Chapter 7

Incremental Analysis for Short-Term Decision

Making

ANSWERS TO QUESTIONS

1. The steps of the management decision making process include:

 The first step is to identify the decision problem, or determine why a decision
needs to be made in the first place.
 The second step is to determine the decision alternatives, or decide what the
potential solutions to the problem are.
 The third step is to evaluate the costs and benefits of the decision alternatives
that were identified in step 2.
 The fourth step is to make the decision based on the information gathered in step
3.
 The final step is to review the results of the decision with the goal of improving
future decision making.

2. Examples of costs and benefits of taking a part-time job include:

 Money earned in the part-time job.
 Costs to travel to/from job.
 Opportunity costs of working would include less leisure time, giving up hobbies,
losing the opportunity to work elsewhere or take additional classes, etc.
 Money saved by not enrolling in classes (if decision were work vs. school).
 Incidental costs of the job, such as training, supplies, or clothing needed for the
job.

3. Tom has completed Step 5 of the decision-making process, which involves

reviewing the results of his decision.

4. For a cost to be relevant it must be a future cost that differs between decision
alternatives.

5. An avoidable cost is one that can be avoided by selecting a particular decision

alternative. It is a relevant cost because it will differ between decision alternatives.

6. An opportunity cost is what you give up when you choose to do something. When
you enroll in class, you forego other opportunities, such as working, leisure time,
taking other classes, etc.

Managerial Accounting, 4/e 7-1

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
7. Opportunity costs should be factored into the decision-making process because they
are a relevant cost of future decisions. However, opportunity costs are difficult to
measure because they are the costs of NOT doing something. For example, it may
be impossible to know exactly how much money was given up if you chose to enroll
in classes instead of taking a summer job. It is also difficult to put a monetary value
on opportunity costs such as leisure time or sleep.

8. Excess capacity exists when a company has not yet reached the limit on its
resources, while full capacity indicates that the limit on one or more resources has
been reached. If a company has excess capacity, increasing production will only
increase the costs that vary with production. If a company is at capacity, production
cannot be increased without incurring additional fixed costs. Opportunity costs also
are relevant when firms are at capacity because choosing to do one thing forces
managers to give up something else.

9. When a company is operating at full capacity, it means the limit on one or more
resources has been reached, and making the choice to do one thing means giving
up the opportunity to do something else. At full capacity, opportunity costs become
relevant and should be incorporated into the analysis.

10. Special-order decisions involve deciding whether to accept or reject an order that is
outside the normal scope of business, often at a reduced price. Fixed overhead
costs can be ignored because these costs will remain the same regardless of
whether the order is accepted or not, so long as the company has the capacity to fill
the order.

11. Negative consequences of accepting a special-order include the potential impact on

sales made through “regular” channels, such as customers demanding the same
reduced price that was given to the “special” order. If the company has limited
production capacity, filling the special-order may create opportunity costs including
lost revenue from regular sales, back-orders, etc.

12. Excess capacity is the difference between a company’s current level of production
and what it could produce given its current operating structure and cost. If a
company has enough excess capacity to fill a special-order without affecting
“normal” sales, then there are no incremental fixed costs or opportunity costs to
consider. In this situation, only the variable costs of the order must be covered by
the sales price.

13. Examples of decisions that might be made by the manager of a local deli include:

a. A special-order would be whether to provide catering for a special event that

is outside the scope of normal sales. Relevant costs/benefits of this decision
would include the cost of supplies, cost of personnel, transportation to and
from the event, the amount of revenue to be earned at the event, etc.
b. A make-or-buy decision would be whether to make the bread “in-house” or
buy it from a local bakery. Relevant costs of making the bread include the
Managerial Accounting, 4/e 7-2
Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
 cost of ingredients, direct labor, storage for raw materials, etc. The price the
bakery would charge and transportation costs are also relevant, as is the
quality of the final product.
c. A keep or drop decision would involve eliminating product offerings, such as a
particular menu item. Relevant costs include savings on the ingredients used
to make the menu item, the potential for lost revenue from that menu item, as
well as the opportunity to add other menu items that might be more or less
profitable.

14. Potential problems and solutions involved with outsourcing include:

Problem Potential Solution

Quality of outsourced product Stringent guidelines for quality, penalties
for poor quality
Ability to make design changes Input into production process, identified
process between companies to develop
new designs
Future price increases Long-term contracts and partnerships that
include limits on price increases, minimum
required notice of increases

15. Opportunity costs of make-or-buy decisions occur when a company loses an

opportunity by making something internally as opposed to buying it from someone
else (or vice versa). For example, by using resources (people, machines, space,
etc.) to make a part or provide a service internally, a company may be giving up the
opportunity to do something else with those resources (either eliminate them, or use
the resource in a different productive way). These opportunity costs can be
measured as the potential cost savings, the potential revenue earned from other
uses, etc.

16. Only the direct fixed costs traceable to a product are avoidable. As such, the
decision to eliminate one product or service is unlikely to eliminate the common fixed
costs that are shared by other product or service lines. For example, companies will
still incur costs for the facility, machines, and supervision. These common fixed
costs will simply be redistributed between the remaining product or service lines.

17. When a product line is eliminated, the common fixed costs allocated to that product
will be redistributed to the remaining product lines. Elimination of one product may
also impact sales (and thus variable costs) of the remaining products as customers
either move to one of the remaining products or perhaps move all or part of their
business to another company.

Managerial Accounting, 4/e 7-3

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
18. When a product line is eliminated, total variable cost should decrease in direct
proportion to the reduction in production and sales of that product line.

19. Opportunity costs of a keep-or-drop decision include revenue given up if the product
is dropped, revenue from another product that could be produced if the item were
dropped, and potential impact on other complementary products.

20. In the long run, managers can manage constrained resources by eliminating non-
value-added activities such as rework or waiting, or by increasing the capacity of the
constrained resources such as hiring more workers, buying bigger or faster
machines, or leasing additional space. But all of these actions take time and may
result in higher cost. In the short-run, managers should make decisions that
maximize the amount of contribution margin generated by the most limited resource
(i.e., the bottleneck). The reason we focus on contribution margin is that fixed costs
will not change in the short-run. Therefore, we need to look at the amount of
contribution margin that is generated per unit of the constrained resource.

21. The bottleneck limits the overall output of the system and therefore limits how much
contribution margin can be generated in a given amount of time. We focus on
contribution margin because fixed costs do not change in the short-run and are
therefore considered irrelevant.

Managerial Accounting, 4/e 7-4

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
 Authors' Recommended Solution Time
(Time in minutes)

Cases and
Mini-exercises Exercises Problems Projects*
No. Time No. Time No. Time No. Time
1 4 1 5 PA−1 7 1 20
2 3 2 6 PA−2 8 2 20
3 3 3 6 PA−3 6 3 25
4 4 4 5 PA−4 8 4 25
5 4 5 5 PA−5 9
6 3 6 6 PA−6 7
7 4 7 6 PA−7 8
8 4 8 5 PA−8 6
9 4 9 5 PA−9 8
10 4 10 5 PB−1 7
11 3 11 6 PB−2 8
12 3 12 6 PB−3 6
13 6 PB−4 8
14 6 PB−5 9
15 6 PB−6 7
16 6 PB−7 8
17 6 PB−8 6
PB−9 8

* Due to the nature of cases, it is very difficult to estimate the amount of time students
will need to complete them. As with any open-ended project, it is possible for students
to devote a large amount of time to these assignments. While students often benefit
from the extra effort, we find that some become frustrated by the perceived difficulty of
the task. You can reduce student frustration and anxiety by making your expectations
clear, and by offering suggestions (about how to research topics or what companies to
select).

Managerial Accounting, 4/e 7-5

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
ANSWERS TO MINI-EXERCISES

M7−1

C. Exists when a company has not yet reached

1. Excess capacity. the limit on its resources.

K. First step of the management decision-

2. Identify the decision problem. making process.

J. Resource that is insufficient to meet the

3. Bottleneck. demands placed on it.

A. Short-term management decision made using

differential analysis.
E. Management decision in which fixed
4. Special-order decision. manufacturing overhead is ignored as long as
there is enough excess capacity to meet the
order.

O. Costs that change across decision

5. Differential costs. alternatives.

6. Evaluate the costs and benefits of P. Step 3 of the management decision-making

process.
alternatives.

A. Short-term management decision made using

differential analysis.
7. Make-or-buy decision. H. Management decision in which relevant costs
of making a product internally are
compared to the cost of purchasing that product.

D. Costs that have already been incurred.

8. Sunk costs. I. Costs that are irrelevant to short-term decision
making.

N. Benefits given up when one alternative is

9. Opportunity costs. chosen over another.

A. Short-term management decision made using

differential analysis.
10. Keep-or-drop decision. B. Management decision in which lost revenue
is compared to the reduction of costs
to determine the overall effect on profit.

M. Exists when a company has met its limit on

11. Full capacity. one or more resources.

F. Costs that can be avoided by choosing one

12. Avoidable costs. option over another.

Managerial Accounting, 4/e 7-6

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
M7-2

10. Identify the decision problem.

6. Determine the decision alternatives.
4. Evaluate the costs and benefits of the alternatives.
2. Make the decision.
8. Review the results of the decision.

Items 1, 3, 5, 7, and 9 are not related to the decision-making process.

M7−3

1. Relevant
2. Irrelevant
3. Irrelevant
4. Relevant
5. Irrelevant
6. Relevant (qualitative factor)

M7−4

Req. 1
a. Irrelevant. Old uniforms have to be repaired regardless of fundraising choice.
b. Relevant. Only present with Option #1.
c. Relevant. Only present with Option #2.
d. Irrelevant. The water is being donated so the league doesn’t pay for it either way.
e. Irrelevant. The new uniforms cost $2,500 regardless of the fundraising choice.
f. Relevant. Qualitative factor. The teams presumably want new uniforms sooner
rather than later.

Req. 2
Other qualitative factors:
 Safety concerns for children selling products door-to-door as well as around moving
vehicles.
 Problems or delays collecting money from everyone after candy is sold.
 Weather affecting car washes — might cause some days to be rained out.

M7−5

Req. 1
Yes, Blowing Sand should accept the offer. The offer price of $22 is more than the
variable cost of $17, resulting in $5 in additional contribution margin per fan.

Managerial Accounting, 4/e 7-7

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
M7-5 (continued)

Req. 2
Since fixed costs will not increase, profit will increase by $50,000 (10,000 fans × $5
contribution margin).

M7-6

When a company is operating at full capacity, making the choice to do one thing means
giving up the opportunity to do something else. At full capacity, opportunity costs
become relevant and managers would not accept a special-order for less than the price
charged through normal channels.

M7−7

Contribution Margin Given Up $(25,000)

Direct/Avoidable Fixed Costs 18,000
Net Effect of Elimination $(7,000)

Total profit will decrease by $7,000 if the Draft model is eliminated ($25,000 contribution
margin given up vs. $18,000 direct fixed costs eliminated).

M7−8

Blowing Sand should continue to make the thermostat internally. If it purchases the part
from Flurry, Blowing Sand’s total costs would increase by $45,000 annually ($4.00 cost
to buy vs. $2.50 variable costs of making × 30,000 units).

M7-9

More Parts should sell the parts as is and not incorporate them into a new product.

Parts only New Product Incremental

w/Parts
Sales Revenue $120,000 190,000 $ 70,000
Cost of parts (100,000) (100,000) -0-
Additional Costs -0- (75,000) (75,000)
Profit $ 20,000 $15,000 $ (5,000)

Managerial Accounting, 4/e 7-8

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
M7−10

Students’ answers will vary, but should show an understanding of the terms full
capacity, excess capacity, and constrained resource as well as the impact this
constrained resource will have on manufacturing decisions in the company for which
Joe is working.

M7−11

Since kiln time is the constrained resource, Anne must compare the CM per hour of
firing time for the two types of ceramic pots.

Square Ceramic Pot:

CM/unit = Sales Price − Variable Cost
= $70 − 15
= $55 per square pot

CM/hr = $55 / 2.5 hours firing time

= $22 of CM per hour of kiln time for the square pot

Round Ceramic Pot:

CM/unit = Sales Price − Variable Cost
= $90 − 20
= $70 per round pot

CM/hr = $70 / 3.5 hours firing time

= $20.00 of CM per hour of kiln time for the round pot

The square ceramic pot generates more contribution margin per hour of kiln time so
Anne should choose to make the square pot.

Managerial Accounting, 4/e 7-9

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
M7-12

Rectangular Ceramic Pot:

CM/unit = Sales Price − Variable Cost
= $60 − 10
= $50 per rectangular pot

However, 2 rectangular pots can be fired together. So the CM will be $50 × 2 =

$100 of CM generated.

CM / hr = $100 / 4 hours firing time

= $25 of CM per hour of kiln time for the rectangular pot

Since two rectangular pots can be fired at the same time, Anne will generate $25 in
contribution margin per hour, which is higher than firing a single square pot ($22 per
hour) or a single round pot ($20 per hour). The maximum contribution margin she can
earn with 40 hours of firing time per week is $25 × 40 = $1,000.

Managerial Accounting, 4/e 7-10

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
ANSWERS TO EXERCISES

E7-1

F 1. Capacity
O 2. Common fixed costs
N 3. Complementary products
P 4. Constrained resource
J 5. Direct fixed cost
G 6. Idle capacity
A 7. Incremental analysis
I 8. Segment margin
K 9. Substitute products

Managerial Accounting, 4/e 7-11

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7-2

1. The final step in management’s decision-making process is to actually make the

decision.
Incorrect. The final step in the decision-making process is to review the results of
the decision-making process.

2. In making business decisions, management will ordinarily only consider financial

information because it’s objectively determined.
Incorrect. In the decision-making process managers should incorporate a variety
of factors in addition to financial information. These factors include legal and
ethical issues, quality considerations, and strategic issues, among others.

3. The first step in management’s decision-making process is to determine the

decision alternatives.
Incorrect. The first step in the decision-making process is to identify the decision
problem.

4. Relevant costing is used for short-term decision making because it focuses only
on the costs and benefits that are relevant to the decision at hand.
Correct.

5. Under incremental analysis, variable costs will change under different courses of
action, but fixed costs will not change.
Incorrect. Under incremental analysis, sometimes variable costs will not change
under alternative courses of action, and sometimes fixed costs will change. It all
depends on the alternatives considered.

6. Decisions involve a choice among alternative courses of action.

Correct.

7. When using differential analysis, some costs will change under alternative
courses of action, but revenues will not change.
Incorrect. When using differential analysis, either costs or revenues or both will
change under alternative courses of action.

Managerial Accounting, 4/e 7-12

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7-3

Req. 1
Factors to Consider
Step 1: Identify
You need (or want) to buy another vehicle, presumably because
the decision
your old one is no longer fulfilling its purpose.
problem.
Step 2: What kind of vehicle should you buy (a car, a truck, an SUV)?
Determine the Should you buy a new or a used vehicle? What is your price
decision range? What fuel economy should the vehicle you buy offer?
alternatives. What other features are important to you?
Step 3: Evaluate
For each alternative, what is the difference in price, fuel
the costs and
economy, cost of insurance, cost of maintenance, reliability
benefits of the
ratings, future resale value, and other benefits or costs?
alternatives.
Step 4: Make Which cost and qualitative considerations, such as style and
the decision. function, outweigh the others?
Step 5: Review
Does the vehicle you purchased meet your needs? Is it reliable?
the results of
Are you comfortable in it? Can you make the payments?
the decision.

Req. 2

a. Irrelevant.
b. Irrelevant.
c. Relevant.
d. Relevant.
e. Relevant.
f. Irrelevant.
g. Relevant.
h. Relevant.
i. Relevant.

Req. 3

a. Yes, the $1,500 value of your current vehicle would be relevant because
you could sell it if you decided to buy a new car.
b. Yes, the 1,500 value of your current vehicle would be relevant because
you could sell it if you decided you don’t need a car. In addition, the cost of
on-campus parking would be relevant because you could avoid it if you did
not own a vehicle.

Managerial Accounting, 4/e 7-13

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7−4

Req. 1
Relevant Irrelevant Sunk Cost Qualitative
$450 spent on application fee X X
$8,000 per year tuition X
$60,000 salary with master’s degree X
$600 per month current rent X
$25,000 current salary X
Time spent with family and friends X X
$50,000 new salary X
$5,000 moving expenses X
$800 rent per month in new location X
Cultural activities in new location X X
Ability to have MLB season tickets X X

Req. 2
a. Rent will be $200 more per month if she accepts the job offer.
b. For the next two years, salary will be $25,000 ($50,000 − $25,000) more per year if
she accepts the job offer.
c. After two years, salary will be $10,000 ($60,000 − $50,000) more per year if she
completes the master’s degree.
d. Moving expenses are not differential (relevant) since the employer pays the cost.

E7-5

1. Sunk costs are costs that have already been incurred and are not relevant to
future decisions.
2. Capacity is a measure of the limit placed on a specific resource.
3. An opportunity cost is the forgone benefit of choosing to do one thing instead
of another.
4. Monthly utility costs are estimated to be $1,200 regardless of the course of
action; in this case the utility costs are considered an irrelevant cost .
5. When a company has not yet reached the limit on its resources, it has idle/
excess capacity .
6. A relevant cost has the potential to influence a particular decision and will
change depending on the alternative a manager selects.
7. At full capacity opportunity costs become relevant and should be incorporated
into the analysis.
8. When managers are forced to choose one alternative over another due to limited
employee time and equipment availability, the business manager is facing
opportunity costs.

Managerial Accounting, 4/e 7-14

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7−6

Req. 1
The special-order would increase profit by $150, as shown below:
Incremental revenue (1,000 × $5) $5,000
Incremental variable costs [1,000 × ($1.50 + $0.60 + $2.25)] ( 4,350)
Modification costs ( 500)
Incremental profit $ 150

Req. 2
Yes, net income will increase by $150 if the order is accepted.

Req. 3
The special-order would decrease profits by $350, as shown below:
Incremental revenue (1,000 × $4.50) $4,500
Incremental variable costs [1,000 × ($1.50 + $0.60 + $2.25)] ( 4,350)
Modification costs ( 500)
Incremental profit $ (350)

Req. 4
If MSI is operating at capacity, the indifference price is equal to the market price the
company would receive by selling to existing customers ($12.00 per unit) plus any
incremental costs to modify the program for the special order ($500). Thus, the
minimum price is (($12 × 1,000) + $500) / 1,000 units = $12.50.

Req. 5
Reasons to accept a special-order that does not immediately increase profits include
future potential sales to the school system, the ability to market the product to other
school systems, development of similar history programs for other states, etc.

E7−7

Req. 1
Relevant cost of making ($9 + $4 + $2) × 10,000 $150,000
Relevant cost of buying ($16 × 10,000) 160,000
Differential cost of making versus buying $ 10,000 (favors making)

Req. 2
All other factors equal, MSI should continue to make the hand-held control modules
because it is $10,000 less expensive than buying.

Managerial Accounting, 4/e 7-15

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7−7 (continued)

Req. 3
If there were $35,000 in potential profit that could be earned under the buy option, this
would change the decision so that it now favors buying the control modules. The
$35,000 can either be ADDED to the cost of making or SUBTRACTED from the buy
option, as shown below.

Relevant Cost of Making Cost of Buying Difference

$150,000 + $35,000 = $185,000 $160,000 $25,000
$150,000 $160,000 − $35,000 = $125,000 $25,000

Yes, this would change the recommendation to buying (outsourcing) because it is

$25,000 less expensive to buy than to make.

E7−8

Req. 1
Incremental Effect of Eliminating the Post Office Polka:
Decrease in sales revenue $(15,000)
Decrease in variable costs 10,000
Direct (avoidable) fixed costs 3,500
Effect on profit $(1,500) (Decreased profit)

Req. 2
MSI should not eliminate the product line because it would lose $15,000 in revenue and
only save $13,500 in costs, resulting in a $1,500 reduction in profit.

Req. 3
If MSI could avoid $3,700 of common fixed costs, it would save $2,200 by eliminating
the Post Office line.

Incremental Effect of Eliminating the Post Office Polka:

Decrease in sales revenue $ (15,000)
Decrease in variable costs 10,000
Avoidable fixed costs ($3,500 + $3,700) 7,200
Effect on profit $ 2,200 (Increased profit)

Yes, this would change the recommendation. In this case, MSI should eliminate the
product because the decrease in revenue is more than offset by the decrease in the
fixed costs.

Managerial Accounting, 4/e 7-16

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
 E7-9

Req. 1
CD Only CD with Instructions Materials Incremental
Sales revenue 50,000 × $20.00 =$1,000,000 50,000 × $35 = $1,750,000 $ 750,000
Variable costs 50,000 × $6.25 = (312,500) 50,000 × $13 = (650,000) (337,500)
Contribution margin $ 687,500 $1,100,000 $ 412,500
Additional development costs (65,000) (65,000)
Differential profit $ 687,500 $1,035,000 $ 347,500

Req. 2
MSI should process the program further to include instructional materials because it will
increase the company’s short-term profit by $347,500 (= $1,035,000 − $687,500).

Req. 3

CD Only CD with Instructions Materials Incremental

Sales revenue 50,000 × $20.00 =$1,000,000 32,000 × $35 = $1,120,000 $ 120,000
Variable costs 50,000 × $6.25 = (312,500) 32,000 × $13 = (416,000) (103,500)
Contribution margin $ 687,500 $ 704,000 $ 16,500
Additional development costs (65,000) (65,000)
Differential profit $ 687,500 $ 639,000 $ (48,500)

In this case, MSI should not process the programs further because it will lower MSI’s
net income by $48,500 (= $639,000 − $687,500).

E7−10

Qualitative factors to consider include:

 Special-order decision: employee morale if layoffs result from excess capacity
downtime, whether the customer would continue to expect reduced prices in the
future, whether the special-order would draw resources from other products to the
point that their quality or delivery time would be affected.
 Make-or-buy decision: quality, reliability of supplier, ability to change design as
needed, ability to lock in price, employee morale if layoffs occur, costs of re-training
work force for reassignment.
 Keep-or-drop decision: employee morale if layoffs result from eliminating a segment,
customer dissatisfaction if a popular item is dropped, potential effects on related
product lines.

Managerial Accounting, 4/e 7-17

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7-11

Req. 1
Relevant cost to make: ($65,000 + $55,000 + $30,000)/10,000 units = $15 per unit
Relevant cost to buy: $18 per unit
Differential cost of making versus buying: $18 − $15 = $3 more per unit to buy
Change in net income = $3 per unit × 10,000 units = $30,000 decrease in net income

Based strictly on the economic analysis, managers should continue to make the
remotes.

Req. 2
Relevant cost to make: ($65,000 + $55,000 + $30,000 + $50,000)/10,000 units = $20
per unit
Relevant cost to buy: $18 per unit + ($30,000/10,000 units) = $21 per unit
Differential cost of making versus buying: $20 − $21 = $1 more per unit to buy
Change in net income = $1 per unit × 10,000 units = $10,000 decrease in net income

Based strictly on the economic analysis, managers should continue to make the
remotes.

Req. 3
Relevant cost to make: ($65,000 + $55,000 + $30,000 + $50,000)/10,000 units = $20
per unit
Relevant cost to buy: $18 per unit + ($30,000/10,000 units) = $21 − 2 ($20,000/10,000
units from rental revenue) = $19 per unit
Differential cost of making versus buying: $20 − $19 = $1 less per unit to buy
Change in net income = $1 per unit × 10,000 units = $10,000 increase in net income

Based strictly on the economic analysis, managers should buy the remotes.

Managerial Accounting, 4/e 7-18

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7-12

Req. 1
Book Division Magazine Division Total
Sales revenue $7,800,000 $3,300,000 $11,100,000
Variable costs
Manufacturing costs 2,000,000 997,000 2,997,000
Operating expenses 135,000 198,000 333,000
Contribution margin 5,665,000 2,105,000 7,770,000
Direct fixed costs
Manufacturing 215,500 240,000 455,500
(20% Direct)
Operating expenses 1,749,600 713,400 2,463,000
(60% Direct)
Segment margin 3,699,900 1,151,600 4,851,500
Common fixed costs
Manufacturing costs 862,000 960,000 1,822,000
(80% Common)
Operating expenses 1,166,400 475,600 1,642,000
(40% Common)
Net income $1,671,500 $(284,000) $1,387,500

Req. 2
The company will lose $1,151,600 in segment margin if the magazine division is
eliminated. Since the common fixed costs will not change, this will reduce net income by
$1,151,600. The new net income would be $235,900, as shown in the income
statement below:

Book Division
Sales revenue $7,800,000
Variable costs
Manufacturing costs 2,000,000
Operating expenses 135,000
Contribution margin 5,665,000
Direct fixed costs
Manufacturing (20% Direct) 215,500
Operating expenses (60% Direct) 1,749,600
Segment margin 3,699,900
Common fixed costs*
Manufacturing costs 1,822,000
Operating expenses 1,642,000
Net income 235,900

*Note that total common fixed costs are constant, but must now be absorbed by the
Book division.

Managerial Accounting, 4/e 7-19

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7-12 (continued)

Net income before elimination of Magazine Division $1,387,500

Net income after elimination of Magazine Division 235,900
Decrease in net income $1,151,600

E7-13

Req. 1
CM / unit = Sales price − Variable cost
= $32 − ($6 + $3 + $2 + $2)
= $19.00 CM / unit for special-order units

Additional CM = 2,000 units × $19

= $38,000 additional CM

Ironwood should accept the special order because it will increase CM by $38,000.

Req. 2
Current CM / unit = Sales price − Variable cost
= $37.50 − ($6 + $3 + $2)
= $26.50 CM / unit

If Ironwood is at full capacity, it should not accept the special order because it would be
giving up sales that generate $26.50 / unit in CM in order to sell units that only generate
$19.00 in CM.

Req. 3
For the two choices to be equivalent, Ironwood would have to earn as much CM from the
special-order units as it does from its current sales.

Current variable cost / unit $11.00

Add’l VC / unit for special order 2.00
CM necessary to be equivalent 26.50
Special order price $39.50 per unit

Alternatively,
Current price / unit $37.50
+ Add’l VC / unit 2.00
Special order price / unit $39.50

So the price per unit of the special order would have to be $39.50 for Ironwood to be
indifferent to the choice.

Managerial Accounting, 4/e 7-20

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7-14

Req. 1
750,000/2 = 375,000 half gallons of ice cream

Req. 2
375,000 × $0.20 = $75,000

Req. 3
Wholesome should continue to sell the milk.

Milk Ice Cream Incremental

Sales revenue $2,227,500 $2,246,250 $ 18,750
Cost of process to make milk (1,250,000) (1,250,000) -0-
Additional costs to make ice cream -0- (75,000) (75,000)
Profit $ 977,500 $921,250 $ (56,250)

E7-15

Contribution Margin per Direct Labor Hour:

Product A: ($35 − $17) = $18 CM / 1.25 DL hours = $14.40 CM per DL hour
Product B: ($45 − $21) = $24 CM / 2 DL hours = $12 CM per DL hour
Product C: ($75 − $32) = $43 CM / 2.5 DL hours = $17.20 CM per DL hour

Thus, Cordova’s preference would be to produce Product C because it generates the

most CM per unit of the constrained resource, DL hours. Cordova’s second choice
would be Product A and last choice would be Product B, which produces the least CM
per DL hour.

E7-16

From E7-15, Cordova’s preferred order of production is Product C, Product A, Product

B.

Product Demand DLH/unit DLH Available DLH Consumed Units Produced DLH Remaining
C 4,000 2.5 40,000 10,000 4,000 30,000
A 18,000 1.25 30,000 22,500 18,000 7,500
B 12,000 2.0 7,500 7,500 3,750* 0
* 7,500 / 2

Cordova cannot meet full demand for Product B as there are only 7,500 DLH available.
It can produce 3,750 units of Product B with the 7,500 available hours.

Cordova’s production is 18,000 units of A, 4,000 units of C, and 3,750 units of B.

Managerial Accounting, 4/e 7-21

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
E7-17

1. Irrelevant because the cost will not change regardless of the decision made, in
either case the brakes must be repaired.
2. Irrelevant because the cost will be incurred regardless of the decision made, the
fixed overhead is unavoidable.
3. Irrelevant because the price charged for the product will not change across
decision alternatives.
4. Relevant.
5. Irrelevant because it’s a sunk cost, the cost is incurred regardless of the decision
whether to sell as is or process further.
6. Irrelevant because these costs will be incurred even if the company drops one of
its tire models.
7. Relevant.
8. Irrelevant because the flight crew must work regardless of whether the special
order is accepted or not.
9. Relevant.
10. Relevant.

Managerial Accounting, 4/e 7-22

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
ANSWERS TO GROUP A PROBLEMS

PA7−1

Req. 1
The special order would increase profit by $750, as shown below:
Incremental revenue (1,500 × $11.00) $16,500
Incremental variable costs [1,500 × ($5 + $2 + $3.50)] (15,750)
Incremental profit $ 750

An alternative way to answer this question is to compare the sales price of $11.00 to the
variable cost per unit of $10.50 ($5 + $2 + $3.50). Since the offer price is greater than
the variable cost per unit, each unit will add $0.50 in contribution margin ($11.00 −
$10.50). Since fixed costs will not increase (because the company has excess
capacity), the total increase in profit is $750 (1,500 units × $0.50 unit contribution
margin).

Req. 2
Yes, Mohave should accept the special order since net income will increase by $750 if
the order is accepted.

Req. 3
Total profit would decrease by $3,000:
Incremental revenue (2,000 × $9.00) $18,000
Incremental variable costs [2,000 × ($5 + $2 + $3.50)] (21,000)
Incremental loss $(3,000)

An alternative way to answer this question is to compare the new sales price of $9.00 to
the variable cost per unit of $10.50 ($5 + $2 + $3.50). Since the offer price is less than
the variable cost per unit, each unit will result in a loss of $1.50 in contribution margin.
Since fixed costs will not increase (because the company has excess capacity), the total
decrease in profit is $3,000 (2,000 units × $1.50 loss in unit contribution margin).

Req. 4
If Mohave was at full capacity, then the special order sales price would have to be
$19.00. At that price, Mohave is indifferent as to where it sells the units because the CM
and income generated by the units is the same.

Managerial Accounting, 4/e 7-23

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PA7−2

Req. 1
Relevant cost of making ($3 + $2 + $1 + ($2 × 40%)) × 8,000$ 54,400
Relevant cost of buying ($7.50 × 8,000) 60,000
Differential cost of making versus buying $ 5,600 (favors making)

Req. 2
Based strictly on the quantitative analysis, Mohave should continue to make the bags as
the relevant cost of making ($54,400) is less than the cost of buying ($60,000).

Req. 3
If there were $10,000 in potential profit that could be earned under the buy option, this
would change the decision so that it now favors buying the tote bags. The $10,000 can
either be ADDED to the cost of making or SUBTRACTED from the buy option, as
shown below.

Relevant Cost of Making Cost of Buying Difference

$54,400 + $10,000 = $64,400 $60,000 $4,400
$54,400 $60,000 − $10,000 = $50,000 $4,400

Either way, it is $4,400 less expensive to buy than to make.

Req. 4
If managers have a sustainability goal to increase the percentage of spending from local
suppliers, the outsourcing option would be less desirable because the supplier is
located in Vietnam.

Req. 5
Managers would want to consider a variety of other qualitative factors, such as whether
the supplier can provide the same quality product as they can make in-house. Are there
any risks or liability issues with outsourcing? Will the supplier use appropriate labor
standards, including providing safe working conditions, fair wages, and abiding by child
labor laws? How will outsourcing impact employees and other critical stakeholders?
What will happen to employees who are let go? Will the supplier hire them? How will it
impact the local community?   

Managerial Accounting, 4/e 7-24

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PA7−3

Req. 1
Mohave’s revised income statement if they drop the Azul line is shown below:

Indigo Verde Total

Sales revenue $60,000 × 110% = $66,000 $60,000 × 115% = $69,000 $135,000
Variable costs 34,000 × 110% = 37,400 31,000 × 115% = 35,650 73,050
Contribution margin 26,000 × 110% = 28,600 29,000 × 115% = 33,350 61,950
Less: direct fixed costs 1,900 2,500 4,400
Segment margin 26,700 30,850 57,550
Common fixed costs* 21,804 22,796 44,600
Profit $ 4,896 $ 8,054 $ 12,950

* It is not necessary to reallocate the fixed costs to calculate the incremental effect on profit. These costs
are irrelevant since they will not change.

However, if instructors wanted to show how the costs would be reallocated to the two product lines, the
computations are below:

Indigo’s share of the common fixed costs = $44,600 × ($66,000 / $135,000) = $21,804
Verde’s share of the common fixed costs = $44,600 × ($69,000 / $135,000) = $22,796

Since the company was earning $8,000 in net income WITH the Azul model, the
decision to drop it will increase net income by $4,950 ($12,950 − $8,000).

An alternative approach is to calculate the change in contribution margin that will result
from dropping the Azul model, as follows:

Change in Contribution Margin

Contribution margin gained on Indigo $26,000 × 10% = $ 2,600
Contribution margin gained on Verde $29,000 × 15% = 4,350
Contribution margin lost on Azul (4,000)
Net increase in contribution margin 2,950
Change in direct fixed costs 2,000
Net change in profit if Azul is eliminated $ 4,950

Req. 2
Based strictly on this financial analysis, Mohave should eliminate the Azul model.

Req. 3
If none of the fixed overhead costs could be avoided by dropping the Azul model, the
company should eliminate the model because it would increase profit by $2,950, as
shown below:

Managerial Accounting, 4/e 7-25

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
 PA7-3 (continued)

Change in Contribution Margin

Contribution margin gained on Indigo $26,000 × 10% = $ 2,600
Contribution margin gained on Verde $29,000 × 15% = 4,350
Contribution margin lost on Azul (4,000)
Net decrease in contribution margin 2,950
Change in fixed costs 0
Net change in profit if Azul is eliminated $ 2,950

PA7−4

Req. 1
Rosa Umbrella Decorated Umbrella Incremental
Sales revenue 10,000 × $8.00 = $80,000 10,000 × $19 = $190,000 $ 110,000
Variable costs 10,000 × $4.50 = (45,000) 10,000 × $12 = (120,000) (75,000)
Contribution margin $ 35,000 $ 70,000 $ 35,000
Additional development costs (10,000) (10,000)
Differential profit $ 35,000 $60,000 $ 25,000

Req. 2
Mohave should add the decorations to the Rosa umbrella because it will increase profit
by $25,000.

Req. 3
Rosa Umbrella Decorated Umbrella Incremental
Sales revenue 10,000 × $8.00 = $80,000 8,000 × $19 = $152,000 $ 72,000
Variable costs 10,000 × $4.50 = (45,000) 8,000 × $12 = (96,000) (51,000)
Contribution margin $ 35,000 $ 56,000 $ 21,000
Additional development costs (10,000) (10,000)
Differential profit $ 35,000 $46,000 $ 11,000

In this case, Mohave should still add the decorations to the Rosa umbrella because it
will increase profit by $11,000.
.

Managerial Accounting, 4/e 7-26

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PA7-5

Ben’s conclusion and analysis are both flawed as shown in the following schedule. The
company’s net income will decrease by $30,000 if the North East division is eliminated
because the contribution margin of the division will be lost if the division is eliminated.

Elimination of North East

Lost sales revenue ($200,000)
Avoidable variable expenses 170,000*
Lost contribution margin ($ 30,000)

*(153,000 − 33,000 + 96,000 − 46,000)

Managerial Accounting, 4/e 7-27

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PA7−6

Req. 1
Priority based on Contribution Margin per Direct Labor Hour:

Table A: ($38 − $9) = $29 CM / 0.5 DL hours = $58 CM per DL hour (Rank #2)
Table B: ($42 − $12) = $30 CM / 0.5 DL hours = $60 CM per DL hour (Rank #1)
Table C: ($56 − $17) = $39 CM / 1 DL hours = $39 CM per DL hour (Rank #3)

Req. 2
Product Demand DLH/unit DLH Available DLH Consumed Units Produced DLH Remaining
B 20,000 0.5 36,000 10,000 20,000 26,000
A 50,000 0.5 26,000 25,000 50,000 1,000
C* 30,000 1 1,000 1,000 1,000* 0
* 1,000 / 1

Blossom cannot meet full demand for Table C due to the limited direct labor hours
available. When demand for Tables B and A is met, there are 1,000 direct labor hours
remaining (36,000 − 10,000 − 25,000 = 1,000). Because each unit of Table C requires 1
direct labor hour, it can produce 1,000 units of Table C with the 1,000 remaining hours.

Req. 3
Contribution Margin per Machine Hour:
Product A: ($38 − $9) = $29 CM / 4 MHrs = $7.25 CM per MH (Rank #3)
Product B: ($42 − $12) = $30 CM / 2.5 MHrs = $12.00 CM per MH (Rank #2)
Product C: ($56 − $17) = $39 CM / 2.0 MHrs = $19.50 CM per MH (Rank #1)

Req. 4
From Req. 3, the preferred order of production is Table C, Table B, Table A.

Product Demand MH/unit MH Available MH Consumed Units Produced MH Remaining

C 30,000 2.0 230,000 60,000 30,000 170,000
B 20,000 2.5 170,000 50,000 20,000 120,000
A 50,000 4.0 120,000 120,000 30,000* 0
* 120,000 / 4.0

Blossom cannot meet full demand for Table A due to the limited machine hours
available. When demand for Tables C and B is met, there are 120,000 machine hours
remaining (230,000 − 60,000 − 50,000 = 120,000). Because each unit of Table A
requires 4 machine hours, it can product 30,000 units of Table A with the 120,000
remaining hours (120,000 / 4 = 30,000).

Managerial Accounting, 4/e 7-28

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PA7-7

Req. 1
The relevant costs and benefits in this decision are the incremental revenues and the
incremental costs incurred by Chino Company after the split-off point. The $400,000 in
joint costs is a sunk cost and is not relevant to the sell-or-process further decision.

Req. 2
Pants
Revenue at split-off: $120,000 (6,000 × $20)
Revenue after processing: 180,000 (6,000 × $30)
Incremental revenue: $ 60,000
Less incremental costs: 28,450
Increase (decrease) in profit: $ 31,550
Decision: Process further

Shirts
Revenue at split-off: $278,400 (12,000 × $23.20)
Revenue after processing: 388,800 (12,000 × $32.40)
Incremental revenue: $ 110,400
Less incremental costs: 64,400
Increase (decrease) in profit: $ 46,000
Decision: Process further

Coats
Revenue at split-off: $155,200 (4,000 × $38.80)
Revenue after processing: 172,800 (4,000 × $43.20)
Incremental revenue: $ 17,600
Less incremental costs: 18,300
Increase (decrease) in profit: $ (700)
Decision: Sell at split-off point

Req. 3
The decisions reached in Req. 2 would not change. The joint costs are sunk costs and
are not relevant to the sell-or-process further decision.

Managerial Accounting, 4/e 7-29

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PA7-8

Req. 1
Incremental Analysis of the Special Order for 20,000 Coffee Cups:

Per cup Total

Incremental revenue $8.00 $ 160,000
Less: incremental costs
Variable COGS* 4.10 82,000
Variable op. exp.** 0.30 6,000
Endorsement fee*** 3.00 60,000
Incremental profit $0.60 $ 12,000

*$492,000 × 80% = $393,600 / 96,000 = $4.10

**$36,000 × 80% = $28,800 / 96,000 = $0.30
***$60,000 / 20,000 = $3

Req. 2
Yes, Camino should accept the special order because company profits will increase by
$12,000 and the company has excess capacity of 24,000 units (96,000 / .8 = 120,000 −
96,000 = 24,000).

Req. 3
If Camino is operating at capacity, the company would need to receive its normal sales
price of $10 ($960,000 / 96,000) plus the incremental $3 endorsement fee per cup for a
total of $13 per cup.

Managerial Accounting, 4/e 7-30

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PA7-9

Req. 1
Incremental Analysis of Make-or-Buy for Awnings:

Make Buy Net income

increase (decrease)
Direct materials $ 70,000 $ 70,000
Direct labor 50,000 50,000
Variable OH 40,000 40,000
Fixed OH 32,000 $ 32,000
Purchase price 180,000 (180,000)
Total $192,000 $212,000 $(20,000)

Req. 2
Old Camp should continue to manufacture the awnings because purchasing the
awnings will cost the company an additional $20,000.

Req. 3
If Old Camp were able to produce net income of $22,000 from the released capacity, it
should purchase the awnings as shown below:

Make Buy Net income

increase (decrease)
Total (from Req. 1) $ 192,000 $212,000 $ (20,000)
Opportunity cost 22,000 22,000
Variable OH $ 214,000 $212,000 $ 2,000

Managerial Accounting, 4/e 7-31

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
ANSWERS TO GROUP B PROBLEMS

PB7−1

Req. 1
The special order would increase profit by $80, as shown below:
Incremental revenue (80 × $65) $ 5,200
Incremental variable costs [80 × ($30 + $22 + $12)] (5,120)
Incremental profit $ 80

An alternative way to answer this question is to compare the sales price of $65 to the
variable cost per unit of $64 ($30 + $22 + $12). Since the offer price is greater than the
variable cost per unit, each unit will add $1 in contribution margin ($65 − $64). Since
fixed costs will not increase (because the company has excess capacity), the total
increase in profit is $80 (80 units × $1 unit contribution margin).

Req. 2
Yes, Greenview should accept the special order since net income will increase by $80 if
the order is accepted.

Req. 3
Total profit would decrease by $400:
Incremental revenue (100 × $60) $ 6,000
Incremental variable costs [100 × ($30 + $22 + $12)] (6,400)
Incremental profit $(400)

An alternative way to answer this question is to compare the sales price of $60 to the
variable cost per unit of $64 ($30 + $22 + $12). Since the offer price is less than the
variable cost per unit, each unit will result in $4 less in contribution margin ($60 − $64).
Since fixed costs will not increase (because the company has excess capacity), the total
decrease in profit is $400 (100 units × $4 decrease in unit contribution margin).

Req. 4
If Greenview was at full capacity, then the special order sales price would have to be
$99.00. At that price, Greenview is indifferent as to where it sells the units because the
CM and short-term income generated by the units is the same.

Managerial Accounting, 4/e 7-32

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PB7−2

Req. 1
Relevant cost of making ($4 + $1 + $2 + ($3 × 30%)) × 1,000 $ 7,900
Relevant cost of buying ($9 × 1,000) 9,000
Differential cost of making versus buying $ 1,100 (favors making)

Req. 2
All other things held constant, Greenview should continue to make the chair pads as the
relevant cost of making ($7,900) is less than the cost of buying ($9,000).

Req. 3
There would have to be more than $1,100 in additional profit generated from another
product line for Greenview to be indifferent between making and buying the chair pads.

Req. 4
If managers have a sustainability goal to increase the percentage of spending from local
suppliers, the outsourcing option would be less desirable because the supplier is
located in China.

Req. 5
Managers would want to consider a variety of other qualitative factors, such as whether
the supplier can provide the same quality product as they can make in-house. Are there
any risks or liability issues with outsourcing? Will the supplier use appropriate labor
standards, including providing safe working conditions, fair wages, and abiding by child
labor laws? How will outsourcing impact employees and other critical stakeholders?
What will happen to employees who are let go? Will the supplier hire them? How will it
impact the local community?   

Managerial Accounting, 4/e 7-33

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
 PB7−3

Req. 1
Greenview’s revised income statement if they drop the Blanco model is shown below:

Sunrise Noche Total

Sales revenue $110,000 × 110% = $121,000 $77,000 × 105% = $80,850 $201,850
Variable costs 77,000 × 110% = 84,700 52,000 × 105% = 54,600 139,300
Contribution margin 33,000 × 110% = 36,300 25,000 × 105% = 26,250 62,550
Less: direct fixed costs 3,200 2,400 5,600
Segment margin 33,100 23,850 56,950
Common fixed costs* 20,142 13,458 33,600
Profit $ 12,958 $ 10,392 $ 23,350

* It is not necessary to reallocate the fixed costs to calculate the incremental effect on profit.
These costs are irrelevant since they will not change.

However, if instructors wanted to show how the costs would be reallocated to the two product
lines, the computations are below:

Sunrise’s share of the common fixed costs = $33,600 × ($121,000 / $201,850) = $20,142
Noche’s share of the common fixed costs = $33,600 × ($80,850 / $201,850) = $13,458

Since the company was earning $23,300 in net income WITH the Blanco model, the
decision to drop it will increase net income by $50 ($23,300 − $23,350).

An alternative approach is to calculate the change in contribution margin and fixed costs
that will result from dropping the Blanco model, as follows:

Change in Contribution Margin

Contribution margin gained on Sunrise $33,000 × 10%= $ 3,300
Contribution margin gained on Noche $25,000 × 5%= 1,250
Contribution margin lost on Blanco (7,500)
Net decrease in contribution margin (2,950)
Decrease in direct fixed costs 3,000
Net change in profit if Blanco is eliminated $ 50

Req. 2
Based strictly on this financial analysis, Greenview should eliminate the Blanco model.

Req. 3
If $3,800 in fixed overhead costs could be avoided by dropping the Blanco model, the
company should drop the line because it will have an $850 increase in profit, as shown
below:

Managerial Accounting, 4/e 7-34

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
 PB7-3 (continued)

Change in Contribution Margin

Contribution margin gained on Sunrise $33,000 × 10% = $ 3,300
Contribution margin gained on Noche $25,000 × 5% = 1,250
Contribution margin lost on Blanco (7,500)
Net decrease in contribution margin (2,950)
Decrease in direct fixed costs 3,800
Net change in profit if Blanco is eliminated $ 850

PB7−4

Req. 1
Unfinished Bookcases Finished Bookcases Incremental
Sales revenue 8,000 × $50.00 = $ 400,000 8,000 × $80.00 = $ 640,000 $ 240,000
Variable costs 8,000 × $19.50 = (156,000) 8,000 × $36.50 = (292,000) (136,000)
Contribution margin $ 244,000 $ 348,000 $ 104,000
Additional development costs (75,000) (75,000)
Differential profit $ 244,000 $ 273,000 $ 29,000

Req. 2
Greenview should process the bookcase further because it will increase the company’s
net income by $29,000 (= $273,000 − $244,000).

Req. 3
Unfinished Bookcases Finished Bookcases Incremental
Sales revenue 8,000 × $50.00 = $ 400,000 6,500 × $80.00 = $ 520,000 $ 120,000
Variable costs 8,000 × $19.50 = (156,000) 6,500 × $36.50 = (237,250) (81,250)
Contribution margin $ 244,000 $ 282,750 $ 38,750
Additional development costs (75,000) (75,000)
Differential profit $ 244,000 $ 207,750 $ (36,250)

In this case, Greenview should not process the bookcase further because it will lower
company net income by $36,250 ($207,750 − $244,000).

Managerial Accounting, 4/e 7-35

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PB7-5

Barb’s conclusion and analysis are both flawed as shown in the following schedule.
The company’s net income will decrease by $111,000 if the Colorado division is
eliminated because the contribution margin of the division will be lost if the division is
eliminated.

Elimination of Colorado
Lost sales revenue ($300,000)
Avoidable variable expenses 189,000*
Lost contribution margin ($111,000)

*(153,000 − 70,000 + 196,000 − 90,000)

Managerial Accounting, 4/e 7-36

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PB7−6

Req. 1
Contribution Margin per Pound of Beeswax:
Candle X: ($18 − $5) = $13 CM / 1.5 lbs. = $8.67 CM per lb. (Rank #1)
Candle Y: ($20 − $7) = $13 CM / 2 lbs. = $6.50 CM per lb. (Rank #2)
Candle Z: ($24 − $11.50) = $12.50 CM / 2 lbs. = $6.25 CM per lb. (Rank #3)

Req. 2
From Req. 1, the preferred order of production is Candle X, Candle Y, Candle Z.
Product Demand Lbs./unit Lbs. Available Lbs. Consumed Units Produced Lbs. Remaining
X 22,000 1.5 50,000 33,000 22,000 17,000
Y 8,000 2.0 17,000 16,000 8,000 1,000
Z 15,000 2.0 1,000 1,000 500* 0
* 1,000 / 2

Prospector cannot meet full demand for Candle Z due to the limited amount of beeswax
available. When the demand for Candles × and Y is met, there are 1,000 pounds of
beeswax remaining (50,000 − 33,000 − 16,000 = 1,000). Because each unit of Candle Z
requires 2 pounds of beeswax, it can produce 500 units of Candle Z with the 1,000
available pounds.

Req. 3
Contribution Margin per Direct Labor Hour:
Candle X: ($18 − $5) = $13 CM / 5.0 DLH = $2.60 CM per DLH (Rank #1)
Candle Y: ($20 − $7) = $13 CM / 6.0 DLH = $2.16 CM per DLH (Rank
#3)
Candle Z: ($24 − $11.50) = $12.50 CM / 5.0 DLH = $2.50 CM per DLH (Rank #2)
Req. 4

From Req. 3, the preferred order of production is Candle X, Candle Z, Candle Y.

Product Demand DLH/unit DLH Available DLH Consumed Units Produced DLH Remaining
X 22,000 5.0 215,000 110,000 22,000 105,000
Z 15,000 5.0 105,000 75,000 15,000 30,000
Y 22,000 6.0 30,000 30,000 5,000* 0
* 30,000 / 6

Prospector cannot meet full demand for Candle Y due to the limited direct labor hours.
When demand for Candles × and Z is met, there are 30,000 direct labor hours remaining
(215,000 − 110,000 − 75,000 = 30,000). Because each unit of Candle Y requires 6 direct
labor hours, it can produce 5,000 units of Candle Z with the 30,000 direct labor hours
remaining.

Managerial Accounting, 4/e 7-37

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PB7-7

Req. 1
The relevant costs and benefits in this decision are the incremental revenues and the
incremental costs incurred by Golden Trophy Inc. after the split-off point. The $360,000
in joint costs is a sunk cost and is not relevant to the sell-or-process further decision.

Req. 2
Trophy A
Revenue at split-off: $472,500 (4,500 × $105)
Revenue after processing: 498,600 (4,500 × $110.80)
Incremental revenue: $ 26,100
Less incremental costs: 46,200
Increase (decrease) in profit: $ (20,100)
Decision: Sell at split-off point

Trophy B
Revenue at split-off: $570,400 (6,200 × $92.00)
Revenue after processing: 734,700 (6,200 × $118.50)
Incremental revenue: $ 164,300
Less incremental costs: 85,500
Increase (decrease) in profit: $ 78,800
Decision: Process further

Trophy C
Revenue at split-off: $121,814 (980 × $124.30)
Revenue after processing: 143,570 (980 × $146.50)
Incremental revenue: $ 21,756
Less incremental costs: 22,450
Increase (decrease) in profit: $ (694)
Decision: Sell at split-off point

Req. 3
The decisions reached in Req. 2 would not change. The joint costs are sunk costs and
are not relevant to the sell-or-process further decision.

Managerial Accounting, 4/e 7-38

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PB7-8

Req. 1
Incremental Analysis of the Special Order for 25,000 Pillows:

Per pillow Total

Incremental revenue $10.00 $250,000
Less: incremental costs
Variable COGS* 6.75 168,750
Variable op. exp.** 1.50 37,500
Endorsement fee*** 2.00 50,000
Incremental profit $(0.25) $ (6,250)

*$1,036,800 × 75% = $777,600 / 115,200 = $6.75

**$230,400 × 75% = $172,800 / 115,200 = $1.50
***$50,000 / 25,000 = $2

Req. 2
No, Shasta should not accept the special order because company profits will decrease
by $6,250. Although the company has excess capacity of 28,800 units (115,200 / .8 =
144,000 − 115,200 = 28,800), this special order would cost the company more than the
special order price offered by Honeysuckle Community College.

Req. 3
If Shasta is operating at capacity, the company would need to receive its normal sales
price of $12 ($1,382,400 / 115,200) plus the incremental $2 endorsement fee per pillow
for a total of $14 per pillow.

Managerial Accounting, 4/e 7-39

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
PB7-9

Req. 1
Incremental Analysis of Make-or-Buy for Glass Screens

Make Buy Net income

increase (decrease)
Direct materials $200,000 $ 200,000
Direct labor 160,000 160,000
Variable OH 120,000 120,000
Fixed OH 48,000 $ 48,000
Purchase price 520,000 (520,000)
Total $528,000 $568,000 $(40,000)

Req. 2
Gold Dust should continue to manufacture the glass screens because purchasing the
screens will cost the company an additional $40,000.

Req. 3
If Gold Dust were able to produce net income of $38,000 from the released capacity, it
should still continue to make the glass screens as shown below:

Make Buy Net income

increase (decrease)
Total (from Req. 1) $528,000 $568,000 $ (40,000)
Opportunity cost 38,000 38,000
Variable OH 566,000 $568,000 $ (2,000)

Managerial Accounting, 4/e 7-40

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
ANSWERS TO SKILLS DEVELOPMENT CASES
S7−1

Req. 1
PED = % Change in Demand
% Change in Price

PED = [(24,000,000 − 25,000,000) / 25,000,000]

[($16.00 − $10.00] / $10.00

PED = 4% Decrease in Demand

60% Increase in Price

PED = -0.067

The absolute value of PED is less than one, indicating that Netflix’s demand was
relatively inelastic to the change in price. In this case, a 60% increase in price only
resulted in a 4% decrease in demand. Note that PED is negative because there is an
inverse relationship between price and demand, as is the case for most goods and
services.

Req. 2
Old Pricing Plan New Pricing Plan
Revenue Streaming video revenue
(25,000,000 × $10) $ 250,000,000 (21,000,000 × $8) $ 168,000,000
Variable costs DVD-by-mail
(25,000,000 × (5 × $0.40)) 50,000,000 (15,000,000 × $8) 120,000,000
Contribution margin $ 200,000,000 Total Revenue $ 288,000,000
Variable Costs
(15,000,000 × (5 × $0.40)) 30,000,000
Contribution Margin $ 258,000,000

Increase in Contribution Margin $ 58,000,000

Managerial Accounting, 4/e 7-41

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
S7−1 (continued)

Assuming fixed costs remain constant in the short-run, the pricing change would boost
short-term profits by $58,000,000.

Req. 3
Answers will vary.

Req. 4
Answers will vary. As an additional assignment, you could ask students to research
what happened to Netflix’s stock price in the days and months after the price change.

Req. 5
This was most likely not an attempt to boost short-term profits, but rather a strategic
decision on the part of Netflix to focus their future direction on streaming video rather
than DVD by mail.

Req. 6
Answers will vary.

S7−2

Req. 1
No, WTS won’t see an immediate impact of $582,000 in cost savings because some of
these expenses won’t be fully eliminated.

Req. 2
Scholarships: Probably only partially eliminated since schools often continue the
scholarship commitments to student athletes for a period of time or until they transfer to
other colleges.

Coaches’ Salaries: Fully eliminated for any coach who immediately finds a position at
another college. Only partially eliminated (or perhaps not eliminated) for any coach who
stays with WTS in another capacity. For example, the men’s diving coach may also be
the coach for women’s diving and the swim teams that are all being retained.

Team Travel: Fully eliminated.

Venue maintenance: Partially eliminated or not eliminated. Presumably, the venue for
each cancelled sport is also used by another sport (lacrosse field also used by soccer
teams, softball field also used by baseball team, pool also used by swim teams).

Equipment: Partially eliminated if some of the equipment is used by other teams.

Managerial Accounting, 4/e 7-42

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
S7−2 (continued)

Team Support: This category could include items such as weight rooms, trainers,
academic tutoring, etc. Most of these items are shared with other teams so would only
be partially eliminated at best.

Req. 3
Answers will vary.

Req. 4
Sports such as football and basketball generally bring in the most revenue and are
much more likely to be “profitable” for the university. They are also the most visible
sports on a national level and can sometimes help advertise a school by getting its
name out to a wider audience. For example, small schools that make it into the NCAA
basketball tournament get recognition on a national level that they wouldn’t otherwise
receive. These sports are also the ones most likely to be followed and supported by
college alumni.

Req. 5
Answers will vary. In conjunction with the “reactions” section of this requirement, some
students may bring up the Title IX (“Title 9”) Education Amendment of 1972. A number
of people feel that this amendment forces the elimination of men’s sports and may give
women’s sports an unfair “protection” from budget cuts. Therefore, you should do some
research of your own in order to lead this discussion effectively.

S7−3

Answers will vary, but students should demonstrate an understanding of both sides of
the decision — Walmart’s focus on profits and the impact on consumers, especially
those in more rural areas.

S7−4

Student answers will vary, but students should demonstrate an understanding of both
the company and the employee/consumer/community sides of the issue.

Managerial Accounting, 4/e 7-43

Copyright © 2020 McGraw-Hill Education.  All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.