Introduction to Management Accounting (ACC 202)

Spring 2018/19

Chapter 26
Incremental Analysis

Part I: Exercises

Ex. 1
Billings Company manufactures toasters. For the fi rst 8 months of 2013,
the company reported the following operating results while operating at 75%
of plant capacity.
Sales (400,000 $4,000,000
units)
Cost of goods sold 2,400,000
Gross profit 1,600,000
Operating expenses 900,000
Net income 700,000

Cost of goods sold was 70% variable and 30% fixed. Operating expenses
were 60% variable and 40% fixed.
In September, Billings Company receives a special order for 40,000 toasters
at $6.00 each from Del Carpic Company of Lima, Peru. Acceptance of the
order would result in $8,000 of shipping costs but no increase in fi xed
operating expenses.

Instructions
a. Prepare an incremental analysis for the special order.
b. Should Billings Company accept the special order? Why or why not?

Ex. 2
Nona Inc. has been manufacturing its own shades for its table lamps. The
company is currently operating at 100% of capacity. Variable manufacturing
overhead is charged to production at the rate of 50% of direct labor cost. The
direct materials and direct labor cost per unit to make the lamp shades are
$4.00 and $6.00, respectively. Normal production is 40,000 table lamps per
year.
A supplier offers to make the lamp shades at a price of $13.50 per unit. If
Nona Inc. accepts the supplier’s offer, all variable manufacturing costs will
be eliminated, but the $40,000 of fixed manufacturing overhead currently
being charged to the lamp shades will have to be absorbed by other
products.

Instructions
a. Prepare the incremental analysis for the decision to make or buy the
lamp shades.
b. Should Nona Inc. buy the lamp shades?

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 c. Would your answer be different in (b) if the productive capacity
released by not making the lamp shades could be used to produce
income of $35,000?

Ex.3
Top Gear Bikes could sell its bicycles to retailers either assembled or
unassembled. The cost of an unassembled bike is as follows.

Direct materials $150

Direct labor 70
Variable overhead (70% of direct 49
labor)
Fixed overhead (30% of direct labor) 21
Manufacturing cost per unit $290

The unassembled bikes are sold to retailers at $400 each.

Top Gear currently has unused productive capacity that is expected to
continue indefinitely; management has concluded that some of this capacity
can be used to assemble the bikes and sell them at $450 each. Assembling
the bikes will increase direct materials by $5 per bike, and direct labor by
$20 per bike. Additional variable overhead will be incurred at the normal
rates, but there will be no additional fixed overhead as a result of
assembling the bikes.

Instructions
a. Prepare an incremental analysis for the sell-or-process-further
decision.
b. Should Top Gear sell or process further? Why or why not?

Ex.4
Haggis Enterprises uses a word processing computer to handle its sales
invoices. Lately, business has been so good that it takes an extra 3 hours
per night, plus every third Saturday, to keep up with the volume of sales
invoices. Management is considering updating its computer with a faster
model that would eliminate all of the overtime processing.
Current New
Machine Machine
Original purchase cost $15,000 $21,000
Accumulated depreciation 6,000 —
Estimated operating costs 24,000 20,000
Useful life 5 years 5 years
If sold now, the current machine would have a salvage value of $5,000. If
operated for the remainder of its useful life, the current machine would have
zero salvage value. The new machine is expected to have zero salvage value
after 5 years.

Instructions

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Should the current machine be replaced? (Ignore the time value of money.)

Ex.4
Gaby Rodriquez, a recent graduate of State’s accounting program, evaluated
the operating performance of Schultz Company’s six divisions. Gaby made
the following presentation to the Schultz board of directors and suggested
the Ketchum Division be eliminated. “If the Ketchum Division is eliminated,”
she said, “our total profits would increase by $16,870.”

The Other Ketchum

Five Divisions Division Total
Sales $1,664,200 $ 98,200 $1,762,400
Cost of goods sold 978,520 76,470 1,054,990
Gross profit 685,680 21,730 707,410
Operating 527,940 38,600 566,540
expenses
Net income $ 157,740 $(16,870 $ 140,870
)

In the Ketchum Division, cost of goods sold is $56,000 variable and $20,470
fixed, and operating expenses are $12,000 variable and $26,600 fixed. None
of the Ketchum Division’s fixed costs will be eliminated if the division is
discontinued.

Instructions
Is Gaby right about eliminating the Ketchum Division? Prepare a schedule
to support your answer.

Part II: Problems

Prob.1 (Make incremental analysis related to make or buy; consider

opportunity cost, and identify nonfinancial factors)
The management of Garcon Manufacturing Company has asked for your
assistance in deciding whether to continue manufacturing a part or to buy it
from an outside supplier. The part, called Tropica, is a component of
Garcon’s finished product.
An analysis of the accounting records and the production data revealed the
following information for the year ending December 31, 2012.
1. The Machinery Department produced 36,000 units of Tropica.
2. Each Tropica unit requires 10 minutes to produce. Three people in the
Machinery Department work full time (2,000 hours per year) producing
Tropica. Each person is paid $11.00 per hour.
3. The cost of materials per Tropica unit is $2.00.
4. Manufacturing overhead costs directly applicable to the production of
Tropica are: indirect labor, $5,500; utilities, $1,300; depreciation,

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 $1,600; property taxes and insurance, $1,000. All of the costs will be
eliminated if Tropica is purchased.
5. The lowest price for a Tropica from an outside supplier is $3.90 per
unit. Freight charges will be $0.30 per unit, and a part-time receiving
clerk at $8,500 per year will be required.
6. If Tropica is purchased, the excess space will be used to store Garcon’s
finished product. Currently, Garcon rents storage space at
approximately $0.60 per unit stored per year.
7. Approximately 6,000 units per year are stored in the rented space.

Instructions
a. Prepare an incremental analysis for the make-or-buy decision. Should
Garcon make or buy the part? Why?
b. Prepare an incremental analysis, assuming the released facilities can be
used to produce $10,000 of net income in addition to the savings on the
rental of storage space. What decision should now be made?
c. What nonfinancial factors should be considered in the decision?

Prob.2 (Compute contribution margin, and prepare incremental

analysis concerning elimination of divisions)
Pierre Manufacturing Company has four operating divisions. During the first
quarter of 2012, the company reported total income from operations of
$61,000 and the following results for the divisions.
Division
San
Denver Miami Diego Tacoma
Sales $455,00 $730,000 $920,00 $515,000
0 0
Cost of goods sold 380,000 480,000 576,000 430,000
Selling and administrative 120,000 207,000 246,000 120,000
expenses
Income (loss) from operations $(45,000) $ 43,000 $ 98,000 $(35,000)

Analysis reveals the following percentages of variable costs in each division.

San
Denver Miami Diego Tacoma
Cost of goods sold 95% 80% 90% 90%
Selling and administrative expenses 80 60 70 60

Discontinuance of any division would save 60% of the fixed costs and
expenses for that division.

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Top management is deeply concerned about the unprofitable divisions
(Denver and Tacoma). The consensus is that one or both of the divisions
should be eliminated.

Instructions
a. Compute the contribution margin for the two unprofitable divisions.
b. Prepare an incremental analysis concerning the possible elimination of
(1) the Denver Division and (2) the Tacoma Division. What course of
action do you recommend for each division?
c. Prepare a columnar condensed income statement using the CVP format
for Pierre Manufacturing Company, assuming (1) the Denver Division is
eliminated, and (2) the unavoidable fixed costs and expenses of the
Denver Division are allocated 30% to Miami, 50% to San Diego, and
20% to Tacoma.
d. Compare the total income from operations with the Denver Division
($61,000) to total income from operations without this division.