Cost Accounting A Managerial Emphasis 14e Charles T. Horngren Solutions Manual Test Bank SM Ch11

Cost Accounting A Managerial Emphasis 14e Charles T. Horngren Solutions Manual Test Bank

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SM Ch11


11-1 Outline the five-step sequence in a decision process.

11-2 Define relevant costs. Why are historical costs irrelevant?

11-3 “All future costs are relevant.” Do you agree? Why?

11-4 Distinguish between quantitative and qualitative factors in decision making.

11-5 Describe two potential problems that should be avoided in relevant-cost analysis.

11-6 “Variable costs are always relevant, and fixed costs are always irrelevant.” Do you agree? Why?

11-7 “A component part should be purchased whenever the purchase price is less than its total manufacturing cost per unit.” Do you agree? Why?

11-8 Define opportunity cost.

11-9 “Managers should always buy inventory in quantities that result in the lowest purchase cost per  unit.” Do you agree? Why?

11-10 “Management should always maximize sales of the product with the highest contribution margin per unit.” Do you agree? Why?

11-11 “A branch office or business segment that shows negative operating income should be shut down.” Do you agree? Explain briefly.

11-12 “Cost written off as depreciation on equipment already purchased is always irrelevant.” Do you agree? Why?

11-13 “Managers will always choose the alternative that maximizes operating income or minimizes  costs in the decision model.” Do you agree? Why?

11-14 Describe the three steps in solving a linear programming problem.

11-15 How might the optimal solution of a linear programming problem be determined?

11-16 Disposal of assets. Answer the following questions.
1. A company has an inventory of 1,100 assorted parts for a line of missiles that has been discontinued. The inventory cost is $78,000. The parts can be either (a) remachined at total additional costs of $24,500 and then sold for $33,000 or (b) sold as scrap for $6,500. Which action is more profitable? Show your calculations.
2. A truck, costing $101,000 and uninsured, is wrecked its first day in use. It can be either (a) disposed of for $17,500 cash and replaced with a similar truck costing $103,500 or (b) rebuilt for $89,500, and thus be brand-new as far as operating characteristics and looks are concerned. Which action is less costly? Show your calculations.  

11-17 Relevant and irrelevant costs. Answer the following questions.
1. DeCesare Computers makes 5,200 units of a circuit board, CB76 at a cost of $280 each. Variable cost per unit is $190 and fixed cost per unit is $90. Peach Electronics offers to supply 5,200 units of CB76 for $260. If DeCesare buys from Peach it will be able to save $10 per unit in fixed costs but continue to incur the remaining $80 per unit. Should DeCesare accept Peach’s offer? Explain.
2. LN Manufacturing is deciding whether to keep or replace an old machine. It obtains the following information:  
Old Machine New Machine
Original cost  $10,700  $9,000 
Useful life  10 years  3 years 
Current age  7 years  0 years 
Remaining useful life  3 years  3 years 
Accumulated depreciation  $7,490  Not acquired yet 
Book value  $3,210  Not acquired yet 
Current disposal value (in cash)  $2,200  Not acquired yet 
Terminal disposal value (3 years from now)  $0  $0 
Annual cash operating costs  $17,500  $15,500 
LN Manufacturing uses straight-line depreciation. Ignore the time value of money and income taxes. Should LN Manufacturing replace the old machine? Explain.

11-18 Multiple choice. (CPA) Choose the best answer.
1.  The Woody Company manufactures slippers and sells them at $10 a pair. Variable manufacturing cost is $4.50 a pair, and allocated fixed manufacturing cost is $1.50 a pair. It has enough idle capacity avail-able to accept a one-time-only special order of 20,000 pairs of slippers at $6 a pair. Woody will not incur any marketing costs as a result of the special order. What would the effect on operating income be if the special order could be accepted without affecting normal sales: (a) $0, (b) $30,000 increase,  (c) $90,000 increase, or (d) $120,000 increase? Show your calculations.
2. The Reno Company manufactures Part No. 498 for use in its production line. The manufacturing cost  per unit for 20,000 units of Part No. 498 is as follows: 
Direct materials  $6 
Direct manufacturing labor  30 
Variable manufacturing overhead  12 
Fixed manufacturing overhead allocated  .16 
Total manufacturing cost per unit  $64 
The Tray Company has offered to sell 20,000 units of Part No. 498 to Reno for $60 per unit. Reno will make the decision to buy the part from Tray if there is an overall savings of at least $25,000 for Reno. If Reno accepts Tray’s offer, $9 per unit of the fixed overhead allocated would be eliminated. Furthermore, Reno has determined that the released facilities could be used to save relevant costs in the manufacture of Part No. 575. For Reno to achieve an overall savings of $25,000, the amount of relevant costs that would have to be saved by using the released facilities in the manufacture of Part No. 575 would be which of the following: (a) $80,000, (b) $85,000, (c) $125,000, or (d) $140,000? Show your calculations.

11-19 Special order, activity-based costing. (CMA, adapted) The Award Plus Company manufactures medals for winners of athletic events and other contests. Its manufacturing plant has the capacity to pro-duce 10,000 medals each month. Current production and sales are 7,500 medals per month. The company normally charges $150 per medal. Cost information for the current activity level is as follows:
Variable costs that vary with number of units produced
Direct materials  $ 262,500
Direct manufacturing labor 300,000 Variable costs (for setups, materials handling, quality control, and so on) 75,000 that vary with number of batches, 150 batches * $500 per batch Fixed manufacturing costs 275,000 Fixed marketing costs ...175,000 Total costs $1,087,500
Award Plus has just received a special one-time-only order for 2,500 medals at $100 per medal. Accepting the special order would not affect the company’s regular business. Award Plus makes medals for its exist-ing customers in batch sizes of 50 medals (150 batches * 50 medals per batch = 7,500 medals). The special order requires Award Plus to make the medals in 25 batches of 100 each.
1. Should Award Plus accept this special order? Show your calculations.
2. Suppose plant capacity were only 9,000 medals instead of 10,000 medals each month. The special order must either be taken in full or be rejected completely. Should Award Plus accept the special order? Show your calculations.
3. As in requirement 1, assume that monthly capacity is 10,000 medals. Award Plus is concerned that if it accepts the special order, its existing customers will immediately demand a price discount of $10 in the month in which the special order is being filled. They would argue that Award Plus’s capacity costs are now being spread over more units and that existing customers should get the benefit of these lower costs. Should Award Plus accept the special order under these conditions? Show your calculations.  

11-20 Make versus buy, activity-based costing. The Svenson Corporation manufactures cellular modems. It manufactures its own cellular modem circuit boards (CMCB), an important part of the cellular modem. It reports the following cost information about the costs of making CMCBs in 2011 and the expected costs in 2012:
Current Costs  Expected   in 2011  Costs in 2012 
Variable manufacturing costs 
Direct material cost per CMCB  $ 180  $ 170 
Direct manufacturing labor cost per CMCB  50  45 
Variable manufacturing cost per batch for setups, materials   handling, and quality control  1,600  1,500 
Fixed manufacturing cost 
Fixed manufacturing overhead costs that can be avoided if 
CMCBs are not made  320,000  320,000 
Fixed manufacturing overhead costs of plant depreciation,   insurance, and administration that cannot be avoided even if 
CMCBs are not made  800,000  800,000 
Svenson manufactured 8,000 CMCBs in 2011 in 40 batches of 200 each. In 2012, Svenson anticipates need-ing 10,000 CMCBs. The CMCBs would be produced in 80 batches of 125 each.
The Minton Corporation has approached Svenson about supplying CMCBs to Svenson in 2012 at $300 per CMCB on whatever delivery schedule Svenson wants.
1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2012.
2. Suppose the capacity currently used to make CMCBs will become idle if Svenson purchases CMCBs from Minton. On the basis of financial considerations alone, should Svenson make CMCBs or buy them from Minton? Show your calculations.
3. Now suppose that if Svenson purchases CMCBs from Minton, its best alternative use of the capacity currently used for CMCBs is to make and sell special circuit boards (CB3s) to the Essex Corporation. Svenson estimates the following incremental revenues and costs from CB3s:  
Total expected incremental future revenues $2,000,000 Total expected incremental future costs $2,150,000
On the basis of financial considerations alone, should Svenson make CMCBs or buy them from Minton? Show your calculations.

11-21 Inventory decision, opportunity costs. Lawn World, a manufacturer of lawn mowers, predicts that it will purchase 264,000 spark plugs next year. Lawn World estimates that 22,000 spark plugs will be required each month. A supplier quotes a price of $7 per spark plug. The supplier also offers a special discount option: If all 264,000 spark plugs are purchased at the start of the year, a discount of 2% off the $7 price will be given. Lawn World can invest its cash at 10% per year. It costs Lawn World $260 to place each purchase order.
1. What is the opportunity cost of interest forgone from purchasing all 264,000 units at the start of the year instead of in 12 monthly purchases of 22,000 units per order?
2. Would this opportunity cost be recorded in the accounting system? Why?
3. Should Lawn World purchase 264,000 units at the start of the year or 22,000 units each month? Show your calculations.  

11-22 Relevant costs, contribution margin, product emphasis. The Seashore Stand is a take-out food store at a popular beach resort. Susan Sexton, owner of the Seashore Stand, is deciding how much refrig-erator space to devote to four different drinks. Pertinent data on these four drinks are as follows:
Cola Lemonade Punch Natural Orange Juice  
Selling price per case  $18.75  $20.50  $27.75  $39.30 
Variable cost per case  $13.75  $15.60  $20.70  $30.40 
Cases sold per foot of shelf space per day  22  12  6  13 
Sexton has a maximum front shelf space of 12 feet to devote to the four drinks. She wants a minimum of 1 foot and a maximum of 6 feet of front shelf space for each drink.
1. Calculate the contribution margin per case of each type of drink.
2. A coworker of Sexton’s recommends that she maximize the shelf space devoted to those drinks with the highest contribution margin per case. Evaluate this recommendation.
3. What shelf-space allocation for the four drinks would you recommend for the Seashore Stand? Show your calculations.   

11-23 Selection of most profitable product. Body-Builders, Inc., produces two basic types of weight-lifting equipment, Model 9 and Model 14. Pertinent data are as follows:
A  B  C 
1  Per Unit 
2  Model 9  Model 14 
3  ng priceillSe  $100.00  $70.00 
4  Costs 
5  lairect materiD 28.00  13.00 
6  Direct manufacturing labor  15.00  25.00
7  Variable manufacturing overhead*  25.00  12.50
8  Fixed manufacturing overhead*  10.00  5.00
9  Marketing (all variable)  14.00  10.00 
10  costlTota  92.00  65.50 
11  ncomeiOperating 8.00$  4.50$ 
13  *Allocated on the basis of machine-hours 
The weight-lifting craze is such that enough of either Model 9 or Model 14 can be sold to keep the plant operating at full capacity. Both products are processed through the same production departments. Which products should be produced? Briefly explain your answer.

11-24 Which center to close, relevant-cost analysis, opportunity costs. Fair Lakes Hospital Corporation has been operating ambulatory surgery centers in Groveton and Stockdale, two small communities each about an hour away from its main hospital. As a cost control measure the hospital has decided that it needs only one of those two centers permanently, so one must be shut down. The decision regarding which center to close will be made on financial considerations alone. The following informa-tion is available:
a. The Groveton center was built 15 years ago at a cost of $5 million on land leased from the City of Groveton at a cost of $40,000 per year. The land and buildings will immediately revert back to the city if the center is closed. The center has annual operating costs of $2.5 million, all of which will be saved if the center is closed. In addition, Fair Lakes allocates $800,000 of common administrative costs to the Groveton center. If the center is closed, these costs would be reallocated to other ambulatory cen-ters. If the center is kept open, Fair Lakes plans to invest $1 million in a fixed income note, which will earn the $40,000 that Fair Lakes needs for the lease payments.
b. The Stockdale center was built 20 years ago at a cost of $4.8 million, of which Fair Lakes and the City of Stockdale each paid half, on land donated by a hospital benefactor. Two years ago, Fair Lakes spent $2 million to renovate the facility. If the center is closed, the property will be sold to developers for $7 million. The operating costs of the center are $3 million per year, all of which will be saved if the center is closed. Fair Lakes allocates $1 million of common administrative costs to the Stockdale cen-ter. If the center is closed, these costs would be reallocated to other ambulatory centers.
c. Fair Lakes estimates that the operating costs of whichever center remains open will be $3.5 million per year.  
The City Council of Stockdale has petitioned Fair Lakes to close the Groveton facility, thus sparing the Stockdale center. The Council argues that otherwise the $2 million spent on recent renovations would be wasted. Do you agree with the Stockdale City Council’s arguments and conclusions? In your answer, identify and explain all costs that you consider relevant and all costs that you consider irrele-vant for the center-closing decision.

11-25 Closing and opening stores. Sanchez Corporation runs two convenience stores, one in Connecticut and one in Rhode Island. Operating income for each store in 2012 is as follows:
Connecticut Store Rhode Island Store
Revenues  $1,070,000  $860,000 
Operating costs 
Cost of goods sold  750,000  660,000 
Lease rent (renewable each year)  90,000  75,000 
Labor costs (paid on an hourly basis)  42,000  42,000 
Depreciation of equipment  25,000  22,000 
Utilities (electricity, heating)  43,000  46,000 
Allocated corporate overhead  ....50,000  ..40,000 
Total operating costs  .1,000,000  .885,000 
Operating income (loss)  $...70,000  $.(25,000) 
The equipment has a zero disposal value. In a senior management meeting, Maria Lopez, the management accountant at Sanchez Corporation, makes the following comment, “Sanchez can increase its profitability by closing down the Rhode Island store or by adding another store like it.”
1. By closing down the Rhode Island store, Sanchez can reduce overall corporate overhead costs by $44,000. Calculate Sanchez’s operating income if it closes the Rhode Island store. Is Maria Lopez’s statement about the effect of closing the Rhode Island store correct? Explain.
2. Calculate Sanchez’s operating income if it keeps the Rhode Island store open and opens another store with revenues and costs identical to the Rhode Island store (including a cost of $22,000 to acquire equipment with a one-year useful life and zero disposal value). Opening this store will increase corpo-rate overhead costs by $4,000. Is Maria Lopez’s statement about the effect of adding another store like the Rhode Island store correct? Explain.  

11-26 Choosing customers. Broadway Printers operates a printing press with a monthly capacity of 2,000 machine-hours. Broadway has two main customers: Taylor Corporation and Kelly Corporation. Data on each customer for January follows:
Taylor Corporation Kelly Corporation Total
Revenues $120,000 $80,000 $200,000 
Variable costs ..42,000 .48,000 ..90,000 
Contribution margin 78,000 32,000 110,000 
Fixed costs (allocated) ..60,000 .40,000 .100,000 
Operating income $.18,000 $.(8,000) $.10,000 
Machine-hours required 1,500 hours 500 hours 2,000 hours 
Kelly Corporation indicates that it wants Broadway to do an additional $80,000 worth of printing jobs during 
February. These jobs are identical to the existing business Broadway did for Kelly in January in terms of   variable costs and machine-hours required. Broadway anticipates that the business from Taylor 
Corporation in February will be the same as that in January. Broadway can choose to accept as much of the 
Taylor and Kelly business for February as its capacity allows. Assume that total machine-hours and fixed   costs for February will be the same as in January. 
What action should Broadway take to maximize its operating income? Show your calculations.   

11-27 Relevance of equipment costs. The Auto Wash Company has just today paid for and installed a   special machine for polishing cars at one of its several outlets. It is the first day of the company’s fiscal year. 
The machine costs $20,000. Its annual cash operating costs total $15,000. The machine will have a four-year   useful life and a zero terminal disposal value. 
After the machine has been used for only one day, a salesperson offers a different machine that prom-  ises to do the same job at annual cash operating costs of $9,000. The new machine will cost $24,000 cash,   installed. The “old” machine is unique and can be sold outright for only $10,000, minus $2,000 removal cost. 
The new machine, like the old one, will have a four-year useful life and zero terminal disposal value. 
Revenues, all in cash, will be $150,000 annually, and other cash costs will be $110,000 annually, regard-  less of this decision. 
For simplicity, ignore income taxes and the time value of money. 
1. a. Prepare a statement of cash receipts and disbursements for each of the four years under each alter-    native. What is the cumulative difference in cash flow for the four years taken together?    
b. Prepare income statements for each of the four years under each alternative. Assume straight-line depreciation. What is the cumulative difference in operating income for the four years taken together?
c. What are the irrelevant items in your presentations in requirements a and b? Why are they irrelevant?  
2. Suppose the cost of the “old” machine was $1 million rather than $20,000. Nevertheless, the old machine can be sold outright for only $10,000, minus $2,000 removal cost. Would the net differences in requirements 1a and 1b change? Explain.
3. Is there any conflict between the decision model and the incentives of the manager who has just pur-chased the “old” machine and is considering replacing it a day later?  

11-28 Equipment upgrade versus replacement. (A. Spero, adapted) The TechGuide Company pro-duces and sells 7,500 modular computer desks per year at a selling price of $750 each. Its current produc-tion equipment, purchased for $1,800,000 and with a five-year useful life, is only two years old. It has a terminal disposal value of $0 and is depreciated on a straight-line basis. The equipment has a current dis-posal price of $450,000. However, the emergence of a new molding technology has led TechGuide to con-sider either upgrading or replacing the production equipment. The following table presents data for the two alternatives:
A  B  C 
1  Upgrade  Replace 
2  One-time equipment costs  $3,000,000  $4,800,000 
3  Variable manufacturing cost per desk  150$  75$ 
4  Remaining useful life of equipment (years)  3  3 
5  Terminal disposal value of equipment  0$  0$   
All equipment costs will continue to be depreciated on a straight-line basis. For simplicity, ignore income taxes and the time value of money.
1. Should TechGuide upgrade its production line or replace it? Show your calculations.
2. Now suppose the one-time equipment cost to replace the production equipment is somewhat nego-tiable. All other data are as given previously. What is the maximum one-time equipment cost that TechGuide would be willing to pay to replace the old equipment rather than upgrade it?
3. Assume that the capital expenditures to replace and upgrade the production equipment are as given in the original exercise, but that the production and sales quantity is not known. For what production and sales quantity would TechGuide (i) upgrade the equipment or (ii) replace the equipment?
4. Assume that all data are as given in the original exercise. Dan Doria is TechGuide’s manager, and his bonus is based on operating income. Because he is likely to relocate after about a year, his current bonus is his primary concern. Which alternative would Doria choose? Explain.     

11-29 Special Order. Louisville Corporation produces baseball bats for kids that it sells for $32 each. At capacity, the company can produce 50,000 bats a year. The costs of producing and selling 50,000 bats are as follows:
Cost per Bat Total Costs
Direct materials  $12  $ 600,000 
Direct manufacturing labor  3  150,000 
Variable manufacturing overhead  1  50,000 
Fixed manufacturing overhead  5  250,000 
Variable selling expenses  2  100,000 
Fixed selling expenses  ..4  ...200,000 
Total costs  $27  $1,350,000 
Required 1.  Suppose Louisville is currently producing and selling 40,000 bats. At this level of production and sales, its fixed costs are the same as given in the preceding table. Ripkin Corporation wants to place a one-time special order for 10,000 bats at $25 each. Louisville will incur no variable selling costs for this spe-cial order. Should Louisville accept this one-time special order? Show your calculations.
2. Now suppose Louisville is currently producing and selling 50,000 bats. If Louisville accepts Ripkin’s offer it will have to sell 10,000 fewer bats to its regular customers. (a) On financial considerations alone, should Louisville accept this one-time special order? Show your calculations. (b) On financial consid-erations alone, at what price would Louisville be indifferent between accepting the special order and continuing to sell to its regular customers at $32 per bat. (c) What other factors should Louisville con-sider in deciding whether to accept the one-time special order?

11-30 International outsourcing. Bernie’s Bears, Inc., manufactures plush toys in a facility in Cleveland, Ohio. Recently, the company designed a group of collectible resin figurines to go with the plush toy line. Management is trying to decide whether to manufacture the figurines themselves in existing space in the Cleveland facility or to accept an offer from a manufacturing company in Indonesia. Data concerning the decision follows:
Expected annual sales of figurines (in units)  400,000 
Average selling price of a figurine  $5 
Price quoted by Indonesian company, in Indonesian Rupiah (IDR), for each figurine  27,300 IDR 
Current exchange rate  9,100 IDR = $1 
Variable manufacturing costs  $2.85 per unit 
Incremental annual fixed manufacturing costs associated with the new product line  $200,000 
Variable selling and distribution costsa  $0.50 per unit 
Annual fixed selling and distribution costsa  $285,000    aSelling and distribution costs are the same regardless of whether the figurines are manufactured in Cleveland or imported.
1. Should Bernie’s Bears manufacture the 400,000 figurines in the Cleveland facility or purchase them from the Indonesian supplier? Explain.
2. Bernie’s Bears believes that the US dollar may weaken in the coming months against the Indonesian Rupiah and does not want to face any currency risk. Assume that Bernie’s Bears can enter into a for-ward contract today to purchase 27,300 IDRs for $3.40. Should Bernie’s Bears manufacture the 400,000 figurines in the Cleveland facility or purchase them from the Indonesian supplier? Explain.
3. What are some of the qualitative factors that Bernie’s Bears should consider when deciding whether to outsource the figurine manufacturing to Indonesia?  

11-31 Relevant costs, opportunity costs. Larry Miller, the general manager of Basil Software, must decide when to release the new version of Basil’s spreadsheet package, Easyspread 2.0. Development of Easyspread 2.0 is complete; however, the diskettes, compact discs, and user manuals have not yet been produced. The product can be shipped starting July 1, 2011.
The major problem is that Basil has overstocked the previous version of its spreadsheet package, Easyspread 1.0. Miller knows that once Easyspread 2.0 is introduced, Basil will not be able to sell any more units of Easyspread 1.0. Rather than just throwing away the inventory of Easyspread 1.0, Miller is wondering if it might be better to continue to sell Easyspread 1.0 for the next three months and introduce Easyspread 2.0 on October 1, 2011, when the inventory of Easyspread 1.0 will be sold out.
The following information is available:
Easyspread 1.0 Easyspread 2.0
Selling price $160 $195
Variable cost per unit of diskettes, compact discs, user manuals 25 30
Development cost per unit 70 100
Marketing and administrative cost per unit ..35 ..40
Total cost per unit .130 .170
Operating income per unit $.30 $.25
Development cost per unit for each product equals the total costs of developing the software product divided by the anticipated unit sales over the life of the product. Marketing and administrative costs are fixed costs in 2011, incurred to support all marketing and administrative activities of Basil Software. Marketing and administrative costs are allocated to products on the basis of the budgeted revenues of each product. The preceding unit costs assume Easyspread 2.0 will be introduced on October 1, 2011.
1. On the basis of financial considerations alone, should Miller introduce Easyspread 2.0 on July 1, 2011, or wait  until October 1, 2011? Show your calculations, clearly identifying relevant and irrelevant revenues and costs.  
2. What other factors might Larry Miller consider in making a decision?   

11-32 Opportunity costs. (H. Schaefer) The Wild Boar Corporation is working at full production capacity producing 13,000 units of a unique product, Rosebo. Manufacturing cost per unit for Rosebo is as follows:
Direct materials $5 Direct manufacturing labor 1 Manufacturing overhead ..7 Total manufacturing cost $13
Manufacturing overhead cost per unit is based on variable cost per unit of $4 and fixed costs of $39,000 (at full capacity of 13,000 units). Marketing cost per unit, all variable, is $2, and the selling price is $26.
A customer, the Miami Company, has asked Wild Boar to produce 3,500 units of Orangebo, a modifica- tion of Rosebo. Orangebo would require the same manufacturing processes as Rosebo. Miami has offered  to pay Wild Boar $20 for a unit of Orangebo and share half of the marketing cost per unit.
1. What is the opportunity cost to Wild Boar of producing the 3,500 units of Orangebo? (Assume that no overtime is worked.)
2. The Buckeye Corporation has offered to produce 3,500 units of Rosebo for Wolverine so that Wild Boar may accept the Miami offer. That is, if Wild Boar accepts the Buckeye offer, Wild Boar would manufac-ture 9,500 units of Rosebo and 3,500 units of Orangebo and purchase 3,500 units of Rosebo from Buckeye. Buckeye would charge Wild Boar $18 per unit to manufacture Rosebo. On the basis of finan-cial considerations alone, should Wild Boar accept the Buckeye offer? Show your calculations.
3. Suppose Wild Boar had been working at less than full capacity, producing 9,500 units of Rosebo at the time the Miami offer was made. Calculate the minimum price Wild Boar should accept for Orangebo under these conditions. (Ignore the previous $20 selling price.)  

11-33 Product mix, special order. (N. Melumad, adapted) Pendleton Engineering makes cutting tools for metalworking operations. It makes two types of tools: R3, a regular cutting tool, and HP6, a high-precision cutting tool. R3 is manufactured on a regular machine, but HP6 must be manufactured on both the regular machine and a high-precision machine. The following information is available.
R3 HP6
Selling price  $ 100  $ 150 
Variable manufacturing cost per unit  $ 60  $ 100 
Variable marketing cost per unit  $ 15  $ 35 
Budgeted total fixed overhead costs  $ 350,000  $550,000 
Hours required to produce one unit on the regular machine  1.0  0.5 
Additional information includes the following: 
a. Pendleton faces a capacity constraint on the regular machine of 50,000 hours per year.
b. The capacity of the high-precision machine is not a constraint.
c. Of the $550,000 budgeted fixed overhead costs of HP6, $300,000 are lease payments for the high-precision machine. This cost is charged entirely to HP6 because Pendleton uses the machine exclusively to produce HP6. The lease agreement for the high-precision machine can be canceled at any time without penalties.
d. All other overhead costs are fixed and cannot be changed.  
1. What product mix—that is, how many units of R3 and HP6—will maximize Pendleton’s operating income? Show your calculations.
2. Suppose Pendleton can increase the annual capacity of its regular machines by 15,000 machine-hours at a cost of $150,000. Should Pendleton increase the capacity of the regular machines by 15,000 machine-hours? By how much will Pendleton’s operating income increase? Show your calculations.
3. Suppose that the capacity of the regular machines has been increased to 65,000 hours. Pendleton has been approached by Carter Corporation to supply 20,000 units of another cutting tool, S3, for $120 per unit. Pendleton must either accept the order for all 20,000 units or reject it totally. S3 is exactly like R3 except that its variable manufacturing cost is $70 per unit. (It takes one hour to produce one unit of S3 on the regular machine, and variable marketing cost equals $15 per unit.) What product mix should Pendleton choose to maximize operating income? Show your calculations.  

11-34 Dropping a product line, selling more units. The Northern Division of Grossman Corporation makes and sells tables and beds. The following estimated revenue and cost information from the division’s activity-based costing system is available for 2011.  
4,000 Tables 5,000 Beds Total
Revenues ($125 * 4,000; $200 * 5,000)
Variable direct materials and direct manufacturing labor costs ($75 * 4,000; $105 * 5,000)
Depreciation on equipment used exclusively by each product line
Marketing and distribution costs  $40,000 (fixed) + ($750 per shipment * 40 shipments) $60,000 (fixed) + ($750 per shipment * 100 shipments)
Fixed general-administration costs of the division allocated to product lines on the basis of revenue
Corporate-office costs allocated to product lines on the basis of revenues
Total costs
Operating income (loss)
Additional information includes the following:  $500,000 $1,000,000 $1,500,000
300,000 525,000 825,000 42,000 58,000 100,000
205,000 110,000 220,000 330,000  ..50,000 ...100,000 ...150,000 .572,000 .1,038,000 .1,610,000  $.(72,000) $..(38,000) $.(110,000)
a. On January 1, 2011, the equipment has a book value of $100,000, a one-year useful life, and zero dis-posal value. Any equipment not used will remain idle.  
b. Fixed marketing and distribution costs of a product line can be avoided if the line is discontinued.
c. Fixed general-administration costs of the division and corporate-office costs will not change if sales of  individual product lines are increased or decreased or if product lines are added or dropped.   
1. On the basis of financial considerations alone, should the Northern Division discontinue the tables  product line for the year, assuming the released facilities remain idle? Show your calculations.  
2. What would be the effect on the Northern Division’s operating income if it were to sell 4,000 more  tables? Assume that to do so the division would have to acquire additional equipment costing  $42,000 with a one-year useful life and zero terminal disposal value. Assume further that the fixed  marketing and distribution costs would not change but that the number of shipments would double.
Show your calculations.  
3. Given the Northern Division’s expected operating loss of $110,000, should Grossman Corporation  shut it down for the year? Assume that shutting down the Northern Division will have no effect on  corporate-office costs but will lead to savings of all general-administration costs of the division.
Show your calculations.  
4. Suppose Grossman Corporation has the opportunity to open another division, the Southern Division,  whose revenues and costs are expected to be identical to the Northern Division’s revenues and costs  (including a cost of $100,000 to acquire equipment with a one-year useful life and zero terminal dis-posal value). Opening the new division will have no effect on corporate-office costs. Should Grossman  open the Southern Division? Show your calculations.   

11-35 Make or buy, unknown level of volume. (A. Atkinson) Oxford Engineering manufactures small engines. The engines are sold to manufacturers who install them in such products as lawn mowers. The company currently manufactures all the parts used in these engines but is considering a proposal from an external supplier who wishes to supply the starter assemblies used in these engines.
The starter assemblies are currently manufactured in Division 3 of Oxford Engineering. The costs relat-ing to the starter assemblies for the past 12 months were as follows:
Direct materials  $200,000 
Direct manufacturing labor  150,000 
Manufacturing overhead  .400,000 
Total  $750,000 
Over the past year, Division 3 manufactured 150,000 starter assemblies. The average cost for each starter assembly is $5 ($750,000 ÷ 150,000).
Further analysis of manufacturing overhead revealed the following information. Of the total manufac-turing overhead, only 25% is considered variable. Of the fixed portion, $150,000 is an allocation of general overhead that will remain unchanged for the company as a whole if production of the starter assemblies is discontinued. A further $100,000 of the fixed overhead is avoidable if production of the starter assemblies is discontinued. The balance of the current fixed overhead, $50,000, is the division manager’s salary. If produc-tion of the starter assemblies is discontinued, the manager of Division 3 will be transferred to Division 2 at the same salary. This move will allow the company to save the $40,000 salary that would otherwise be paid to attract an outsider to this position.
1. Tidnish Electronics, a reliable supplier, has offered to supply starter-assembly units at $4 per unit. Because this price is less than the current average cost of $5 per unit, the vice president of manufac-turing is eager to accept this offer. On the basis of financial considerations alone, should the outside offer be accepted? Show your calculations. (Hint: Production output in the coming year may be differ-ent from production output in the past year.)
2. How, if at all, would your response to requirement 1 change if the company could use the vacated plant space for storage and, in so doing, avoid $50,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?

11-36 Make versus buy, activity-based costing, opportunity costs. The Weaver Company produces gas grills. This year’s expected production is 20,000 units. Currently, Weaver makes the side burners for its grills. Each grill includes two side burners. Weavers management accountant reports the following costs for mak-ing the 40,000 burners:
Cost per Unit Costs for 40,000 Units
Direct materials $5.00 $200,000 Direct manufacturing labor 2.50 100,000 Variable manufacturing overhead 1.25 50,000 Inspection, setup, materials handling 4,000 Machine rent 8,000 Allocated fixed costs of plant administration, taxes, and insurance ..50,000 Total costs $412,000
Weaver has received an offer from an outside vendor to supply any number of burners Weaver requires at $9.25 per burner. The following additional information is available:
a. Inspection, setup, and materials-handling costs vary with the number of batches in which the burn-ers are produced. Weaver produces burners in batch sizes of 1,000 units. Weaver will produce the 40,000 units in 40 batches.
b. Weaver rents the machine used to make the burners. If Weaver buys all of its burners from the outside vendor, it does not need to pay rent on this machine.   
1. Assume that if Weaver purchases the burners from the outside vendor, the facility where the burners are currently made will remain idle. On the basis of financial considerations alone, should Weaver accept the outside vendor’s offer at the anticipated volume of 40,000 burners? Show your calculations.
2. For this question, assume that if the burners are purchased outside, the facilities where the burners are currently made will be used to upgrade the grills by adding a rotisserie attachment. (Note: Each grill con-tains two burners and one rotisserie attachment.) As a consequence, the selling price of grills will be raised by $30. The variable cost per unit of the upgrade would be $24, and additional tooling costs of $100,000 per year would be incurred. On the basis of financial considerations alone, should Weaver make or buy the burners, assuming that 20,000 grills are produced (and sold)? Show your calculations.
3. The sales manager at Weaver is concerned that the estimate of 20,000 grills may be high and believes that only 16,000 grills will be sold. Production will be cut back, freeing up work space. This space can be used to add the rotisserie attachments whether Weaver buys the burners or makes them in-house. At this lower output, Weaver will produce the burners in 32 batches of 1,000 units each. On the basis of financial consid-erations alone, should Weaver purchase the burners from the outside vendor? Show your calculations.  

11-37 Multiple choice, comprehensive problem on relevant costs. The following are the Class Company’s unit costs of manufacturing and marketing a high-style pen at an output level of 20,000 units per month:
Manufacturing cost Direct materials $1.00 Direct manufacturing labor 1.20 Variable manufacturing overhead cost 0.80 Fixed manufacturing overhead cost 0.50
Marketing cost Variable 1.50 Fixed 0.90
The following situations refer only to the preceding data; there is no connection between the situations. Unless stated otherwise, assume a regular selling price of $6 per unit. Choose the best answer to each question. Show your calculations.
1.  For an inventory of 10,000 units of the high-style pen presented in the balance sheet, the appropriate unit cost to use is (a) $3.00, (b) $3.50, (c) $5.00, (d) $2.20, or (e) $5.90.
2. The pen is usually produced and sold at the rate of 240,000 units per year (an average of 20,000 per month). The selling price is $6 per unit, which yields total annual revenues of $1,440,000. Total costs are $1,416,000, and operating income is $24,000, or $0.10 per unit. Market research estimates that unit sales could be increased by 10% if prices were cut to $5.80. Assuming the implied cost-behavior patterns continue, this action, if taken, would
a.  decrease operating income by $7,200.
b.  decrease operating income by $0.20 per unit ($48,000) but increase operating income by 10% of rev-enues ($144,000), for a net increase of $96,000.
c.  decrease fixed cost per unit by 10%, or $0.14, per unit, and thus decrease operating income by $0.06 ($0.20 – $0.14) per unit.
d.  increase unit sales to 264,000 units, which at the $5.80 price would give total revenues of $1,531,200 and lead to costs of $5.90 per unit for 264,000 units, which would equal $1,557,600, and result in an operating loss of $26,400.
e. None of these  
3.  A contract with the government for 5,000 units of the pens calls for the reimbursement of all manufac-turing costs plus a fixed fee of $1,000. No variable marketing costs are incurred on the government contract. You are asked to compare the following two alternatives:
Sales Each Month to Alternative A Alternative B
Regular customers 15,000 units 15,000 units
Government 0 units 5,000 units
Operating income under alternative B is greater than that under alternative A by (a) $1,000, (b) $2,500,  (c) $3,500, (d) $300, or (e) none of these.
4.  Assume the same data with respect to the government contract as in requirement 3 except that the two alternatives to be compared are as follows:
Sales Each Month to Alternative A Alternative B
Regular customers 20,000 units 15,000 units
Government 0 units 5,000 units
Operating income under alternative B relative to that under alternative A is (a) $4,000 less, (b) $3,000 greater, (c) $6,500 less, (d) $500 greater, or (e) none of these.
5.  The company wants to enter a foreign market in which price competition is keen. The company seeks a one-time-only special order for 10,000 units on a minimum-unit-price basis. It expects that shipping costs for this order will amount to only $0.75 per unit, but the fixed costs of obtaining the contract will be $4,000. The company incurs no variable marketing costs other than shipping costs. Domestic business will be unaffected. The selling price to break even is (a) $3.50, (b) $4.15, (c) $4.25,  (d) $3.00, or (e) $5.00.
6. The company has an inventory of 1,000 units of pens that must be sold immediately at reduced prices. Otherwise, the inventory will become worthless. The unit cost that is relevant for establishing the min-imum selling price is (a) $4.50, (b) $4.00, (c) $3.00, (d) $5.90, or (e) $1.50.
7. A proposal is received from an outside supplier who will make and ship the high-style pens directly to the Class Company’s customers as sales orders are forwarded from Class’s sales staff. Class’s fixed marketing costs will be unaffected, but its variable marketing costs will be slashed by 20%. Class’s plant will be idle, but its fixed manufacturing overhead will continue at 50% of present levels. How much per unit would the company be able to pay the supplier without decreasing operating income?    (a) $4.75, (b) $3.95, (c) $2.95, (d) $5.35, or (e) none of these.

11-38 Closing down divisions. Belmont Corporation has four operating divisions. The budgeted rev-enues and expenses for each division for 2011 follows:
A  B  C  D 
Sales  $630,000  $ 632,000  $960,000  $1,240,000 
Cost of goods sold  550,000  620,000  765,000  925,000 
Selling, general, and administrative expenses  .120,000  135,000  .144,000  ...210,000 
Operating income/loss  $.(40,000)  $(123,000)  $.51,000  $..105,000 
Further analysis of costs reveals the following percentages of variable costs in each division:
Cost of goods sold 90% 80% 90% 85% Selling, general, and administrative expenses 50% 50% 60% 60%
Closing down any division would result in savings of 40% of the fixed costs of that division. Top management is very concerned about the unprofitable divisions (A and B) and is considering clos-ing them for the year.
1. Calculate the increase or decrease in operating income if Belmont closes division A.
2. Calculate the increase or decrease in operating income if Belmont closes division B.
3. What other factors should the top management of Belmont consider before making a decision?  

11-39 Product mix, constrained resource. Westford Company produces three products, A110, B382, and C657. Unit data for the three products follows:
Product A110 B382 C657
Selling price  $84  $56  70 
Variable costs 
Direct materials  24  15  9 
Labor and other costs  28  27  40 
Quantity of Bistide per unit  8 lb.  5 lb.  3 lb. 
All three products use the same direct material, Bistide. The demand for the products far exceeds the direct materials available to produce the products. Bistide costs $3 per pound and a maximum of 5,000 pounds is available each month. Westford must produce a minimum of 200 units of each product.
1. How many units of product A110, B382, and C657 should Westford produce?
2. What is the maximum amount Westford would be willing to pay for another 1,000 pounds of Bistide?  

11-40 Optimal product mix. (CMA adapted) Della Simpson, Inc., sells two popular brands of cookies: Della’s Delight and Bonny’s Bourbon. Della’s Delight goes through the Mixing and Baking departments, and Bonny’s Bourbon, a filled cookie, goes through the Mixing, Filling, and Baking departments.
Michael Shirra, vice president for sales, believes that at the current price, Della Simpson can sell all of its daily production of Della’s Delight and Bonny’s Bourbon. Both cookies are made in batches of 3,000. In each department, the time required per batch and the total time available each day are as follows:  
A  B  C  D 
1  Department Minutes 
2  Mixing  Filling  Baking 
3  ightlla’s DelDe  30  0  10 
4  Bonny’s Bourbon  15  15  15 
5  Total available per day  660  270  300 
Revenue and cost data for each type of cookie are as follows:
A  B  C 
7  Della’s  Bonny’s 
8  Delight  Bourbon 
9  Revenue per batch  $ 475  $ 375 
10  Variable cost per batch  175  125 
11  Contribution margin per batch  $ 300  $ 250 
12  Monthly fixed costs
13  (allocated to each product)  $18,650  $22,350    
1. Using D to represent the batches of Della’s Delight and B to represent the batches of Bonny’s Bourbon  made and sold each day, formulate Shirra’s decision as an LP model.  
2. Compute the optimal number of batches of each type of cookie that Della Simpson, Inc., should make  and sell each day to maximize operating income.   

11-41 Dropping a customer, activity-based costing, ethics. Jack Arnoldson is the management accountant for Valley Restaurant Supply (VRS). Bob Gardner, the VRS sales manager, and Jack are meeting to discuss the profitability of one of the customers, Francos Pizza. Jack hands Bob the following analysis of Franco’s activity during the last quarter, taken from Valley’s activity-based costing system:
Sales $15,600 Cost of goods sold (all variable) 9,350 Order processing (25 orders processed at $200 per order) 5,000 Delivery (2,500 miles driven at $0.50 per mile) 1,250 Rush orders (3 rush orders at $110 per rush order) 330 Sales calls (3 sales calls at $100 per call) ....300 Profits ($ 630)
Bob looks at the report and remarks, “I’m glad to see all my hard work is paying off with Franco’s. Sales have gone up 10% over the previous quarter!”
Jack replies, “Increased sales are great, but I’m worried about Franco’s margin, Bob. We were show-ing a profit with Franco’s at the lower sales level, but now we’re showing a loss. Gross margin percentage this quarter was 40%, down five percentage points from the prior quarter. I’m afraid that corporate will push hard to drop them as a customer if things don’t turn around.”  That’s crazy,” Bob responds. “A lot of that overhead for things like order processing, deliveries, and sales calls would just be allocated to other customers if we dropped Franco’s. This report makes it look like we’re losing money on Franco’s when we’re not. In any case, I am sure you can do something to make its profitability look closer to what we think it is. No one doubts that Franco is a very good customer.”
1. Assume that Bob is partly correct in his assessment of the report. Upon further investigation, it is deter-mined that 10% of the order processing costs and 20% of the delivery costs would not be avoidable if
VRS were to drop Franco’s. Would VRS benefit from dropping Franco’s? Show your calculations.  
2. Bob’s bonus is based on meeting sales targets. Based on the preceding information regarding gross  margin percentage, what might Bob have done last quarter to meet his target and receive his bonus?
How might VRS revise its bonus system to address this?  
3. Should Jack rework the numbers? How should he respond to Bob’s comments about making Franco  look more profitable?     

Collaborative Learning Problem

11-42 Equipment replacement decisions and performance evaluation. Bob Moody manages the Knoxville plant of George Manufacturing. He has been approached by a representative of Darda Engineering regarding the possible replacement of a large piece of manufacturing equipment that George uses in its process with a more efficient model. While the representative made some compelling arguments in favor of replacing the
3-year old equipment, Moody is hesitant. Moody is hoping to be promoted next year to manager of the larger Chicago plant, and he knows that the accrual-basis net operating income of the Knoxville plant will be evaluated closely as part of the promotion decision. The following information is available concerning the equipment replacement decision:  .
The historic cost of the old machine is $300,000. It has a current book value of $120,000, two remaining  years of useful life, and a market value of $72,000. Annual depreciation expense is $60,000. It is  expected to have a salvage value of $0 at the end of its useful life.    .
The new equipment will cost $180,000. It will have a two-year useful life and a $0 salvage value. George  uses straight-line depreciation on all equipment.    .
The new equipment will reduce electricity costs by $35,000 per year, and will reduce direct manufac-turing labor costs by $30,000 per year.   
For simplicity, ignore income taxes and the time value of money.
1. Assume that Moody’s priority is to receive the promotion, and he makes the equipment replacement  decision based on next year’s accrual-based net operating income. Which alternative would he  choose? Show your calculations.  
2. What are the relevant factors in the decision? Which alternative is in the best interest of the company  over the next two years? Show your calculations.  
3. At what cost of the new equipment would Moody be willing to purchase it? Explain.