ACCT200 Chapter Notes - Chapter 13: Sunk Costs, Contribution Margin, Fixed Cost
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The Johnny Pickles Brewing Company is considering adding a newpiece of equipment to the beer making process. No additional spacewill be required if the new equipment is added. Theequipment will result in an increase in production as well asimprovement in quality that should allow the brewery to increasethe price it charges for its premium beers. Determine if the itemsbelow are relevant to the decision to add additional equipment.
| Consideration | Relevant/Irrelevant |
| Rent on the building where the beer is made. No additionalspace required. | [ Select ] ["Relevant", "Irrelevant"] |
| The amount the brewery spends on raw materials | [ Select ] ["Relevant", "Irrelevant"] |
| The top line sales revenue for the brewery | [ Select ] ["Irrelevant", "Relevant"] |
| The cost of the new equipment | [ Select ] ["Irrelevant", "Relevant"] |
| The future salvage of the existing equipment | [ Select ] ["Irrelevant", "Relevant"] |
With respect to pricing, when a company offers a unique, indemand product, it is most likely a [ Select ] ["Cost Plus", "Target Pricing", "PriceTaker", "Market Leader", "Price Setter"] and it will most likely target a [ Select ] ["Cost Plus", "Price Setter", "MarketLeader", "Price Taker", "Target Pricing"] model for setting its price. Conversely, when a companyoffers a relatively undifferentiated product with relativelyaverage demand it would most likely be considereda [Select ] ["Target Pricing", "MarketLeader", "Price Taker", "Price Setter", "Cost Plus"] and would utilize a [ Select ] ["Market Leader", "Price Setter", "CostPlus", "Price Taker", "Target Pricing"] model for setting the price of its products.
The income statement for Bauer Online Real Estate Training ispresented below. The management team at the real estate trainingcompany is not pleased with the performance of their residentialreal estate training line and is considering dropping it. A coststudy of the residential training line has revealed that $42794 ofthe Selling and $33028 of the Administrative fixed expenses cannotbe avoided if the residential real estate training line is dropped.If the management at Bauer Online Real Estate Training decides todrop the line, what will the new company net income be? Calculateyour answer to the nearest whole dollar.
| Total | Residential | Commercial | |
| Sales Revenue | $527000 | $185000 | $342000 |
| Variable Costs | 112000 | 34000 | 78000 |
| Contribution Margin | 415000 | 151000 | 264000 |
| Fixed Costs: | |||
| Selling | 185000 | 88000 | 97000 |
| Administrative | 203000 | 94000 | 109000 |
| Total Fixed Expenses | 388000 | 182000 | 206000 |
| Operating Income (Loss) | $27000 | $(31000) | $58000 |
Make or Buy Decision
American Motor Company annually manufactures 100,000 units ofits Part No. 42356, a bearing, for use in the production of itsautomobiles. The following costs will be incurred for this part inthe current year:
| Direct Materials | $200,000 |
| Direct Labor | 550,000 |
| Variable Factory Overhead | 450,000 |
| Fixed Factory Overhead | 700,000 |
| Total | $1,900,000 |
Smaller Manufacturing Co. has offered to sell American 50,00bearings at a cost of $18 per unit. If the offer is accepted,American can terminate its lease on certain existing facilities atan annual savings of $150,000. In addition, $4 per unit of thefixed overhead utilized for manufacture of the bearing would beeliminated.
Required:
Using the relevant cost approach, determine if American shouldmake or buy the bearings.
B). What qualitative factor(s) may affect the decision?
Tactical decision making
Tactical decision making means choosing among alternatives withan immediate or limited end in view. For example, a company mayaccept a special order for less than the normal selling price touse idle capacity. Tactical decisions tend to be short-runin nature; however, it should be emphasized that short-rundecisions often have long-run consequences. A general tacticaldecision-making model is outlined here.
| 1. | Recognize and define theproblem. |
| 2. | Identify possible alternativesolutions to the problem, and eliminate any unfeasiblealternatives. |
| 3. | Identify the costs and benefitsassociated with each feasible alternative. Eliminate the costs andbenefits that are not relevant to the decision. |
| 4. | Compare the relevant costsand benefits for each alternative. |
| 5. | Assess qualitative factors. |
| 6. | Select the alternative with thegreatest overall benefit. |
Identifying and comparing relevant costs and revenues is theheart of the tactical decision model. Relevant costs (revenues) arefuture costs (revenues) that differ across alternatives. (Revenuesare treated in the same way as costs, so we will simplify thediscussion by referring to costs.) All decisions relate to thefuture; so, only future costs can be relevant. In addition, thecost must differ from one alternative to another. If a future costis the same for more than one alternative, it has no effect on thedecision. Such a cost is an irrelevant cost.
Assume that Reeves Company is considering accepting a specialorder for $25 per unit when the normal selling price is $30 perunit. Reeves has enough excess capacity to make the order withoutdisplacing normal sales. The alternatives facing Reeves Company are(Select "Yes" for the statements that are applicable and "No" forthe items that do not apply):
| Accept the special order. | - Select your answer -YesNoItem1 |
| Reject the special order. | - Select your answer -YesNoItem2 |
| Sell normal sales for $25 perunit. | - Select your answer -YesNoItem3 |
Choose which of the following are relevant in deciding whetheror not to accept the special order. (Select "Yes" for thestatements that are applicable and "No" for the items that do notapply)
| $25 price. | - Select your answer -YesNoItem4 |
| $30 normal price. | - Select your answer -YesNoItem5 |
| Variable cost of making the unitsin the special order. | - Select your answer -YesNoItem6 |
| Depreciation on factory equipmentused in making the special order units. | - Select your answer -YesNoItem7 |
| Increased property taxes on thefactory building which are due while the special order would bemade. | - Select your answer -YesNoItem8 |
While cost and revenue information is important, otherinformation may be needed to make an informed decision. Thesenon-financial factors are termed qualitative and are often relevantin decision making. For example, in deciding whether to make acomponent in-house or purchase it from an outside supplier, thecompany may consider any difference in quality or in responsivenessto the company's production schedules.
