 chairs and 100 tables
Production of tables 80
Additional Exercises
EX 1- Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment.
The company has always produced all of the necessary parts for its engines, including all of
the carburetors. An outside supplier has offered to sell one type of carburetor to Troy
Engines, Ltd., for a cost of $35 per unit. To evaluate this offer, Troy Engines, Ltd., has
gathered the following information relating to its own cost of producing the carburetor
internally:
Required:

1- Assuming the company has no alternative use for the facilities that are now
being used to produce the carburetors, what would be the financial advantage
(disadvantage) of buying 15,000 carburetors from the outside supplier?

2- Should the outside supplier’s offer be accepted?

3- Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use
the freed capacity to launch a new product. The segment margin of the new
product would be $150,000 per year. Given this new assumption, what would be
financial advantage (disadvantage) of buying 15,000 carburetors from the
outside supplier?

4- Given the new assumption in requirement 3, should the outside supplier’s

offer be accepted?
EX 2- Han Products manufactures 40,000 units of part S-6 each year for use on
its production line. At this level of activity, the cost per unit for part S-6 is:

Direct materials $ 3.30

Direct labor 12.00
Variable manufacturing overhead 2.70
Fixed manufacturing overhead 6.00
Total cost per part $ 24.00

An outside supplier has offered to sell 40,000 units of part S-6 each year to Han Products for
$22 per part. If Han Products accepts this offer, the facilities now being used to manufacture
part S-6 could be rented to another company at an annual rental of $90,000. However, Han
Products has determined that two-thirds of the fixed manufacturing overhead being applied
to part S-6 would continue even if part S-6 were purchased from the outside supplier.

Required:
What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?
EX 3
Delta Company produces a single product. The cost of producing and selling a
single unit of this product at the company’s normal activity level of 97,200 units per
year is:

Direct materials $ 2.30

Direct labor $ 3.00
Variable manufacturing overhead $ 0.80
Fixed manufacturing overhead $ 5.15
Variable selling and administrative expenses $ 1.10
Fixed selling and administrative expenses $ 2.00

The normal selling price is $23.00 per unit. The company’s capacity is 117,600
units per year. An order has been received from a mail-order house for 1,700
units at a special price of $20.00 per unit. This order would not affect regular
sales or the company’s total fixed costs.

Required:
What is the financial advantage (disadvantage) of accepting the special order?
 EX 4
The Regal Cycle Company manufactures three types of bicycles—a dirt bike, a mountain
bike, and a racing bike. Data on sales and expenses for the past quarter follow:
Total Dirt Bikes Mountain Bikes Racing Bikes
Sales $ 923,000 $ 265,000 $ 407,000 $ 251,000
Variable manufacturing and selling
477,000 118,000 200,000 159,000
expenses
Contribution margin 446,000 147,000 207,000 92,000
Fixed expenses:
Advertising, traceable 70,500 9,000 40,800 20,700
Depreciation of special equipment 42,700 20,200 7,400 15,100
Salaries of product-line managers 114,600 40,400 38,300 35,900
Allocated common fixed expenses* 184,600 53,000 81,400 50,200
Total fixed expenses 412,400 122,600 167,900 121,900
Net operating income (loss) $ 33,600 $ 24,400 $ 39,100 $ (29,900)

*Allocated on the basis of sales dollars.

Management is concerned about the continued losses shown by the racing bikes and wants a
recommendation as to whether or not the line should be discontinued. The special equipment used to produce
racing bikes has no resale value and does not wear out.

Required:
1. What is the financial advantage (disadvantage) per quarter of discontinuing the Racing Bikes?
2. Should the production and sale of racing bikes be discontinued?
EX 5
Outdoor Luggage, Incorporated, makes high-end hard-sided luggage for sports equipment.
Data concerning three of the company’s most popular models appear below.
Ski Guard Golf Guard Fishing Guard
Selling price per unit $ 260 $ 330 $ 205

Variable cost per unit $ 120 $ 180 $ 135

Plastic injection molding machine processing time required to
produce one unit
9 minutes 12 minutes 11 minutes
Pounds of plastic pellets per unit 12 pounds 15 pounds 11 pounds

Required:
1. If we assume that the total time available on the plastic injection molding machine is
the constraint in the production process, how much contribution margin per minute of
the constrained resource is earned by each product?
2. Which product offers the most profitable use of the plastic injection molding
machine?
3. If we assume that a severe shortage of plastic pellets has required the company to cut
back its production so much that its new constraint has become the total available
pounds of plastic pellets, how much contribution margin per pound of the constrained
resource is earned by each product?
4. Which product offers the most profitable use of the plastic pellets?
5. Which product has the largest contribution margin per unit?
 13-91

End of Chapter