Deck 21: Incremental Analysis

Question 1

A sunk cost is the benefit that could have been obtained by pursuing an alternate course of action.

Answer 1

False

Question 2

Differential costs are those that are the same among alternatives.

Answer 2

False

Question 3

Opportunity costs are recorded in the accounting records.

Answer 3

False

Question 4

The relevant costs and revenues to consider in a special order decision include variable costs,fixed costs,and incremental revenues.

Question 5

Opportunity costs are irrelevant in decision making.

Question 6

In making a decision,management will look thoroughly at both relevant and irrelevant data.

Question 7

Even though costs,revenues,and other factors do not vary among possible courses of action,they may be relevant to a decision.

Question 8

Incremental revenue is relevant in decision making.

Question 9

Identifying information relevant to a particular business decision requires an understanding of both quantitative and qualitative considerations.

Question 10

An opportunity cost is a relevant cost when making a business decision.

Question 11

In order to be consistent with IASB Standards,U.S.GAAP now requires that borrowing costs on assets that require a substantial period to bring them to a marketable condition be expensed immediately.

Question 12

Sunk costs have already been incurred and cannot be changed by future actions.

Question 13

A sunk cost is an expenditure that has proven to be nonproductive.

Question 14

Nonfinancial considerations are relevant in decision making.

Question 15

The term "out-of-pocket cost" is often used to describe costs which have not yet been incurred and which may vary among alternative courses of action.

Question 16

Joint products are similar products that serve the same exact function.

Question 17

Sunk costs are relevant to decisions about replacing plant assets.

Question 18

All incremental revenue or incremental costs are relevant.

Question 19

Incremental analysis rarely requires the decision maker to exercise judgment.

Question 20

Sunk costs may be defined as unavoidable future costs resulting from past decisions.

Question 21

Which cost is not relevant in making financial decisions?

A)Sunk costs.
B)Opportunity costs.
C)Incremental costs.
D)Out-of-pocket costs.

Question 22

Direct material costs are always considered relevant costs in a make or buy decision.

Question 23

A cost that has already been incurred and cannot be changed is called a(n):

A)Opportunity cost.
B)Out-of-pocket cost.
C)Joint cost.
D)Sunk cost.

Question 24

The most common method to allocate joint costs is in proportion to the relative sales value of the products.

Question 25

Incremental costs can be defined as:

A)Costs that are expected to increase regardless of the course of action chosen.
B)The differences between costs incurred under alternative courses of action.
C)Costs incurred in the past.
D)Costs that are irrelevant in decision making.

Question 26

Costs that have not yet been incurred and that may vary among different courses of action are called:

A)Opportunity costs.
B)Out-of-pocket costs.
C)Joint costs.
D)Sunk costs.

Question 27

Assuming that the MR Corporation has an inventory of 200 defective motors costing $450,000 to produce and $150,000 to repair,the repaired units can be sold for $275,000.The company receives an offer to purchase these motors for $100,000 before repairing them.The company's decision should be to sell the motors at the offered price.
The $450,000 production costs are sunk costs and therefore irrelevant to the decision.Net proceed from the sale of repaired units is $125,000 (Proceeds from sale of reworked units $275,000 - relevant costs for repair $150,000)compared to the offer to purchase for $100,000.Since the offer price is less than the net proceed from the sale of repaired units,the decision should be not to sell the motors at the offered price.

Question 28

Incremental revenues:

A)Always increase revenue when one course of action is selected over another.
B)Always decrease revenue when one course of action is selected over another.
C)May increase or decrease when one course of action is selected over another.
D)Cause revenues to remain steady.

Question 29

Which of the following types of cost are always relevant to a decision?

A)Sunk costs.
B)Average costs.
C)Incremental costs.
D)Fixed costs.

Question 30

Mell Co.manufactured 100 personal computers at a cost of $30,000.It can sell them as is for $65,000,or install hard disks in them for $25,000 and sell them for $105,000.The $30,000 original manufacturing cost is:

A)An out-of-pocket cost because it has already been paid.
B)A sunk cost because it is not relevant to the decision.
C)An incremental cost because it is relevant to the decision.
D)A fixed cost because it will remain the same no matter which action is taken.

Question 31

Maple syrup and pancakes are examples of joint products.

Question 32

Sunk costs are relevant costs when considering a special order.

Question 33

Perfect Plumbing Corporation currently manufactures a valve for use in water pumps that it produces for sale.The company is considering purchasing the valves from an outside supplier rather than manufacturing them.Which of the following costs is not relevant to the decision?

A)The cost of direct material required to make the valve.
B)The price charged by the outside supplier for an identical valve.
C)The cost of the machinery owned by Perfect Plumbing used exclusively to manufacture this valve.
D)The salvage value of the machinery owned by Perfect Plumbing used exclusively to manufacture this valve.

Question 34

Products resulting from a shared manufacturing process are

Question 35

In determining whether to scrap or to rebuild defective units of product,the cost already incurred in producing the defective units is not relevant.

Question 36

A decision to discontinue a given product on the basis of contribution margin data should include consideration of the probable impact of the discontinuance on the sales of other products.

Question 37

Assuming that the MR Corporation has an inventory of 200 defective motors costing $450,000 to produce and $150,000 to repair,the repaired units can be sold for $425,000.The company receives an offer to purchase these motors for $325,000 before repairing them.The company's decision should be to sell the motors at the offered price.
The $450,000 production costs are sunk costs and therefore irrelevant to the decision.Net proceed from the sale of repaired units is $275,000 (Proceeds from sale of reworked units $425,000 - relevant costs for repair $150,000)compared to the offer to purchase for $325,000.Since the offer price is more than the net proceed from the sale of repaired units,the decision should be to sell the motors at the offered price.

Question 38

When sales of one product contribute to the sales of another product they are called contribution products.

Question 39

Joint costs are the middle costs of a product.

Question 40

The split-off point is the point at which joint products can be separated into two or more products.

Question 41

Incremental analysis
Information regarding current operations of the Farrell Corporation is given below: A proposed addition to Farrell's factory is estimated by the sales manager to increase sales by a maximum of $750,000.The company's accountants have determined that the proposed addition will add $320,000 to fixed costs each year.
(a)Explain why the existing $310,000 of fixed costs is a sunk cost while the $320,000 of fixed costs associated with the proposed addition is an out-of-pocket cost.
(b)Calculate by how much the proposed addition will either increase or reduce operating income.

Question 42

The Fine Point Company currently produces all of the components for its one product; an electric pencil sharpener.The unit cost of manufacturing the motor for this pencil sharpener is: The company is considering the possibility of buying this motor from a subcontractor and has been quoted a price of $3.60 per unit.The relevant cost of manufacturing the motor to be considered in reaching the decision is:

A)$4.75.
B)$4.15.
C)$3.55.
D)$4.05.

Question 43

In deciding whether or not to accept a special order,what is the opportunity cost of using machinery for which the firm has sufficient excess capacity to accept the order?

A)The historical cost of the machinery.
B)The undepreciated cost of the machinery.
C)The same machinery cost allocated to regular production orders.
D)Zero.

Question 44

Relevant costs in business decisions
(a)Explain what is meant by each of the following terms: opportunity cost,sunk cost,and out-of-pocket cost.
(b)Identify which,if any,of the above three types of cost would be considered relevant in making a business decision.

Question 45

Accounting terminology
Listed below are eight technical accounting terms introduced or emphasized in this chapter: Each of the following statements may (or may not)describe one of these technical terms.In the space provided beside each statement,indicate the accounting term described,or answer "None" if the statement does not correctly describe any of the terms.
____ (a)Data pertaining to future time periods which may vary among alternative courses of action.
____ (b)The point at which manufacturing costs are split between finished goods inventory and work in progress.
____ (c)The benefit foregone by pursuing one course of action over another.
____ (d)Products which emerge from common materials and shared production processes.
____ (e)A cost incurred in the past that will not change as a result of future actions.
____ (f)Costs yet to be incurred which are expected to vary under different courses of action.
____ (g)The examination of differences between future costs and revenue under varying courses of action.

Question 46

Which is an example of joint products?

A)Sugar and beef.
B)Pens and erasers.
C)Granulated charcoal and methyl alcohol.
D)Iron and plastic.

Question 47

Products for which sales of one contribute to the sales of another are called:

A)Complementary products.
B)Competing products.
C)Contributory products.
D)Codependent products.

Question 48

The cost of draining sap out of a maple tree to manufacture maple syrup and maple sugar is an example of:

A)After-split-off costs.
B)Sunk costs.
C)Incremental costs.
D)Joint costs.

Question 49

Products which emerge from a shared manufacturing process are

A)Complementary products.
B)Joint products.
C)Contributory products.
D)Codependent products.

Question 50

Which factor is not relevant in deciding whether or not to accept a special order?

A)Incremental revenue that will be earned.
B)Additional costs that will be incurred.
C)The effect that the order will have on the company's regular sales volume and selling prices.
D)The average cost of production if the special order is accepted.

Question 51

Accepting a special order is profitable whenever the revenue from the special order exceeds:

A)The average unit cost of production multiplied by the number of units in the order.
B)The incremental cost of producing the order.
C)The materials and direct labor costs of producing the order.
D)The fixed manufacturing costs for the period.

Question 52

Pricing special orders
Explain why an American corporation might sell a product in Eastern Europe at a price significantly below that for which it sells the same product in the United States.

Question 53

The Magic Microbrewery has a limited amount of vat capacity available in which it can ferment beer.In deciding which beers to brew,Magic management should consider:

A)The contribution margins of the individual beers.
B)The unit contribution margins of the individual beers.
C)The contribution margin ratios of the individual beers.
D)The contribution margin per unit of vat capacity of the individual beers.

Question 54

Special order decision
Prudent Products Corporation manufactures and sells 1,000 motorcycle engines each month.A primary component in each motor is an oil pump used to keep the motor lubricated.Prudent Products has the monthly capacity to produce 1,500 oil pumps.The variable unit costs associated with manufacturing each pump are shown below: Fixed manufacturing overhead per month (for up to 1,500 units of production)averages $46,000.Volk's Autos,Inc.,has offered to purchase 250 oil pumps from Prudent Products per month to be used in its own motorcycles.
(a)Prudent Product's average unit cost of manufacturing each oil pump if it rejects Volk's Autos' order is $__________ per unit.
(b)The incremental unit cost of producing each additional oil pump is $__________ per unit.
(c)If this special order is accepted,the price per unit that Prudent Products could charge Volk's Autos in order to earn a $20,000 monthly pretax profit on the sale is $__________ per unit.

Question 55

Aircraft Products,a manufacturer of aircraft landing gear,makes 1,000 units each year of a special valve used in assembling one of its products.The unit cost of producing this valve includes variable costs of $70 and fixed costs of $60.The valves could be purchased from an outside supplier at $77 each.If the valve were purchased from the outside supplier,40% of the total fixed costs incurred in producing this valve could be eliminated.Buying the valves from the outside supplier instead of making them would cause the company's operating income to:

A)Increase by $26,000.
B)Increase by $17,000.
C)Decrease by $9,000.
D)Decrease by $29,000.

Question 56

Legendary Motors has 7,000 defective autos on hand which cost $12,880,000 to manufacture.Legendary can either sell these defective autos as scrap for $8,000 per auto,or spend an additional $18,320,000 on repairs and then sell them for $12,000 per unit.What is the net advantage to repair the autos compared to selling them for scrap?

A)$84,000,000.
B)$18,320,000.
C)$9,680,000.
D)$56,000,000.

Question 57

Sunk costs:

A)Have already been incurred as a result of past actions.
B)Vary among the alternative courses of action being considered.
C)Are benefits that could have been obtained by following another course of action.
D)Result from unfavorable cost variances.

Question 58

Which of the following would be an example of a sunk cost?

A)The cost of a new oil burner that replaced a destroyed one.
B)The cost of an old inefficient oil burner that will be replaced by a more modern and efficient one.
C)Depreciation expense.
D)Lost revenue from a bad debt.

Question 59

Seidman Company manufactures and sells 30,000 units of product X per month.Each unit of product X sells for $16 and has a contribution margin of $7.If product X is discontinued,$85,000 in fixed monthly overhead costs would be eliminated and there would be no effect on the sales volume of Seidman Company's other products.If product X is discontinued,Seidman Company's monthly income before taxes should:

A)Increase by $210,000.
B)Increase by $125,000.
C)Decrease by $210,000.
D)Decrease by $125,000.

Question 60

By choosing to go into business for himself,Jim Lazar foregoes the possibility of getting a highly paid job with a large company.This is called a(n):

A)Sunk cost.
B)Out-of-pocket cost.
C)Opportunity cost.
D)Joint cost.

Question 61

Robbins Co.has been producing a part for a camera they manufacture.The costs for this part are as follows: Robbins has an opportunity to purchase this part rather than manufacture it.To purchase the part will cost $3 a unit.If the part is purchased,fixed costs will be reduced by 20%.
Should Robbins Co.make or buy this part.Show how you arrived at your decision.

Question 62

Incremental analysis - make-or-buy decision
Paramount Bikes,Inc.,uses 10,000 derailleurs in its bicycles each year.Derailleurs currently cost the company $20.90 per unit to manufacture,determined as follows: Paramount Bikes,Inc.,has been approached by an outside supplier that will provide derailleurs at a price of $16 per unit.If Paramount Bikes,Inc.,stops producing derailleurs,the direct materials,direct labor,and variable manufacturing overhead will be eliminated,as will $30,000 of the fixed manufacturing overhead.Use incremental analysis to determine whether Paramount Bikes,Inc.,should make or buy derailleurs.Complete the following schedule,and indicate in the space provided your decision to continue making,or to buy the part: Decision: ___________________________________________

Question 63

Joint production decisions
Grassy Fertilizer manufactures two lines of garden grade fertilizer as part of a joint production process: GF10 and GF20.Joint costs up to the split-off point total $85,000 per batch.These joint costs are allocated to GF10 and GF20 in proportion to their relative sales values at the split-off point of $40,000 and $60,000,respectively.
Both lines of garden grade fertilizer can be further processed into commercial grade fertilizer.The following table summarizes the costs and revenue associated with additional processing of GF10 and GF20: (a)The $85,000 in joint costs should be allocated to each product as follows:
GF10 $____________,GF20 $____________
(b)Which product (GF10 or GF20)would result in a net decrease in operating income if processed into a commercial grade fertilizer?
____________
(c)Which product (GF10 or GF20)would result in a net increase in operating income if processed into a commercial grade fertilizer?
____________

Question 64

Limited resources
Portable Enterprises produces two lines of mobile homes: double-wide and single-wide.Unit cost and revenue data pertaining to each product are shown below: Each double-wide home requires 350 different labor hours and 125 machine hours.Each single-wide home requires 175 direct labor hours and 150 machine hours.Demand for each line of homes far exceeds the company's total production capacity.
(a)If Portable's production capacity is constrained by limited direct labor hours,which line of homes should it produce? ___________________
(b)If Portable's total production capacity is constrained by machine hours,which line of homes should it produce? ____________________
Computations

Question 65

Make-or-buy decision
Currier,Inc.,manufactures and distributes a large number of products.The costs per unit for one product,a pole,are as follows: Currier recently decided to buy the pole from another manufacturer for $32 per unit because the unit cost was less than its unit cost of $34.Solely on the basis of the cost data given,evaluate this decision.

Question 66

Links,Inc.produces golf gloves.The gloves sell for $16 each.Variable costs are $8.50 and fixed costs are $1.50 each.An Australian company has offered to pay $12 each for 2,000 gloves.The manufacturing capacity will not be affected by this special order and it will not affect regular sales.Fixed assets will not change but variable selling costs will increase by $1.75 a glove due to delivery costs.
(a)What is the relevant cost per unit on this special order?
(b)How will company profits be affected?
(c)Should the company accept this special order?

Question 67

Scrap or rework decision
Nielson has 5,000 defective televisions on hand which cost $380,000 to manufacture.Nielson can either sell these defective televisions as scrap for $65 per unit,or spend an additional $120,000 on repairs and then sell the televisions for $135 per unit.
Should Nielson repair the defective TVs to sell them as scrap?
Show your supporting computations:

Question 68

Widmark Company originally made cell phones at a cost of $60,000 that have since become obsolete due to new technology.They can sell the phones to a dealer for scrap for $11,500 or put more work into them to bring them up-to-date.To re-do the phones would cost $13,000 and they then could be sold for $20,000.
(A.)Should the company scrap them or rework them? (show calculations)
(B.)If the original cost had been $50,000 and the company could now sell the phones for $25,000 what should Heston do?

Question 69

Incremental analysis - accepting a special order
Essential Company normally produces and sells 4,000 video monitors for personal computers each month.Variable manufacturing costs amount to $62 per unit,and fixed manufacturing costs are $170,000 per month.The regular sales price of the monitors is $140 per unit.The company is considering a special order from a foreign computer maker to buy an additional 1,000 monitors per month at a special price of $70 per unit.Filling this special order would not affect Essential Company's regular sales volume or fixed manufacturing costs.
(a)The average cost per unit at the 4,000-unit-per-month production level is $_______________ per unit.
(b)The average cost per unit at the 5,000-unit-per-month production level is $_______________ per unit.
(c)The amount of increase or decrease (indicate the correct term)in Essential Company's operating income that would result from accepting the special order is $_______________.

Question 70

Seeking creative solutions to problems
Explain why it would be irresponsible and short-sighted for managers to base decisions entirely on revenue and cost figures.