CHAPTER 6

INCREMENTAL ANALYSIS
SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY
Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT
True-False Statements
1. 2 K 8. 3 C 15. 6 C 22. 8 K 29. 7 C
2. 1 K 9. 3 C 16. 6 C 23. 2 K 30. 2 K
3. 2 C 10. 4 C 17. 6 C 24. 3 C 31. 4 K
4. 2 K 11. 4 K 18. 7 C 25. 5 K 32. 6 K
5. 1 K 12. 4 C 19. 7 C 26. 7 C
6. 2 C 13. 5 C 20. 8 C 27. 4 K
7. 3 C 14. 5 C 21. 8 C 28. 2 C
Multiple Choice Questions
45. 1 K 58. 2 C 71. 4 AN 84. 6 C 97. 3 C
46. 1 K 59. 2 C 72. 3 AN 85. 7 AN 98. 4 C
47. 1 K 60. 3 AP 73. 3 AN 86. 7 AP 99. 4 AN
48. 1 K 61. 2 C 74. 4 AN 87. 7 AN 100. 5 AP
49. 2 K 62. 3 C 75. 5 AN 88. 8 AN 101. 5 AN
50. 1 C 63. 3 C 76. 4 C 89. 8 C 102. 5 AN
51. 2 K 64. 3 C 77. 5 AN 90. 8 AN 103. 4 K
52. 2 C 65. 3 C 78. 5 C 91. 3 AP 104. 3 K
53. 2 C 66. 4 K 79. 5 AN 92. 4 C 105. 5 AN
54. 2 K 67. 4 C 80. 6 C 93. 7 AN 106. 6 C
55. 2 K 68. 4 C 81. 6 C 94. 8 AP 107. 4 AN
56. 2 C 69. 4 AP 82. 6 C 95. 4 K
57. 2 C 70. 4 AN 83. 6 C 96. 4 AP
Brief Exercises
108. 4 AP 112. 7 AP 116. 2 AP 120. 7 AN
109. 4 AP 113. 8 AP 117. 8 AN 121. 4 AN
110. 4 AP 114. 4 AP 118. 3 AP 122. 5 AN
111. 7 AP 115. 6 AN 119. 4 AP 123. 7 AN
Exercises
124. 7 AN 127. 6 AN 130. 4 E 133. 6 AN 136. 7 E
125. 7 AP 128. 3 AN 131. 4 AN 134. 6 E 137. 8 E
126. 3,4 AN 129. 3 E 132. 4 E 135. 7 E 138. 8 E
Completion Statements
139. 2 K 141. 4 K 143. 6 K 145. 1 K
140. 2 K 142. 5 K 144. 8 K
Matching
146. 1-4 K
Short Answer Essay Questions
147. 4 AN 148. 6 E
6-2 Test Bank for Managerial Accounting, Third Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type
Study Objective 1
2. TF 45. MC 47. MC 50. MC 146. Ma
5. TF 46. MC 48. MC 145. C
Study Objective 2
1. TF 23. TF 51. MC 55. MC 59. MC 140. C
3. TF 28. TF 52. MC 56. MC 61. MC 146. Ma
4. TF 30. TF 53. MC 57. MC 116. BE
6. TF 49. MC 54. MC 58. MC 139. C
Study Objective 3
7. TF 24. TF 63. MC 72. MC 97. MC 126. Ex 146. Ma
8. TF 60. MC 64. MC 73. MC 104. MC 128. Ex
9. TF 62. MC 65. MC 91. MC 118. BE 129. Ex
Study Objective 4
10. TF 66. MC 71. MC 96. MC 108. BE 121. BE 141. C
11. TF 67. MC 74. MC 98. MC 109. BE 126. Ex 146. Ma
12. TF 68. MC 76. MC 99. MC 110. BE 130. Ex 147. Es
27. TF 69. MC 92. MC 103. MC 115. BE 131. Ex
31. TF 70. MC 95. MC 107. MC 119. BE 132. Ex
Study Objective 5
13. TF 25. TF 77. MC 79. MC 101. MC 105. MC 142. C
14. TF 75. MC 78. MC 100. MC 102. MC 122. BE
Study Objective 6
15. TF 32. TF 82. MC 106. MC 133. Ex 148. Es
16. TF 80. MC 83. MC 115. BE 134. Ex
17. TF 81. MC 84. MC 127. Ex 143. Ex
Study Objective 7
18. TF 29. TF 87. MC 112. BE 124. Ex 136. Ex
19. TF 85. MC 93. MC 120. BE 125. Ex
26. TF 86. MC 111. BE 123. BE 135. Ex
Study Objective 8
20. TF 22. TF 89. MC 94. MC 117. BE 138. Ex
21. TF 88. MC 90. MC 113. BE 137. Ex 144. C

Note: TF = True-False C = Completion Ex = Exercise

MC = Multiple Choice BE = Brief Exercise Ma = Matching Es = Essay
.
 Incremental Analysis 6-3

CHAPTER STUDY OBJECTIVES

1. Identify the steps in management's decision-making process. Management's decision-
making process consists of (a) identifying the problem or opportunity, (b) assigning
responsibility for the decision, (c) determining possible courses of action, (d) developing data
relevant to each course of action, (e) making the decision, and (f) reviewing the results of the
decision.
2. Describe the concept of incremental analysis. Incremental analysis is the process used to
identify financial data that change under alternative courses of action. These data are
relevant to the decision because they will vary in the future among the possible alternatives.
3. Identify the relevant costs in accepting an order at a special price. The relevant
information in accepting an order at a special price is the difference between the variable
manufacturing costs to produce the special order and expected revenues.
4. Identify the relevant costs in a make-or-buy decision. In a make-or-buy decision, the
relevant costs are (a) the variable manufacturing costs that will be saved, (b) the purchase
price, and (c) opportunity costs.
5. Identify the relevant costs in determining whether to sell or process materials further.
The decision rule for whether to sell or process materials further is: Process further as long
as the incremental revenue from processing exceeds the incremental processing costs.
6. Identify the relevant costs to be considered in retaining or replacing equipment. The
relevant costs to be considered in determining whether equipment should be retained or
replaced are the effects on variable costs and the cost of the new equipment. Also, any
disposal value of the existing asset must be considered.
7. Identify the relevant costs in deciding whether to eliminate an unprofitable segment. In
deciding whether to eliminate an unprofitable segment, the relevant information is the
contribution margin, if any, produced by the segment and the disposition of the segment's
fixed expenses.
8. Determine sales mix when a company has limited resources. When a company has
limited resources, it is necessary to find the contribution margin per unit of limited resource.
This amount is then multiplied by the units of limited resource to determine which product
maximizes net income.
6-4 Test Bank for Managerial Accounting, Third Edition

TRUE-FALSE STATEMENTS
1. Incremental analysis identifies the probable effects of management decisions on future
earnings.

2. In making decisions, management considers only financial information because

accounting is presented in financial context.

3. In incremental analysis, total fixed costs will always remain constant under alternative
courses of action.

4. Incremental analysis is also known as differential analysis.

5. Decision-making involves reviewing the results of a decision once the decision has been
made.

6. Decisions made using incremental analysis focus on the amounts which differ among the
alternatives.

7. A special one-time order is acceptable if the unit sales price is greater than the unit
variable cost.

8. Max Company has excess capacity. A customer proposes to buy 400 widgets at a special
unit price even though the price is less than the unit variable cost to manufacture the item.
Max should accept the special order if demand on other products is unaffected.

9. A company should accept an order for its product at less than its regular sales price if the
incremental revenue exceeds the incremental costs.

10. A decision whether to continue to buy a product instead of producing it externally depends
specifically on the incremental costs and incremental revenues of making the change.

11. An opportunity cost is the potential benefit given up by using resources in an alternative
course of action.

12. An incremental make or buy decision depends solely on which alternative is the lowest
cost alternative.

13. In a sell or process further decision, management should process further as long as the
incremental revenues from additional processing are greater than the incremental costs.

14. It is better to process further rather than sell now if the sales price increases.

15. In a decision concerning replacing old equipment with new equipment, the book value of
the old equipment can be considered an opportunity cost.

16. In a decision to retain or replace old equipment, the salvage value of the old equipment is
a sunk cost in incremental analysis.

17. Equipment which is not fully depreciated should always be replaced.

 Incremental Analysis 6-5

18. A company should eliminate any segment in which the contribution margin is less than the
fixed costs that are unavoidable.

19. The elimination of an unprofitable product line will always increase the total profits of a
company.

20. When a company has limited resources to manufacture products, it should manufacture
those products which have the highest contribution margin per unit.

21. If a company has limited machine hours available for production, it is generally more
profitable to produce and sell the product with the highest contribution margin per machine
hour.

22. One incremental analysis decision is the allocation of limited resources.

23. The process used to identify the financial data that change under alternative courses of
action is called incremental analysis.

24. If a company is operating at less than capacity, the incremental costs of a special order
will likely include variable manufacturing costs, but not fixed costs.

25. The basic decision rule in a sell or process further decision is: process further if the
incremental revenue from processing exceeds the incremental processing costs.

26. In deciding on the future status of an unprofitable segment, management should

recognize that net income will increase by eliminating the unprofitable segment.

27. Direct materials, direct labor, and allocated fixed and variable manufacturing overhead are
all relevant in a make or buy decision.

28 Sunk costs are considered relevant when choosing among alternatives because they are
differential.

29. If an unprofitable product is eliminated, fixed expenses allocated to the eliminated

segment will likely be eliminated.

30. Incremental costs are always relevant.

31. A disadvantage of using an outside supplier is the associated loss of control over the
production process.

32. The book value of old equipment is an opportunity cost.

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. T 6. T 11. T 16. F 21. T 26. F 31. T
2. F 7. T 12. F 17. F 22. T 27. F 32. F
3. F 8. F 13. T 18. F 23. T 28. F
4. T 9. T 14. F 19. F 24. T 29. F
5. T 10. F 15. F 20. F 25. T 30. T
6-6 Test Bank for Managerial Accounting, Third Edition

MULTIPLE CHOICE QUESTIONS

33. The cost to produce Part A was $10 per unit in 2005. During 2006, it has increased to $11
per unit. In 2006, Supplier Company has offered to supply Part A for $9 per unit. For the
make-or-buy decision,
a. incremental revenues are $2 per unit.
b. incremental costs are $1 per unit.
c. net relevant costs are $1 per unit.
d. differential costs are $2 per unit.

34. Max Company uses 10,000 units of Part A in producing its products. A supplier offers to
make Part A for $7. Max Company has relevant costs of $8 a unit to manufacture Part A. If
there is excess capacity, the opportunity cost of buying Part A from the supplier is
a. $0.
b. $10,000.
c. $70,000.
d. $80,000

35. Truckel, Inc. currently manufactures a wicket as its main product. The costs per unit are as
follows:
Direct materials and direct labor $11.00
Variable overhead 5.00
Fixed overhead 8.00
Total $24.00
The fixed overhead is an allocated common cost. How much is the relevant cost of the
wicket?
a. $24.00
b. $16.00
c. $11.00
d. $19.00

36. Seran Company has contacted Truckel Inc. with an offer to sell it 5,000 of the wickets for
$18.00 each. If Truckel makes the wickets, variable costs are $11 per unit. Fixed costs are
$12 per unit however $5 per unit is avoidable. Should Truckel make or buy the wickets?
a. Buy; savings = $25,000
b. Buy; savings = $10,000
c. Make; savings = $20,000
d. Make; savings = $10,000

37. Galley Industries can produce 100 units of a necessary component part with the following
costs:
Direct Materials $30,000
Direct Labor 13,000
Variable Overhead 32,000
Fixed Overhead 12,000
If Galley Industries purchases the component externally, $3,000 of the fixed costs can be
avoided. Below what external price for the 100 units would Galley choose to buy instead of
make?
a. $75,000
b. $84,000
c. $66,000
d. $78,000
 Incremental Analysis 6-7

38. Corn Crunchers has three product lines. It’s only unprofitable line is Corn Nuts, the results
of which appear below for 2006:
Sales $350,000
Variable expenses 230,000
Fixed expenses 150,000
Net loss $(30,000)
If this product line is eliminated, 30% of the fixed expenses can be eliminated. How much
are the relevant costs in the decision to eliminate this product line?
a. $45,000
b. $380,000
c. $335,000
d. $275,000

39. North Division has the following information

Sales $600,000
Variable expenses 320,000
Fixed expenses 310,000
If this division is eliminated the fixed expenses will be allocated to the company’s other
divisions. What is the incremental effect on net income if the division is dropped?
a. $30,000 increase
b. $310,000 decrease
c. $280,000 decrease
d. $290,000 increase

40. Peters, Inc. produces chocolate chip cookies. Costs for producing one batch appear
below:
Direct materials $ 8.00
Direct labor 3.00
Variable overhead 1.00
Fixed overhead 4.00
An outside supplier has offered to produce the cookies for $14 per batch. If Peters
decides to buy instead of make the cookies, what is the maximum price it would may?
a. $16.00
b. $12.00
c. $13.60
d. $14.40

41. Walton, Inc. is unsure of whether to sell its product assembled or unassembled. The unit
cost of the unassembled product is $16, while the cost of assembling each unit is
estimated at $17. Unassembled units can be sold for $55, while assembled units could be
sold for $71 per unit. What decision should Walton make?
a. Sell before assembly, the company will save $1 per unit.
b. Sell before assembly, the company will save $15 per unit.
c. Process further, the company will save $1 per unit.
d. Process further, the company will save $16 per unit.

42. Ace Company sells office chairs with a selling price of $25 and a contribution margin per
unit of $15. It takes 3 machine hours to produce one chair. How much is the contribution
margin per unit of limited resource?
a. $5
b. $3.33
c. $45
d. $10
6-8 Test Bank for Managerial Accounting, Third Edition

43. Rosen, Inc. has 10,000 obsolete calculators, which are carried in inventory at a cost of
$20,000. If the calculators are scrapped, they can be sold for $1.10 each (for parts). If
they are repackaged, at a cost of $15,000, they could be sold to toy stores for $2.50 per
unit. What alternative should be chosen, and why?
a. Scrap; profit is $1,000 greater.
b. Repackage; revenue is $5,000 greater than cost.
c. Scrap; incremental loss is $9,000.
d. Repackage; receive profit of $10,000.

44. It costs Lannon Fields $14 of variable costs and $6 of allocated fixed costs to produce an
industrial trash can that sells for $30. A buyer is Mexico offers to purchase 2,000 units at
$18 each. Lannon has excess capacity and can handle the additional production. What
effect will acceptance of the offer have on net income?
a. decrease $4,000
b. increase $4,000
c. increase $36,000
d. increase $8,000

45. Which of the following is a major accounting contribution to the managerial decision-
making process in evaluating possible courses of action?
a. Determine who is responsible for the decision.
b. Prepare internal reports that review the actual impact of a decision made.
c. Calculate how much should be invested for each potential project.
d. Select possible actions that management should consider.

46. Which one of the following stages of the management decision-making process is
properly sequenced?
a. Evaluate possible courses of action, Make decision
b. Review the actual impact of the decision, Determine possible courses of action
c. Assign responsibility for the decision, Identify the problem
d. Make a decision, Assign responsibility

47. Who prepares relevant revenue and cost data for the decision making process?
a. Department heads
b. The controller
c. Management accountants
d. Factory supervisors

48. Which of the following steps in the management decision-making process generally
involves the managerial accountant?
a. Determine possible courses of action
b. Make the appropriate decision based on relevant data
c. Prepare internal reports that review the impact of decisions
d. Assign responsibility

49. What is the process of evaluating financial data that changes under alternative courses of
action called?
a. Incremental analysis
b. Decision-making analysis
c. Contribution margin analysis
d. Cost-benefit analysis
 Incremental Analysis 6-9

50. Which one of the following is nonfinancial information that management might evaluate in
making a decision?
a. Opportunity costs of a decision
b. Contribution margin
c. The effect on profit of a decision
d. The corporate profile in the community

51. Which one of the following is an alternative name for incremental analysis?
a. Managerial analysis
b. Cost analysis
c. Contribution margin analysis
d. Differential analysis

52. Which of the following describes one aspect of incremental analysis?

a. Both costs and revenues that stay the same between alternate courses of action will
be analyzed.
b. Both costs and revenues that differ between alternate courses of action will be
analyzed.
c. All costs and revenues, regardless if they that stay the same or differ between
alternate courses of action, will be analyzed.
d. Only costs relating to the decisions at hand are analyzed.

53. When is incremental analysis most useful?

a. After a decision has been made to determine its effectiveness
b. In choosing between capital budgeting methods
c. In evaluating the profitability of a company
d. In developing relevant information for management decisions

54. Who generates the data used in incremental analysis?

a. Market analysts and engineers
b. Engineers and accountants
c. Market analysts, engineers, and accountants
d. Only the accountants

55. Which one of the following is a true statement about incremental analysis?
a. It is another name for capital budgeting.
b. It is the same as CVP analysis.
c. It is used primarily for long-term planning.
d. It focuses on decisions that involve a choice among alternative courses of action.

56. For which of the following decisions is incremental analysis not appropriate?
a. Elimination of an unprofitable segment
b. Determining cost behavior
c. A make or buy decision
d. An allocation of limited resource decision

57. For which of the following is incremental analysis appropriate?

a. Acceptance of a special order and a make or buy decision
b. A retain or replace equipment decision and CVP analysis
c. A sell or process further decision and allocation of indirect costs
d. Elimination of an unprofitable segment and allocation of indirect costs
6-10 Test Bank for Managerial Accounting, Third Edition

58. Which of the following is a true statement about cost behaviors in incremental analysis?
a. Total variable costs do not change between alternatives.
b. Fixed costs and variable costs will always change between alternatives.
c. Variable costs per unit will always change between alternatives.
d. Fixed costs will generally not change between alternatives.

59. Specik, Inc. is considering the following alternatives:

Alternative 1 Alternative 2
Revenues $120,000 $120,000
Variable costs 60,000 70,000
Fixed costs 35,000 39,000
Which of the following are relevant in choosing between the alternatives?
a. Variable costs
b. Revenues
c. Fixed costs
d. Variable costs and fixed costs

60. Seville Company manufactures a product with a unit variable cost of $42 and a unit sales
price of $75. Fixed manufacturing costs were $80,000 when 10,000 units were produced
and sold, equating to $8 per unit. The company has a one-time opportunity to sell an
additional 1,000 units at $55 each in an international market which would not affect its
present sales. The company has sufficient capacity to produce the additional units. How
much is the relevant income effect of accepting the special order?
a. $42,000
b. $5,000
c. $50,000
d. $13,000

61. Which statement is true about relevant costs in incremental analysis?

a. All costs are relevant if they change between alternatives.
b. Only fixed costs are relevant.
c. Only variable costs are relevant.
d. Relevant costs should be ignored.

62. Sorrento Company’s plant is operating at less than full capacity. The company just
received a one-time opportunity to accept an order at a special price below its usual price.
The special price exceeds it variable costs. Which statement is true?
a. Fixed costs are relevant.
b. The order will likely be accepted.
c. The order will likely be rejected.
d. Sorrento should expand its plant capacity before accepting the order.

63. Canosta, Inc. determined it must expand its capacity to accept a special order. Which
situation is likely?
a. Unit variable costs will increase.
b. Fixed costs will not be relevant.
c. Both variable and fixed costs will be relevant.
d. The company should accept the order.
 Incremental Analysis 6-11

64. A company is within plant capacity. It is contemplating whether a special order should be
accepted. The order will not impact regular sales. If the company accepts a special order,
what will occur?
a. Incremental costs will not be affected.
b. Net income will increase if the special sales price per unit exceeds the unit variable
costs.
c. There are no incremental revenues.
d. Both fixed and variable costs will increase.

65. Argus Company anticipates that other sales will be affected by the acceptance of a
special order. What should the company do?
a. Reject the order
b. Consider the opportunity cost of lost sales in the incremental analysis
c. Accept the order
d. Accept the order if the plant is below capacity

66. Which statement is true of an opportunity cost?

a. It is the cost of a special order option.
b. It reduces the possibility of accepting a particular course of action.
c. It is the potential benefit as a result of following an alternative course of action.
d. It is a variable cost.

67. In which situations should opportunity costs be considered?

a. Decision making that involves alternative uses
b. Forecasting sales
c. Financial accounting
d. Breakeven analysis

68. What is the nature of an opportunity cost?

a. It is always variable.
b. It is a potential benefit.
c. It is included as part of cost of goods sold.
d. It is a sunk cost.

69. Wishnell Toys can make 1,000 toy robots with the following costs:
Direct Materials $56,000
Direct Labor 21,000
Variable Overhead 12,000
Fixed Overhead 12,000
The company can purchase the 1,000 robots externally for $96,000. The avoidable fixed
costs are $4,000 if the units are purchased externally. What is the cost savings if the
company makes the gears?
a. $1,000
b. $4,000
c. $8,000
d. $3,000
6-12 Test Bank for Managerial Accounting, Third Edition

Use the following information for questions 70–71.

Hermantic, Inc. can produce 100 units of a component part with the following costs:
Direct Materials $30,000
Direct Labor 13,000
Variable Overhead 32,000
Fixed Overhead 22,000
70. If Hermantic Industries purchase the units externally for $80,000, by what amount will its
total costs change?
a. An increase of $80,000
b. A increase of $5,000
c. An increase of $17,000
d. A decrease of $22,000

71. If Hermantic, Inc. can purchase the component externally for $88,000 and only $8,000 of
the fixed costs can be avoided, what is the correct "make or buy decision"?
a. Make and save $1,000
b. Buy and save $1,000
c. Make and save $5,000
d. Buy and save $13,000

Use the following information for questions 72–73.

Eminen Music produces 60,000 CDs on which to record music. The CDs have the following
costs:
Direct Materials $11,000
Direct Labor 15,000
Variable Overhead 3,000
Fixed Overhead 7,000
72. Eminem could avoid $4,000 in fixed overhead costs if it acquires the CDs externally. If
cost minimization is the major consideration and the company would prefer to buy the
60,000 units externally, what is the maximum external price that Eminem would expect to
pay for the units?
a. $32,000
b. $29,000
c. $36,000
d. $33,000

73. None of Eminem’s fixed overhead costs can be reduced, but another product could be
made that would increase profit contribution by $4,000 if the CDs were acquired
externally. If cost minimization is the major consideration and the company would prefer to
buy the CDs, what is the maximum external price that Eminem would be willing to accept
to acquire the 60,000 units externally?
a. $36,000
b. $32,000
c. $33,000
d. $40,000
 Incremental Analysis 6-13

74. Harrison Company determines that an opportunity cost of an alternate course of action is
relevant to a make or buy decision. Which statement is true of the opportunity cost?
a. Should be added to the "Buy" costs
b. Should be subtracted from the "Make" costs
c. Should be added to the "Make" costs
d. Should be ignored if it does not involve a cash outlay.

75. A company has a process that results in 4,000 pounds of Product X that can be sold for
$7 per pound. An alternative would be to process Product X further at a cost of $4,000
and then sell it for $12 per pound. Should management sell Product X now or should
Product X be processed further and then sold?
a. Process further, the company will be better off by $44,000.
b. Sell now, the company will be better off by $44,000.
c. Process further, the company will be better off by $1,000.
d. Sell now, the company will be better off by $16,000.

76. Which statement is true concerning the decision rule on whether to make or buy?
a. The company should buy if the cost of buying is less than the cost of producing.
b. The company should buy if the incremental revenue exceeds the incremental costs.
c. The company should buy as long as total revenue exceeds present revenues.
d. The company should buy assuming no additional fixed costs are incurred.

77. PH Toy is unsure of whether to sell its product assembled or unassembled. The unit cost
of the unassembled product is $30 and PH Toy Company would sell it for $65. The cost to
assemble the product is estimated at $21 per unit and PH Toy Company believes the
market would support a price of $85 on the assembled unit. What decision should PH Toy
make?
a. Sell before assembly, the company will be better off by $1 per unit.
b. Sell before assembly, the company will be better off by $20 per unit.
c. Process further, the company will be better off by $29 per unit.
d. Process further, the company will be better off by $14 per unit.

78. What is the nature of a sell or process further decision?

a. It is an incremental revenue decision.
b. It is an incremental cost decision.
c. It is both an incremental revenue and incremental cost decision.
d. It is neither incremental revenue nor incremental cost.

79. Coggin Company gathered the following data about the three products that it produces:
Present Estimated Additional Estimated Sales
Product Sales Value Processing Costs if Processed Further
A $ 9,000 $ 6,000 $ 16,000
B 15,000 5,000 18,000
C 11,000 8,000 16,000
Which of the products should be processed further?
a. Product A
b. Product B
c. Product C
d. All three products
6-14 Test Bank for Managerial Accounting, Third Edition

80. Which of the following is relevant information in a decision whether old equipment
presently being used should be replaced by new equipment?
a. The cost of the old equipment
b. The salvage value of the old equipment
c. The book value of the old equipment
d. The accumulated depreciation of the old equipment

81. What is the salvage value of old equipment considered to be?

a. A relevant cost
b. A non-incremental cost
c. An opportunity cost
d. A cost that is not differential

82. A company is deciding whether or not to replace some old equipment with new
equipment. Which of the following is not considered in the incremental analysis?
a. Annual operating cost of the new equipment
b. Annual operating cost of the old equipment
c. Net cost of the new equipment
d. Book value of the old equipment

83. A company is considering replacing old equipment with new equipment. Which of the
following is a relevant cost for incremental analysis?
a. Total accumulated depreciation of the old equipment
b. Cost of the old equipment
c. Annual operating cost of the new equipment
d. Book value of the old equipment

84. What role does a trade-in allowance on old equipment play in a decision to retain or
replace equipment?
a. It relevant since it increases the cost of the new equipment.
b. It is not relevant since it reduces the cost of the old equipment.
c. It is not relevant to the decision since it does not impact the cost of the new
equipment.
d. It is relevant since it reduces the cost of the new equipment.

85. Diversified Machines has four product lines, one of which reflects the following results:
Sales $220,000
Variable expenses 120,000
Contribution margin 100,000
Fixed expenses 120,000
Net loss $(20,000)
If this product line is eliminated, 40% of the fixed expenses can be eliminated and the
other 60% will be allocated to other product lines. If management decides to eliminate this
product line, what will happen to the company's net income?
a. It will increase by $20,000.
b. It will decrease by $52,000.
c. It will decrease by $32,000.
d. It will increase by $48,000.
 Incremental Analysis 6-15

86. Halliburton Division has the following data:

Sales $500,000
Variable expenses 260,000
Fixed expenses 280,000
The fixed costs are not avoidable and must be allocated to profitable divisions if the
segment is eliminated. What will be the incremental effect on net income if Halliburton
Division is eliminated?
a. $40,000 increase
b. $240,000 decrease
c. $280,000 decrease
d. Cannot be determined from the data provided.

87. SmartCard is considering eliminating one of its product lines. The fixed costs currently
allocated to the product line will be allocated to other product lines upon discontinuance.
What financial effects occur if the product line is discontinued?
a. Net income will decrease by the amount of the contribution margin of the product line
being discontinued.
b. The company's total fixed costs will increase.
c. Total fixed costs will decrease by the amount of the product line's fixed costs.
b. Net income will decrease by the amount of the product line's fixed costs.

88. Shorebuck’s Coffee can sell all the units it can produce of either latte or cappuccino but not
both. Latte has a unit contribution margin of $45 and takes three machine hours to make
and cappuccino has a unit contribution margin of $32 and takes two machine hours to
make. There are 1,200 machine hours available to manufacture a product. What should
Shorebuck’s do?
a. Make latte which creates $13 more profit per unit than cappuccino does
b. Make cappuccino which creates $1 more profit per constraint than latte does
c. Make cappuccino because more units can be made and sold than latte
d. The same total profits exists regardless of which product is made.

89. What is the key factor in performing incremental analysis if a company has limited
resources?
a. Contribution margin per unit of limited resource
b. The amount of fixed costs per unit
c. Total contribution margin
d. The cost of limited resources

90. Harry’s Fish House can produce and sell only one of the following two products:
Fryer Contribution
Hours Required Margin Per Unit
Fried catfish 2 $10
Fried grouper 5 $30
The company has fryer capacity of 5,000 hours. How much will contribution margin be if it
produces only the most profitable product?
a. $150.000
b. $25,000
c. $30,000
d. $150,000
6-16 Test Bank for Managerial Accounting, Third Edition

91. It costs Fortune Company $12 of variable and $5 of fixed costs to produce one bathroom
scale which normally sells for $35. A foreign wholesaler offers to purchase 1,000 scales at
$15 each. Fortune would incur special shipping costs of $1 per scale if the order were
accepted. Fortune has sufficient unused capacity to produce the 1,000 scales. If the
special order is accepted, what will be the effect on net income?
a. $2,000 increase
b. $2,000 decrease
c. $3,000 decrease
d. $15,000 increase

92. Which one of the following does not affect a make or buy decision?
a. Variable manufacturing costs
b. Opportunity cost
c. Incremental revenue
d. Direct labor

93. What will likely occur if a company eliminates an unprofitable segment when a portion of
fixed costs are unavoidable?
a. All expenses of the eliminated segment will be eliminated.
b. Net income will decrease.
c. Net income will increase.
d. The company’s variable costs will increase.

94. Diaz Company’s contribution margin is $4 per unit for Product A and $5 for Product B.
Product A requires 2 machine hours and Product B requires 4 machine hours. How much
is the contribution margin per unit of limited resource for each product?
A B
a. $4.00 $5.00
b. $2.00 $1.25
c. $1.25 $2.00
d. $2.50 $1.00

95. Which one of the following is not a disadvantage of buying rather than making a
component of a company’s product?
a. Quality control specifications may not be met.
b. The outside supplier could increase prices significantly in the future.
c. Profitable product lines may be dropped.
d. The supplier may not deliver on time.

96. Hungry Bites produces corn chips. The cost of one batch is below:
Direct materials $ 18.00
Direct labor 13.00
Variable overhead 11.00
Fixed overhead 14.00
An outside supplier has offered to produce the corn chips for $25 per batch. How much
will Hungry Bites save if it accepts the offer?
a. $2.00 per batch
b. $17.00 per batch
c. $31.00 per batch
d. $6.00 per batch
 Incremental Analysis 6-17

97. Diggs, Inc. has excess capacity. Under what situations should the company accept a
special order for less than the current selling price?
a. Never
b. When additional fixed costs must be incurred to accommodate the order
c. When the company thinks it can use cheaper materials without the customer’s
knowledge
d. When incremental revenues exceed incremental costs

98. Meow Cat Toys utilizes Lincoln Fabrics by purchasing the fabric to cover toy mice for its
mouse toy division. As it pertains to Lincoln Fabrics, what decision situation does this
create?
a. Make or buy
b. Sell or process further
c. Relevant costing
d. Budgeting

99. During 2006, it cost Westa, Inc. $12 per unit to produce Part T5. During 2007, it has
increased to $14 per unit. In 2006, Southside Company has offered to provide Part T5 for
$9 per unit to Westa. As it pertains to the make-or-buy decision, which statement is true?
a. Differential costs are $5 per unit.
b. Incremental costs are $3 per unit.
c. Net relevant costs are $3 per unit.
d. Incremental revenues are $2 per unit.

100. Serene Dairy has 4 product lines: sour cream, ice cream, yogurt, and butter. The total
costs of producing the milk base for the products is $45,000 which has been allocated
based on gallons of milk base used by each product. Results of July follow:
Sour Cream Ice Cream Yogurt Butter Total
Units sold 2,000 500 400 2,000 5,900
Revenue $10,000 $20,000 $10,000 $20,000 $60,000
Variable departmental costs 6,000 13,000 4,200 4,800 28,000
Fixed costs 5,000 2,000 3,000 7,000 17,000
Net income (loss) ($1,000) $5,000 $2,800 $8,200 $15,000
How much are total joint costs of the products?
a. $28,000
b. $17,000
c. $45,000
d. $15,000

101. Whisker Clean Company spent $4,000 to produce Product 89, which can be sold ‘as is’
for $5,000, or processed further incurring additional costs of $1,500 and then be sold for
$7,000. Which amounts are relevant to the decision about Product 89?
a. $4,000, $5,000, and $7,000
b. $4,000, $1,500, and $7,000
c. $5,000, $1,500, and $7,000
d. $4,000, $5,000, $1,500 and $7,000
6-18 Test Bank for Managerial Accounting, Third Edition

102. Narst Company has old inventory on hand that cost $12,000. Its scrap value is $16,000.
The inventory could be sold for $40,000 if manufactured further at an additional cost of
$12,000. What should Narst do?
a. Sell the inventory for $16,000 scrap value
b. Dispose of the inventory to avoid any further decline in value
c. Hold the inventory at its $12,000 cost
d. Manufacture further and sell it for $40,000

103. Which decision will involve no incremental revenues?

a. Make or buy decision
b. Drop a product line
c. Accept a special order
d. Additional processing decision

104. A factory is operating at less than 100% capacity. Potential additional business will not
use up the remainder of the plant capacity. Given the following list of costs, which one
should be ignored in a decision to produce additional units of product?
a. Variable selling expenses
b. Fixed factory overhead
c. Direct labor
d. Contribution margin of additional units

105. Market Makeup produces face cream. Each bottle of face cream costs $10 to produce and
can be sold for $13. The bottles can be sold as is, or processed further into sunscreen at
a cost of $14 each. Market Makeup could sell the sunscreen bottles for $23 each.
a. Face cream must be further processed because its profit is $9 each.
b. Face cream must not be further processed because costs increase more than
revenue.
c. Face cream must not be further processed because it decreases profit by $1 each.
d. Face cream must be further processed because it increases profit by $3 each.

106. A company decided to replace an old machine with a new machine. Which of the following
is considered a relevant cost?
a. The book value of the old equipment
b. Depreciation expense on the old equipment
c. The loss on the disposal of the old equipment
d. The current disposal price of the old equipment
 Incremental Analysis 6-19

107. Chapman Company manufactures widgets. Embree Company has approached Chapman
with a proposal to sell the company widgets at a price of $60,000 for 100,000 units.
Chapman is currently making these components in its own factory. The following costs are
associated with this part of the process when 100,000 units are produced:

Direct material $23,000

Direct labor 22,000
Manufacturing overhead 30,000
Total $75,000
The manufacturing overhead consists of $12,000 of costs that will be eliminated if the
components are no longer produced by Chapman. From Chapman’s point of view, how
much is the incremental cost or savings if the widgets are bought instead of made?
a. $15,000 incremental savings
b. $3,000 incremental cost
c. $3,000 incremental savings
d. $15,000 incremental cost

Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
33. d 44. d 55. d 66. c 77. a 88. b 99. a
34. b 45. b 56. b 67. a 78. c 89. a 100. c
35. b 46. a 57. a 68. b 79. a 90. c 101. c
36. c 47. c 58. d 69. d 80. b 91. a 102. d
37. d 48. c 59. d 70. b 81. a 92. c 103. a
38. d 49. a 60. d 71. c 82. d 93. b 104. b
39. c 50. d 61. a 72. a 83. c 94. b 105. b
40. b 51. d 62. b 73. b 84. d 95. c 106. d
41. a 52. b 63. c 74. c 85. b 96. b 107. b
42. a 53. d 64. b 75. a 86. b 97. d
43. a 54. c 65. b 76. a 87. a 98. a
6-20 Test Bank for Managerial Accounting, Third Edition

BRIEF EXERCISES
Brief Exercise 108
Temple, Inc. produces several models of clocks. An outside supplier has offered to produce the
commercial clocks for Temple for $420 each. Temple needs 1,200 clocks annually. Temple has
provided the following unit costs for its commercial clocks:
Direct materials $ 100
Direct labor 120
Variable overhead 80
Fixed overhead (40% avoidable) 150
Prepare an incremental analysis which shows the effect of the make or buy decision.

Solution Brief Exercise 108

Incremental Analysis Incremental Effect
Cost to buy (1,200 x $420) ($504,000)
Cost savings:
Savings of DM $100 x 1,200 = $120,000
Savings of DL $120 x 1,200 = 144,000
Savings of VOH $80 x 1,200 = 96,000
Savings of FOH 40% x $150 x 1,200 = 72,000
Total cost savings +432,000
Net cost savings if commercial clock are bought $ 72,000

Brief Exercise 109

Calc, Inc. owns a machine that produces baskets for the gift packages the company sells. The
company uses 800 baskets in production each month. The costs of making one basket is $4 for
direct materials, $3 for variable manufacturing overhead, $2 for direct labor and $5 for fixed
manufacturing overhead. The unit cost is based on the monthly production of 800 baskets. The
company determined that 30% of the fixed manufacturing overhead is avoidable. An outside
supplier has offered to sell Calc the baskets for $12 each, and can supply all the units it needs.
Prepare an incremental analysis to determine if Calc should buy the component from the supplier.

Solution Brief Exercise 109

Incremental cost to buy (800 x $12) ($9,600)
Incremental cost savings:
DM ($4 x 800) +3,200
VOH ($3 x 800) +2,400
DL ($2 x 800) +1,600
FOH ($5 x 30% x 800) +1,200
Additional cost to buy ($1,200)
or
Make Buy
Incremental cost to buy (800 x $12) $9,600
Incremental costs to make: DM ($4 x 800) $3,200
VOH ($3 x 800) 2,400
DL ($2 x 800) 1,600
FOH 4,000 2,800
Incremental cost to buy $11,200 $12,400
 Incremental Analysis 6-21

Brief Exercise 110

Signa Corporation currently manufactures 3,000 staplers annually for its main product. The costs
per stapler are as follows:
Direct materials $ 3.00
Direct labor 8.00
Variable overhead 4.00
Fixed overhead 7.00
Total $22.00
Darsel Company has contacted Signa with an offer to sell it 3,000 staplers for $18.00 each. $5 of
the fixed overhead per unit is unavoidable. Prepare an incremental analysis for the make or buy
decision.

Solution Brief Exercise 110

Incremental cost to buy ($54,000)
Incremental savings on direct materials +9,000
Incremental savings on direct labor +24,000
Incremental savings on variable MOH +12,000
Incremental savings on fixed MOH +6,000
Incremental net cost to buy ($3,000)

Brief Exercise 111

Parrino has three product lines in its retail stores: books, videos, and music. The allocated fixed
costs are based on units sold and are unavoidable. Results of the fourth quarter are presented
below:
Books Music Videos Total
Units sold 1,000 2,000 2,000 5,000
Revenue $24,000 $48,000 $34,000 106,000
Variable departmental costs 15,000 22,000 23,000 60,000
Direct fixed costs 3,000 6,000 5,000 14,000
Allocated fixed costs 4,400 8,800 8,800 22,000
Net income (loss) $ 1,600 $11,200 ($2,800) $10,000

Demand of individual products is not affected by changes in other product lines. Prepare an
incremental analysis of the effect of dropping the Video product line.

Solution Brief Exercise 111

Incremental revenue ($34,000)
Incremental savings on variable costs +23,000
Incremental savings on direct fixed costs +5,000
Incremental cost/decrease in profit to drop video line ($6,000)
6-22 Test Bank for Managerial Accounting, Third Edition

Brief Exercise 112

Crisp has 4 product lines: sour cream, ice cream, yogurt, and butter. The allocated fixed costs are
based on units sold and are unavoidable. Demand of individual products is not affected by
changes in other product lines. 40% of the fixed costs are direct, and the other 60% are allocated.
Results of June follow:
Ice
Sour Cream Cream Yogurt Butter Total
Units sold 2,000 500 400 200 3,000
Revenue $10,000 $20,000 $10,000 $20,000 $60,000
Variable departmental costs 6,000 13,000 4,200 4,800 28,000
Fixed costs 5,000 2,000 3,000 7,000 17,000
Net income (loss) ($1,000) $5,000 $2,800 $8,200 $15,000

Prepare an incremental analysis of the effect of dropping the sour cream product line.

Solution Brief Exercise 112

Incremental revenue ($10,000)
Incremental variable cost savings +6,000
Incremental fixed cost savings ($5,000 x .40) +2,000
Incremental decrease in profits if dropped ($2,000)

Brief Exercise 113

Sam Company makes 2 products, footballs and baseballs. Additional information follows:

Footballs Baseballs
Units 2,000 3,000
Sales $60,000 $25,000
Variable costs 24,000 13,750
Fixed costs 10,000 5,250
Net income $26,000 $6,000
Yards of leather per unit 1.25 0.25
Profit per unit $13.00 $2.00
Contribution margin per unit $18.00 $3.75
Assume that Sam is able to order an additional 2,000 yards of leather and wishes to maximize its
income. Of the additional units it produces, at least 300 of each product are necessary for sales.
How many units of each must be produced?

Solution Brief Exercise 113

Footballs Baseballs
Contribution margin per yard $18/1.25 = $14.40 $3.75/.25 = $15
Produce more baseballs since CM per constraint is more.
Footballs Baseballs
Minimum: 300 x 1.25 yds. = 375 yds. 300 footballs
Yards remaining for baseballs:
2,000 - 375 = 1,625 yards .
# of baseballs: 1,625/.25 yds. = 6,500 baseballs
 Incremental Analysis 6-23

Brief Exercise 114

Hernandez, Inc. manufactures 3 models of picture frames, for a total of 5,000 frames per year.
The unit cost to produce a metal frame follows:

Direct Materials $6
Direct Labor 7
Variable Overhead 2
Fixed Overhead (70% unavoidable) 5
Total $20
A local company has offered to supply Hernandez the 5,000 metal frames it needs for $16 each.
Create an incremental analysis for the make or buy decision.

Solution Brief Exercise 114

Incremental cost to buy ($80,000)
Incremental savings:
Direct materials savings +$30,000
Direct labor savings +35,000
Variable overhead savings +10,000
Fixed overhead savings - avoidable portion +7,500
Incremental savings if 'buy' decision is made $2,500

Brief Exercise 115

Kalamoo Company has a machine that affixes labels to bottles. The machine has a book value of
$60,000 and a remaining useful life of 3 years and no salvage value. A new, more efficient
machine is available at a cost of $225,000 that will have a 5-year useful life with no salvage
value. The new machine will lower annual variable production costs from $400,000 to $310,000.
Prepare an analysis showing whether the old machine should be retained or replaced.

Solution Brief Exercise 115

Retain Replace Net Income
Equipment Equipment Change
Variable manufacturing costs $1,200,000 $930,000 $270,000*
New machine cost (225,000)
Net savings over 3 years $ 45,000

*For 3 years of remaining life

Brief Exercise 116

Southern Sisters is considering Plan 1 which is estimated to have sales of $40,000 and costs of
$15,000. The company currently has sales of $38,000 and costs of $14,000. Compare plans
using incremental analysis.

Solution Brief Exercise 116

Incremental revenue ($40,000 - $38,000) $2,000
Incremental costs ($15,000 - $14,000) (1,000)
Incremental increase in profit if Plan 1 is selected $1,000
6-24 Test Bank for Managerial Accounting, Third Edition

Brief Exercise 117

Gladiator Company provided the following information concerning two products:
Contribution margin per unit – Product 12 $22
Contribution margin per unit – Product 43 $15
Machine hours required for one unit – Product 12 2.5 hours
Machine hours required for one unit – Product 43 1.5 hours
Compute the contribution margin per unit of limited resource for each product. Which product
should Gladiator tells its sales personnel to ‘push’ to customers?

Solution Brief Exercise 117

Product 12: $22/2.5 hours = $8.80
Product 43: $15/1.5 hours = $10
Sales personnel should push product 43.

Brief Exercise 118

McIntosh Enterprises produces giant stuffed bears. Each bear consists of $12 of variable costs
and $9 of fixed costs and sells for $45. A wholesaler offers to buy 8,000 units at $14 each, of
which McIntosh has the capacity to produce. McIntosh will incur extra shipping costs of $1.25 per
bear. Determine the incremental income or loss that would result if the special order was
accepted. Determine the incremental income or loss that McIntosh Enterprises would realize by
accepting the special order.

Solution Brief Exercise 118

Incremental revenue (8,000 x $14) $112,000
Incremental variable costs ($12 x 8,000) (96,000)
Incremental shipping costs ($1.25 x 8,000) (10,000)
Incremental profit if special order accepted $6,000

Brief Exercise 119

Chuckie’s Chunks produces fudge candy. It costs $.0.20 to make each box in which the fudge is
packaged. Of this cost, $0.12 is variable and $0.08 is fixed. A supplier offers to make the boxes
for the fudge for $0.15 each. If the offer is accepted, Chuckie’s will save all variable costs but no
fixed costs. Chuckie’s uses 2,000 boxes per year. Prepare an incremental analysis showing the
total effect on costs if the boxes are bought instead of manufactured.

Solution Brief Exercise 119

Incremental cost to buy (2,000 x $0.15) ($300)
Incremental variable costs (2,000 x $0.12) 240
Incremental cost of buying ($ 60)
 Incremental Analysis 6-25

Brief Exercise 120

Harmark has three product lines in its retail stores: kites, wind socks, and flags. Results of the
fourth quarter are presented below:

Kites Wind Socks Flags Total

Units sold 1,000 2,000 2,000 5,000
Revenue $22,000 $40,000 $23,000 $85,000
Variable departmental costs 15,000 22,000 12,000 49,000
Direct fixed costs 1,000 3,000 2,000 6,000
Allocated fixed costs 8,000 8,000 8,000 28,000
Net income (loss) ($2,000) $ 7,000 $ 1,000 $ 6,000
The allocated fixed costs are unavoidable. Demand of individual products are not affected by
changes in other product lines. What will happen to profits if Harmark discontinues the ‘Kites’
product line?

Solution Brief Exercise 120

Incremental revenue ($22,000)

Incremental costs:
Variable costs savings +15,000
Direct fixed costs savings +1,000
Drop in profits if discontinued ($6,000)

Brief Exercise 121

Wood Chuck Furniture currently manufactures rocking chairs as its main product. Each chair
uses one seat cushion and one back cushion with the following costs per set of cushions (one
seat and one back):
Direct materials $ 1.00
Direct labor 10.00
Variable overhead 5.00
Fixed overhead 8.00
Total $24.00
Sherpert Company has contacted Wood Chuck with an offer to sell it 5,000 of sets of cushions for
$18.00 each. If Wood Chuck makes the cushions, $5 of the fixed overhead per unit will be
allocated to other products. Should Wood Chuck make or buy the cushions?

Solution Exercise 121

Cost to make − costs to buy = incremental cost
($24 − $3) − $18 = $3 = incremental cost per set
Incremental cost to make = $3 x 5,000 units = $15,000
Wood Chuck should buy to save $3 per set.
6-26 Test Bank for Managerial Accounting, Third Edition

Brief Exercise 122

Cluck Farms, Inc. produces a crop of chickens at a total cost of $66,000. The production
generates 60,000 chickens which can be sold for $1 each to a slaughtering company, or the
chickens can be slaughtered in house and then sold for $2.25 each. It costs $55,000 more to turn
the annual chicken crop into chicken meat. If Cluck Farms slaughters the chickens, how much is
incremental profit or loss? What should Cluck Farms do?

Solution Brief Exercise 122

Incremental revenues: ($2.25 - $1.00) x 60,000 chickens = $75,000

Incremental costs: given as $55,000
Incremental profits: $75,000 - $55,000 = $20,000 profit

Cluck Farms should slaughter.

Brief Exercise 123

Dolls R Us sells three products in its retail stores: baby dolls, teenage dolls, and plush dolls.
Results of the 4th quarter are below:
Baby Dolls Teenage Plush Total
Units sold 1,000 2,000 2,000 5,000
Revenue $31,000 $43,000 $26,000 $100,000
Variable departmental costs 22,000 24,000 13,000 59,000
Direct fixed costs 5,000 4,000 3,000 12,000
Allocated fixed costs 6,000 7,000 7,000 20,000
Net income ($2,000) $ 8,000 $ 3,000 $ 9,000
Demand of individual products are not affected by changes in other product lines. Prepare an
incremental analysis to determine if baby dolls should be discontinued.

Brief Exercise 123

Incremental revenue ($31,000)
Incremental costs:
Variable costs savings +22,000
Direct fixed costs savings +5,000
Drop in profits if discontinued ($4,000)
 Incremental Analysis 6-27

EXERCISES
Exercise 124
Anheiser has three divisions: Bud, Wise, and Er. The results of May, 2006 are presented below:

Bud Wise Er Total

Units sold 3,000 5,000 2,000 10,000
Revenue $70,000 $50,000 $40,000 $160,000
Less variable costs 32,000 26,000 16,000 74,000
Less direct fixed costs 14,000 19,000 12,000 45,000
Less allocated fixed costs 6,000 10,000 4,000 20,000
Net income $18,000 ($5,000) $ 8,000 $21,000
All of the allocated costs will continue even if a division is discontinued. Anheiser allocates
indirect fixed costs based on the number of units to be sold. Since the Wise division has a net
loss, Anheiser feels that it should be discontinued. Anheiser feels if the division is closed, that
sales at the Bud division will increase by 20%, and that sales at the Er division will stay the
same.

Instructions
A. Prepare an analysis showing the effect of discontinuing the Wise division.
B. Should Anheiser close the Wise division? Briefly indicate why or why not.

Solution Exercise 124 (10–12 min.)

A. Bud Er Total
Revenue $84,000 $40,000 $124,000
Less variable costs 38,400 16,000 54,400
Less direct fixed costs 14,000 12,000 26,000
Less allocated fixed costs 12,857 7,143 20,000
Net income $18,743 $ 4,857 $23,600

Calculations:
Revenue = $70,000 x 120% = $84,000
Variable costs = $32,000 x 120% = $38,400
Allocation of total allocated fixed costs of $20,000:
To Bud: 3,600/(3,600 + 2,000) x $20,000 = $12,857
To Er: 2,000/(3,600 + 2,000) x $20,000 = $7,143
B. Yes. The profit increases by $2,600 ($23,600 - $21,000) when the division is eliminated.
Direct fixed costs and variable costs for the Wise division were relatively high compared to
those for the Bud and Er divisions. The increase in sales by 20% of the Bud division was
enough to offset the loss of the Wise division.
6-28 Test Bank for Managerial Accounting, Third Edition

Exercise 125
Beyonce Company sells two items, peanuts and soybeans. The company is considering dropping
soybeans. It is expected that sales of peanuts will increase by 40% as a result. Dropping
soybeans will allow the company to cancel its monthly rental of its bean shucker costing $100 a
month. The other existing equipment will be used for additional production of peanuts. One
employee earning $200 per month can be terminated if soybean production is dropped.
Beyonce’s other fixed costs are allocated and will continue regardless of the decision made. A
condensed, budgeted monthly income statement with both products is below:

Total Soybeans Peanuts

Sales $18,000 $8,000 $10,000
Food materials 4,500 2,000 2,500
Direct labor 3,200 1,200 2,000
Equipment rental 2,900 2,600 300
Other allocated overhead 3,100 2,100 1,000
Operating income $4,300 $ 100 $4,200

Instructions
Prepare an incremental analysis to determine the financial effect of dropping soybean production.

Solution Exercise 125 (10–12 min.)

Beyonce Company
Incremental Analysis
Incremental change in revenue:
Increase in peanut sales: $10,000 x 40% +$4,000
Decrease in soybean sales (8,000)
Incremental decrease in revenue ($4,000)

Incremental change in variable costs:

Food materials: Increase in peanut costs: $2,500 x 40% (1,000)
Decrease in soybean costs +2,000
Direct labor: Increase in peanut labor: $2,000 x 40% (800)
Decrease in soybean labor +200
Incremental decrease in variable costs +400
Equipment rental reduction - soybean shucker +100
Incremental decrease in profits if soybean production is dropped ($3,500)
 Incremental Analysis 6-29

Exercise 126
Turner, Inc. budgeted 10,000 widgets for production during 2006. Turner has capacity to produce
12,000 units. Fixed factory overhead is allocated using ABC. The following estimated costs were
provided:
Direct material ($7/unit) $ 70,000
Direct labor ($15/hr. x 2 hrs./unit) 300,000
Variable manufacturing overhead ($3/unit) 30,000
Fixed factory overhead costs ($4/unit) 40,000
Total $440,000

Cost per unit = $44.00

Instructions
Answer each of the following independent questions:
1. Turner received an order for 1,000 units from a new customer in a country in which Turner
has never done business. This customer has offered $41 per widget. Should Turner accept
the order?
2. Turner received an offer from another company to manufacture the same quality widgets for
$38. Should Turner let someone else manufacture all 10,000 widgets and focus only on
distribution?

Solution Exercise 126 (10–12 min.)

1. Yes, it can make $1,000.
Incremental revenue per widget $41
Incremental cost per widget:
$7 + ($15 x 2) + $3 = 40
Incremental profit per unit $ 1
Total incremental profit = $1 x 1,000 = $1,000

2. Yes, Turner will save $20,000 if they are bought instead of made.
Cost to buy per widget $38
Cost to make per widget:
$7 + ($15 x 2) + $3 = 40
Incremental savings per widget if purchased $2

Total incremental savings if purchased = $2 x 10,000 = $20,000

6-30 Test Bank for Managerial Accounting, Third Edition

Exercise 127
Paulsen Company produced and sold 8,000 units of product and is operating at 80% of plant
capacity. Unit information about its product is as follows:
Sales Price $35
Variable manufacturing cost $16
Fixed manufacturing cost ($48,000 ÷ 8,000) 6 22
Profit per unit $13
The company received a proposal from a foreign company to buy 1,000 units of Paulsen
Company's product for $20 per unit. This is a one-time only order and acceptance of this proposal
will not affect the company's regular sales. The president of Paulsen Company is reluctant to
accept the proposal because he is concerned that the company will lose money on the special
order. All fixed costs are allocated to individual products.

Instructions
Prepare a schedule reflecting an incremental analysis of this proposal. Indicate the effect the
acceptance of this order might have on the company's income.

Solution Exercise 127 (7–9 min.)

Paulsen Company
Incremental Analysis
Proposal to buy 1,000 units at $20
Net Income
Reject Order Accept Order Increase (Decrease)
Revenues (1,000 × $20) $ -0- $ 20,000 $20,000
Variable costs (1,000 × $16) -0- (16,000) (16,000)
Net Income $ 4,000
Paulsen Company would increase its income by $4,000 in accepting the special order.
 Incremental Analysis 6-31

Exercise 128
Smooth Brew manufactures cappuccino makers. For the first eight months of 2006, the company
reported the following operating results while operating at 80% of plant capacity:
Sales (120,000 units) $6,000,000
Cost of goods sold 3,600,000
Gross profit 2,400,000
Operating expenses 1,800,000
Net income $ 600,000
An analysis of costs and expenses reveals that variable cost of goods sold is $25 per unit and
variable operating expenses are $10 per unit.

In September, Smooth Brew received a special order for 5,000 machines at $40 each from a
major coffee shop franchise. Acceptance of the order would result in $2,000 of shipping costs but
no increase in fixed expenses.

Instructions
1. Prepare an incremental analysis for the special order.
2. Should Smooth Brew accept the special order? Justify your answer.

Solution Exercise 128 (10–12 min.)

1. Net Income
Reject Order Accept Order Increase (Decrease)
Revenues $ -0- $200,000 $200,000
Cost of Goods Sold -0- 125,000* (125,000)
Operating Expense -0- 52,000** (52,000)
Net Income $ -0- $ 23,000 $ 23,000

*Variable cost of goods sold = 5,000 × $25 = $125,000

**Variable operating expenses = 5,000 × $10 = $50,000 + $2,000 = $52,000

2. The incremental analysis shows that Smooth Brew should accept the special order because
incremental revenues exceed incremental costs. This recommendation assumes that
acceptance of the special order will not affect relations with existing customers.
6-32 Test Bank for Managerial Accounting, Third Edition

Exercise 129
Vincent Company supplies schools with floor mattresses to use in physical education classes.
Vincent has received a special order from a large school district to buy 500 mats at $40 each.
Acceptance of the special order will not affect fixed costs but will result in $800 of shipping costs.

For the first 6 months of 2006, the company reported the following operating results while
operating at 80% capacity:
Sales (25,000 units) $1,250,000
Cost of goods sold 980,000
Gross profit 270,000
Operating expenses 170,000
Net income $ 100,000

Cost of goods sold was 80% variable and 20% fixed; operating expenses were 70% variable and
30% fixed.

Instructions
1. Prepare an incremental analysis for the special order.
2. Should Vincent Company accept the special order? Justify your answer.

Solution Exercise 129 (10–12 min.)

1. Net Income
Reject Order Accept Order Increase (Decrease)
Revenues $ -0- $20,000 $20,000
Cost of Goods Sold -0- 15,680 (15,680)
Operating Expense -0- 3,180 (3,180)
Net Income $ -0- $ 1,140 $1,140

Variable cost of goods sold = $980,000 × 80% = $784,000

Variable cost of goods sold per unit = $784,000 ÷ 25,000 = $31.36
Variable cost of goods sold for the special order = 500 × $31.36 = $15,680

Variable operating expenses = $170,000 × 70% = $119,000

Variable operating expenses per unit = $119,000 ÷ 25,000 = $4.76
Variable operating expenses for the special order = 500 × $4.76 = $2,380 + $800 = $3,180

2. The incremental analysis shows Vincent Company should accept the special order because
incremental revenues exceed incremental costs.
 Incremental Analysis 6-33

Exercise 130
Johnson Motors manufactured 4,000 gears are used in its motors and incurred the following
costs:

Direct materials $40,000

Direct labor 16,000
Variable manufacturing overhead 20,000
Fixed manufacturing overhead 12,000
$88,000

A supplier has offered to sell the gears to Johnson for $20.00 each. The fixed manufacturing
overhead consists mainly of depreciation on the equipment used to manufacture the part and
would not be reduced if the gears were purchased from the outside firm. If the gears are
purchased from the supplier, Johnson has the opportunity to use the factory equipment to
produce another product which is estimated to have a contribution margin of $5,000.

Instructions
Prepare an incremental analysis report for Johnson Motors which can serve as informational
input into this make or buy decision.

Solution Exercise 130 (10–12 min.)

Make Buy Increase (Decrease)
Direct materials $ 40,000 $ -0- $ 40,000
Direct labor 16,000 -0- 16,000
Variable manufacturing overhead 20,000 -0- 20,000
Fixed manufacturing overhead 12,000 12,000 -0-
Purchase price (4,000 × $20.00) -0- 80,000 (80,000)
Total annual cost 88,000 92,000 (4,000)
Opportunity cost 5,000 -0- 5,000
Total cost $93,000 $92,000 $ 1,000

Income is expected to increase by $1,000 if the component part is purchased from the outside
supplier if the company also manufactured its new product.
6-34 Test Bank for Managerial Accounting, Third Edition

Exercise 131
Escher Skateboards has been manufacturing its own wheels for its skateboards. The company is
currently operating at 100% capacity, and variable manufacturing overhead is charged to
production at the rate of 30% of direct labor cost. The direct materials and direct labor cost per
unit to make the wheels are $1.50 and $1.80, respectively. Normal production is 200,000 wheels
per year.

A supplier offers to make the wheels at a price of $4 each. If the skateboard company accepts
this offer, all variable manufacturing costs will be eliminated, but the $42,000 of fixed
manufacturing overhead currently being charged to the skateboard wheels will have to be
absorbed by other products.

Instructions
1. Prepare the incremental analysis for the decision to make or buy the wheels.
2. Should Escher Skateboard buy the wheels from the outside supplier? Justify your answer.

Solution Exercise 131 (10–12 min.)

1. Net Income
Make Buy Increase (Decrease)
Direct Materials (200,000 × $1.50) $300,000 $ -0- $300,000
Direct Labor (200,000 × $1.80) 360,000 -0- 360,000
Variable Manufacturing Costs
($360,000 × 30%) 108,000 -0- 108,000
Purchase Price (200,000 × $4) -0- 800,000 (800,000)
Total annual cost $810,000 $842,000 ($ 32,000)

2. The wheels should continue to be manufactured by Escher Skateboard. As indicated, the

company's net income would decrease $32,000 by purchasing the wheels.
 Incremental Analysis 6-35

Exercise 132
Jackson Chemical Corporation produces a water-based pest control chemical which it sells to
pest-control companies to manufacturer as a pesticide. In 2006, the company incurred $140,000
of costs to produce 14,000 gallons of the chemical. The selling price of the chemical is $21.00 per
gallon. The costs per unit to manufacture a gallon of the chemical are presented below:
Direct materials $ 3.50
Direct labor 3.00
Variable manufacturing overhead 2.00
Fixed manufacturing overhead 1.50
Total manufacturing costs $10.00
The company is considering manufacturing the pesticide itself. If the company processes the
chemical further and manufactures the pesticide itself, the following additional costs per gallon
will be incurred: Direct materials $1.00, Direct labor $.25, Variable manufacturing overhead,
$1.00. No increase in fixed manufacturing overhead is expected. The company can sell the
pesticide at $25.00 per gallon.

Instructions
Determine the incremental per gallon increase in net income and the total increase in net income
if the company manufactures the paint.

Solution Exercise 132 (10–12 min.)

Net Income
Sell Chemical Process Further Increase (Decrease)
Sales price per unit $21.00 $25.00 $4.00
Cost per unit:
Direct materials (A) 3.50 4.50 (1.00)
Direct labor (B) 3.00 3.25 (.25)
Variable manufacturing overhead (C) 2.00 3.00 (1.00)
Fixed manufacturing overhead 1.50 1.50 —
Total 10.00 12.25 (2.25)
Net income per unit $11.00 $12.75 $ 1.75
(A) $3.50 + $1.00
(B) $3.00 + $0.25
(C) $2.00 + $1.00

Assuming the company sells all 14,000 gallons that it produces, the incremental net income
would be $24,500 (14,000 gallons × $1.75).
6-36 Test Bank for Managerial Accounting, Third Edition

Exercise 133
Evett Corporation uses a machine that winds twine onto spools. The machine is unreliable and
results in a significant amount of downtime and excessive labor costs. The management is
considering replacing the machine with a more efficient one which will minimize downtime and
excessive labor costs. Data are presented below for the two machines:
Old Machine New Machine
Original purchase cost $160,000 $240,000
Accumulated depreciation 120,000 —
Estimated life 4 years 4 years
It is estimated that the new machine will produce annual cost savings of $55,000. The old
machine can be sold to a scrap dealer for $24,000. Both machines will have a salvage value of
zero if operated for the remainder of their useful lives.

Instructions
Determine whether the company should purchase the new machine.

Solution Exercise 133 (7–8 min.)

Retain Replace Net Income
Equipment Equipment Increase/(Decrease)
Cost savings $ -0- $220,000 (A) $220,000
New machine cost -0- (240,000) (240,000)
Proceeds from sale of old machine $ -0- 24,000 24,000
Net incremental net income $ -0- $ 4,000 $ 4,000
(A) $55,000 × 4 = $220,000
The company should purchase the new machine because there will be an increase in net income
of $4,000 over the 4 year life of the new machine.
 Incremental Analysis 6-37

Exercise 134
Cheatem and Howe, Attorneys, rely heavily on a color laser printer to process the paperwork.
Recently the printer has not functioned well and print jobs were not being processed.
Management is considering updating the printer with a faster model.
Current Printer New Model
Original purchase cost $30,000 $24,000
Accumulated depreciation 17,000 —
Estimated operating costs (annual) 3,000 2,000
Useful life 4 years 4 years
If sold now, the current printer would have a salvage value of $4,000. If operated for the
remainder of its useful life, the current printer would have zero salvage value. The new printer is
expected to have zero salvage value after four years.
Instructions
Prepare an analysis to show whether the company should retain or replace the printer.

Solution Exercise 134 (7–9 min.)

Net Income
Retain Machine Replace Machine Increase (Decrease)
Operating costs $12,000 $ 8,000 $4,000
New machine cost -0- 24,000 (24,000)
Salvage value -0- (4,000) 4,000
Totals $12,000 $28,000 ($16,000)
The current printer should not be replaced. The incremental analysis shows that net income for
the four-year period will be $16,000 higher by replacing.
6-38 Test Bank for Managerial Accounting, Third Edition

Exercise 135
Herman Corporation operates two divisions, the A Division and the B Division. Both divisions
manufacture and sell logs to paper manufacturers. The company is considering disposing of the
B Division since it has been consistently unprofitable for a number of years. The income
statements for the two divisions for the year ended December 31, 2006 are presented below:
A Division B Division Total
Sales $400,000 $300,000 $700,000
Cost of goods sold 150,000 200,000 350,000
Gross profit 250,000 100,000 350,000
Selling & administrative expenses 200,000 120,000 320,000
Net income $ 50,000 $(20,000) $ 30,000

In the B Division, 80% of cost of goods sold is variable costs and 20% of selling and
administrative expenses are variable costs. The management of the company feels it can save
$30,000 of fixed cost of goods sold and $30,000 of fixed selling expenses if it discontinues
operation of the B Division.

Instructions
1. Determine whether the company should discontinue operating the B Division.
2. If the company had discontinued the division for 2006, determine what net income or would
have been reported.

Solution Exercise 135 (10–12 min.)

1. Net Income
Continue Eliminate Increase (Decrease)
Sales $300,000 $ -0- $(300,000)
Variable expenses:
Cost of goods sold 160,000 (A) -0- 160,000
Selling and admin. exp. 24,000 (B) -0- 24,000
Contribution margin 116,000 -0- (116,000)
Fixed expenses:
Cost of goods sold 40,000 (C) 10,000 30,000
Selling and admin. exp. 96,000 (D) 66,000 30,000
Net income $ (20,000) $(76,000) $ (56,000)

(A) $200,000 × 80% = $160,000 (C) $200,000 – $160,000 = $40,000

(B) $120,000 × 20% = $24,000 (D) $120,000 – $24,000 = $96,000

The company should continue the B Division because its contribution margin, $116,000, is
greater than the avoidable fixed costs, $60,000.

2. A Division + Decrease in Net Income

$50,000 + $(56,000) = ($6,000)
 Incremental Analysis 6-39

Exercise 136
A recent accounting graduate from Duke University evaluated the operating performance of Fane
Company's three divisions. The following presentation was made to Fane’s Board of Directors.
During the presentation, the accountant made the recommendation to eliminate the Southern
Division stating that total net income would increase by $20,000, as shown in the analysis below.
Other Two Divisions Southern Division Total
Sales $1,000,000 $300,000 $1,300,000
Cost of Goods Sold 650,000 200,000 850,000
Gross Profit 350,000 100,000 450,000
Operating Expenses 100,000 120,000 220,000
Net Income $ 250,000 $ (20,000) $ 230,000

Cost of goods sold is 80% variable and operating expenses are 70% variable. If the division is
eliminated, 40% of the fixed costs will be eliminated.

Instructions
Do you concur with the new accountant's recommendation? Present a schedule to support your
answer.

Solution Exercise 136 (12–14 min.)

Net Income
Continue Eliminate Increase (Decrease)
Sales $300,000 $ -0- $(300,000)
Variable Expenses
Cost of goods sold 160,000 -0- 160,000
Operating expenses 84,000 -0- 84,000
Total Variable 244,000 -0- 244,000
Contribution Margin 56,000 -0- (56,000)
Fixed Expenses
Cost of goods sold 40,000 24,000 16,000
Operating expenses 36,000 21,600 14,400
Net Income (Loss) $(20,000) $(45,600) $(25,600)

The accountant is not correct. If the Southern Division is eliminated, the net income will be
$25,600 less, not $20,000 greater.
6-40 Test Bank for Managerial Accounting, Third Edition

Exercise 137
Movie House has 4,000 machine hours available to use to produce either Product 22 or Product
44. The cost accounting department developed the following unit information for each of the
products:
Product 22 Product 44
Sales price $20.00 $40.00
Direct materials 5.00 8.00
Direct labor 3.00 2.00
Variable manufacturing overhead 4.50 5.00
Fixed manufacturing overhead 3.00 5.00
Machine time required 15 minutes 75 minutes

Instructions
Management wants to know which product to produce in order to maximize the company's
income. Taking into consideration the constraint under which the company operates, prepare a
report to show which product should be produced and sold.

Solution Exercise 137 (10–12 min.)

Contribution Margin per Unit Limited Resource
Contribution margin per unit: Product 22 Product 44
Sales price $20.00 $40.00
Variable costs
Direct material $5.00 $8.00
Direct labor 3.00 2.00
Variable overhead 4.50 12.50 5.00 15.00
Contribution margin $ 7.50 $25.00

Machine hours required: 1/4 hr 1 1/4 hrs

Contribution margin per unit of limited resource

($7.50 ÷ .25) $ 30.00
($25 ÷ 1.25) $ 20.00
Machine hours available 4,000 4,000
Contribution margin $120,000 $80,000

The company should produce and sell Product 22.

 Incremental Analysis 6-41

Exercise 138
PHR Company manufactures and sells two products. Relevant per unit data concerning each
product are given below:
Product
Standard Deluxe
Selling price $50 $75
Variable costs $30 $30
Machine hours 1.6 3

Instructions
1. Compute the contribution margin per unit of the limited resource for each product.
2. If 1,200 additional machine hours are available, which product should be manufactured?

Solution Exercise 138 (6–8 min.)

1. Product
Standard Deluxe
Contribution margin per unit $20 $45
Machine hours required 1.6 3
Contribution margin per unit of limited resource $12.50 $15.00

2. The Deluxe product should be manufactured because it results in the highest contribution
margin per machine hour: $15.00 x 1,200 = $18,000
6-42 Test Bank for Managerial Accounting, Third Edition

COMPLETION STATEMENTS

139. The process used to identify the financial data that change under alternative courses of
action is called __________________ analysis.
140. In a decision on whether an order should be accepted at a special price when there is
plant capacity available, a major consideration is whether the special price exceeds
__________________.
141. The potential benefit that may be obtained by following an alternative course of action is
called an _________________ cost.
142. A decision whether to sell a product now or to process it further, depends on whether the
incremental _____________ from processing further are greater than the incremental
processing ______________.
143. The ______________ value of old equipment is irrelevant in a decision to replace that
equipment and is often referred to as a _____________ cost.
144. In an environment where there are limited resources, the products with the highest
contribution per unit of ______________ should identify the products to be produced.
145. An important purpose of management accounting is to provide _____________________
for decision making.

Answers to Completion Statements

139. incremental (differential)

140. variable costs (incremental costs)
141. opportunity
142. revenues, costs
143. book, sunk
144. limited resource
145. relevant information

MATCHING
146. Match the items below by entering the appropriate code letter in the space provided.
A. Incremental analysis
B. Opportunity cost
C. Sunk cost

____ 1. A cost that cannot be changed by any present or future decision.

____ 2. The process of identifying the financial data that change under alternative courses of
action.

____ 3. The potential benefit that may be lost from following an alternative course of action.

Answers to Matching

1. C 2. A 3. B
 Incremental Analysis 6-43

SHORT-ANSWER ESSAY QUESTIONS

Short Answer Essay 147
Management is often faced with the alternative of continuing to make a product or component
internally, or going to an external source and purchasing the product or component. In gathering
relevant information for these two alternatives, briefly identify the quantitative factors that should
be considered. Are there any qualitative factors that should also be considered?

Solution Short Answer Essay 147

The quantitative factors to be considered in a make or buy decision include the incremental costs
to make the product, the incremental costs of buying the product, and the opportunity cost
(potential benefit foregone) if the product is made. Generally, all variable production costs are
relevant in a make or buy decision, but only some fixed costs, or no fixed costs, are relevant
because many fixed costs will be incurred regardless of whether the decision is to make or buy.
Qualitative factors include the possible adverse effect on employees and the stability of the
supplier's price and quality.

Short Answer Essay 148 (Communication)

You are the general accountant for Word Systems, Inc., a typing service based in Los Angeles,
California. The company has decided to upgrade its equipment. It currently has a widely used
version of a word processing program. The company wishes to invest in more up-to-date software
and to improve its printing capabilities.

Two options have emerged. Option D is for the company to keep its existing computer system,
and upgrade its word processing program. The memory of each individual work station would be
enhanced, and a larger, more efficient printer would be used. Better telecommunications
equipment would allow for the electronic transmission of some documents as well.

Option Z would be for the company to invest in an entirely different computer system. The
software for this system is extremely impressive, and it comes with individual laser printers.
However, the company is not well known, and the software does not connect well with well-known
software. The net present value information for these options follows:

Option Z Option D
Initial Investment $95,000 $270,000
Cost savings of labor over 4 years 89,000 284,000

Required:
Prepare a brief report for management in which you make a recommendation for one system or
the other, using the information given.

Solution Short Answer Essay 148

I recommend that the company accept Option D, to purchase upgrades to our present system
and to buy a more efficient printer. In the first place, the changes will be easier to implement
because the equipment is similar to that which we already use. Second, the costs savings exceed
those of Option Z.