In Class #12.1 – Dropping or Retaining a Segment
Required
If the Bath Department is dropped, what will be the effect on the operating income of the company as
a whole?
Contribution margin lost if the Bath Department is dropped:
Lost from the Bath Department.....................................................$700,000.......
Lost from the Kitchen Department (10% × $2,400,000).............................. 240,000
Total lost contribution margin.......................................................940,000............
Less avoidable fixed costs ($900,000 – $370,000).....................................530,000
Decrease in overall operating income................................................$410,000......
1 In Class #12.2 – Make or Buy a Component
Required 1:
Assuming that the company has no alternative use for the facilities now be ing used to produce the
thermostat, should the outside supplier’s offer be accepted? Show all computations.
1. Per Unit
Differential
unsis 15,000
Make Buy Make Buy
Cost of purchasing........................................ $20 $300,000
Directmaterials..................................$ 6........ $ 90,000
Direlatbo...................................8........... 120,000
Variabmleanufacturogverhe................1 15,000
Fixed manufacturing overhead, traceable 1.... 2 30,000
Fixed manufacturing overhead, common ..... 0 0 0 0
Totcl..t.s.................................................. $1$20 $255,000 $300,000
Difference in favour of continuing to make
the parts............................................$3....... $45,000
1Only the supervisory salaries can be avoided if the parts are purchased. The remaining
book value of the special equipment is a sunk cost; hence, the $3 per unit depreciation
expense is not relevant to this decision. Based on these data, the company should reject
the offer and should continue to produce the parts internally.
Required 2:
Suppose that if the thermostats were purchased, Climate-Control, Inc., could use the freed capacity to
launch a new product. The segmen t margin of the new product would be $65,000 per year. Should
Climate-Control, Inc., accept the offer to buy the thermostats from the outside supplier for $20 each?
Show computations.
2. Make Buy
Cost of purchasing (part 1) ................................................ $300,000
Cost of making (part 1)...........................................$255,000...
Opportunity cost—segment margin forgone on a potential
new product line...................................................65,000....
Totc...t........................................................................ $3$300,000
Difference in favour of purchasing from the outside
supplier .................................................................$20,000...
Thus, the company should accept the offer and purchase the parts from the outside supplier.
2 In Class #12.3 – Evaluating a Special Order
Required:
What effect would accepting this order have on the company’s operating income if a special price of
$349.95 is offered per bracelet for this order? Should the special order be accepted at this price?
Only the incremental costs and benefits are relevant. In particular, only the variable manufacturing
overhead and the cost of the special tool are relevant overhead costs in this situation. The other
manufacturing overhead costs are fixed and are not affected by the decision.
Total Per
bracelets 10 Unit
Incrementa revenu........................................$349.95... $3,499.50
Incrementa closts:
Variacblets:
Dmia...t..l.s.........................43.00......1,430.00
Dl.r...t.r.........................................860.00.00
Varmiaanefactuvri................... 7.00 70.00
Special filigree..................................................6.00 60.00
Total variable cost..............................................$242.00 2,420.00
Fixed costs:
Purchase of special tool..................................... 465.00
Total incremental cost............................................... 2,885.00
Incremental operating income .................................. $ 614.50
Even though the price for the special order is below the company's regular price for such an item, the
special order would add to the company’s operating income and should be accepted. This conclusion
would not necessarily follow if the special order affected the regular selling price of bracelets or if it
required the use of a constrained resource.
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