Incremental Analysis

INCREMENTAL ANALYSIS
TRUE-FALSE STATEMENTS
1.
An important step in management's decision-making process is to determine and evaluate

possible courses of action.
2.
In making decisions, management ordinarily considers both financial and nonfinancial

information.
3.
In incremental analysis, total variable costs will always change under alternative courses
of action, and total fixed costs will always remain constant.
4.
Accountants are mainly involved in developing nonfinancial information for management's

consideration in choosing among alternatives.
5.
Decision-making involves choosing among alternative courses of action.
6.
Financial data are developed for a course of action under an incremental basis and then it
is compared to data developed under a differential basis before a decision is made.
7.
A special one-time order should never be accepted if the unit sales price is less than the
unit variable cost.
8.
If a company has excess capacity and present markets will not be affected, it would be
profitable to accept an order at a special unit price even though the price is less than the
unit variable cost to manufacture the item.
9.
A company should never accept an order for its product at less than its regular sales price.
10.
A decision whether to continue to make a product or buy it externally, depends on the

external price and the amount of variable and fixed costs that can be eliminated assuming
no alternative uses of resources.
11.
An opportunity cost is the potential benefit obtained by using resources in an alternative

course of action.
12.
If an incremental make or buy analysis indicates that it is cheaper to buy rather than make
an item, management should always make the decision to choose the lowest cost
alternative.
13.
In a sell or process further decision, management should process further as long as the
incremental revenues from additional processing exceed the incremental variable costs.
14.
It is always better to sell now rather than process further because of the time value of
money.
15.
In a decision concerning replacing old equipment with new equipment, the book value of
the old equipment can be considered a sunk cost.
Incremental Analysis
9-2
16.
In a decision to retain or replace old equipment, the salvage value of the old equipment is
relevant in incremental analysis.
17.
It is better not to replace old equipment if it is not fully depreciated.
18.
From a quantitative standpoint, a segment should be eliminated if its contribution margin

is less than the fixed costs that can be eliminated.
19.
The elimination of an unprofitable product line may adversely affect the remaining product
lines.
20.
Sales mix is the relative combination in which a companys products are sold.
21.
Break-even sales can be computed for a mix of two or more products by determining the
total contribution margin of all the products.
22.
Net income will be greater if more high contribution margin units are sold than low
contribution margin units at any given level of units sold.
23.
When a company has limited resources to manufacture products, it should manufacture

those products which have the highest contribution margin per unit of limited resource.
24.
If a company has only a certain number of machine hours available for production, it is
generally more profitable to produce and sell the product with the highest unit contribution
margin.
25.
Contribution margin per unit of limited resource is usually the same as contribution margin
per unit.
Answers to True-False Statements

Item
1.
2.
3.
4.
Ans.
T
T
F
F
Item
5.
6.
7.
8.
Ans.
T
F
T
F
Item
9.
10.
11.
12.
Ans.
F
T
T
F
Item
13.
14.
15.
16.
Ans.
F
F
T
T
Item
17.
18.
19.
20.
Ans.
F
T
T
T
Item
21.
22.
23.
24.
Ans.
F
T
T
F
Item
25.
Ans.
9-3
MULTIPLE CHOICE QUESTIONS

26.
A major accounting contribution to the managerial decision-making process in evaluating

possible courses of action is to
a. assign responsibility for the decision.
b. provide relevant revenue and cost data about each course of action.
c. determine the amount of money that should be spent on a project.
d. decide which actions that management should consider.
27.
Which of the following stages of the management decision-making process is improperly

sequenced?
a. Evaluate possible courses of action Make decision.
b. Assign responsibility for decision Identify the problem.
c. Identify the problem Determine possible courses of action.
d. Assign responsibility for decision Determine possible courses of action.
28.
Internal reports that review the actual impact of decisions are prepared by
a. department heads.
b. the controller.
c. management accountants.
d. factory workers.
29.
Which of the following steps in the management decision-making process does not
generally involve the managerial accountant?
a. Determine possible courses of action.
b. Make the appropriate decision based on relevant data.
c. Prepare internal reports that review results of decisions.
d. None of these
30.
The process of evaluating financial data that change under alternative courses of action is
called
a. double entry analysis.
b. contribution margin analysis.
c. incremental analysis.
d. cost-benefit analysis.
31.
Nonfinancial information that management might evaluate in making a decision would not
include
a. employee turnover.
b. contribution margin.
c. the environment.
d. the corporate profile in the community.
32.
Incremental analysis is synonymous with

a. difficult analysis.
b. differential analysis.
c. gross profit analysis.
d. derivative analysis.
9-4
Test Bank for Managerial Accounting, Second Edition

33.
In incremental analysis,
a. only costs are analyzed.
b. only revenues are analyzed.
c. both costs and revenues may be analyzed.
d. both costs and revenues that stay the same between alternate courses of action will
be analyzed.
34.
Incremental analysis is most useful

a. in developing relevant information for management decisions.
b. in choosing between the net present value method and the internal rate of return
method.
c. in evaluating the master budget.
d. as a replacement technique for variance analysis.
35.
The source of data to serve as inputs in incremental analysis is generated by

a. market analysts.
b. engineers.
c. accountants.
d. all of these.
36.
Which of the following is not a true statement?

a. Incremental analysis might also be referred to as differential analysis.
b. Incremental analysis is the same as CVP analysis.
c. Incremental analysis is useful in making decisions.
d. Incremental analysis focuses on decisions that involve a choice among alternative
courses of action.
37.
Incremental analysis would not be appropriate for

a. a make or buy decision.
b. an allocation of limited resource decision.
c. elimination of an unprofitable segment.
d. analysis of manufacturing variances.
38.
Incremental analysis would be appropriate for

a. acceptance of an order at a special price.
b. retain or replace equipment.
c. sell or process further.
d. all of these.
39.
Which of the following is a true statement about cost behaviors in incremental analysis?
1. Fixed costs will not change between alternatives.
2. Fixed costs may change between alternatives.
3. Variable costs will always change between alternatives.
a. 1
b. 2
c. 3
d. 2 and 3
40.
9-5
A company is considering the following alternatives:

Revenues
Variable costs
Fixed costs
Alternative 1
$120,000
60,000
35,000
Alternative 2
$120,000
70,000
35,000
Which of the following are relevant in choosing between the alternatives?

a. Variable costs
b. Revenues
c. Fixed costs
d. Variable costs and fixed costs
41.
Adler Company manufactures a product with a unit variable cost of $50 and a unit sales
price of $88. Fixed manufacturing costs were $240,000 when 10,000 units were produced
and sold. The company has a one-time opportunity to sell an additional 3,000 units at $70
each in a foreign market which would not affect its present sales. If the company has
sufficient capacity to produce the additional units, acceptance of the special order would
affect net income as follows:
a. Income would decrease by $12,000.
b. Income would increase by $12,000.
c. Income would increase by $210,000.
d. Income would increase by $60,000.
42.
In incremental analysis,
a. costs are not relevant if they change between alternatives.
b. all costs are relevant if they change between alternatives.
c. only fixed costs are relevant.
d. only variable costs are relevant.
43.
If a plant is operating at full capacity and receives a one-time opportunity to accept an

order at a special price below its usual price, then
a. only variable costs are relevant.
b. fixed costs are not relevant.
c. the order will likely be accepted.
d. the order will likely be rejected.
44.
If a company must expand capacity to accept a special order, it is likely that there will be
a. an increase in unit variable costs.
b. no increase in fixed costs.
c. an increase in variable and fixed costs per unit.
d. an increase in fixed costs.
45.
Which of the following is true if a company can accept a special order without affecting its
regular sales and is within plant capacity?
a. Net income will not be affected.
b. Net income will increase if the special sales price per unit exceeds the unit variable
costs.
c. Net income will decrease.
d. Additional fixed costs will probably be incurred.
9-6
46.
If a company anticipates that other sales will be affected by the acceptance of a special
order, then
a. lost sales should be considered in the incremental analysis.
b. lost sales should not be considered in the incremental analysis.
c. the order should not be accepted.
d. the order will only be accepted if the plant is below capacity.
47.
An opportunity cost
a. should be initially recorded as an asset.
b. is the cost of a new product proposal.
c. is the potential benefit that may be obtained by following an alternative course of
action.
d. is classified as manufacturing overhead.
48.
Opportunity cost must be considered in decisions involving

a. budgeting.
b. financial accounting.
c. CVP analysis.
d. resources that have alternative uses.
49.
The opportunity cost of an alternate course of action that is relevant to a make or buy
decision is
a. subtracted from the "Make" costs.
b. added to the "Make" costs.
c. added to the "Buy" costs.
d. none of these.
50.
Opportunity cost is usually

a. a standard cost.
b. a potential benefit.
c. a sunk cost.
d. included as part of cost of goods sold.
Use the following information for questions 5152.

Sam's Manufacturing Company can make 100 units of a necessary component part with the
following costs:
Direct Materials
Direct Labor
Variable Overhead
Fixed Overhead
51.
$80,000
13,000
40,000
27,000
If Sam's Manufacturing Company purchases the component externally, $20,000 of the

fixed costs can be avoided. At what external price for the 100 units is the company
indifferent between making or buying?
a. $160,000.
b. $113,000.
c. $153,000.
d. $133,000.
9-7
52.
If Sam's Manufacturing Company can purchase the component externally for $145,000
and only $4,000 of the fixed costs can be avoided, what is the correct make or buy
decision?
a. Make and save $8,000
b. Buy and save $8,000
c. Make and save $20,000
d. Buy and save $20,000
53.
Cole's Shop can make 1,000 units of a necessary component with the following costs:
Direct Materials
Direct Labor
Variable Overhead
Fixed Overhead
$64,000
16,000
8,000
?
The company can purchase the 1,000 units externally for $104,000. The unavoidable
fixed costs are $5,000 if the units are purchased externally. An analysis shows that at this
external price, the company is indifferent between making or buying the part. What are the
fixed overhead costs of making the component?
a. $21,000.
b. $16,000.
c. $11,000.
d. Cannot be determined.
Use the following information for questions 5455.
May Company produces 1,000 units of a necessary component with the following costs:
Direct Materials
Direct Labor
Variable Overhead
Fixed Overhead
$48,000
32,000
8,000
14,000
54.
May Company could avoid $6,000 in fixed overhead costs if it acquires the components
externally. If cost minimization is the major consideration and the company would prefer
to buy the components, what is the maximum external price that May Company would
accept to acquire the 1,000 units externally?
a. $102,000.
b. $94,000.
c. $96,000.
d. $88,000.
55.
None of May Company's fixed overhead costs can be reduced, but another product could
be made that would increase profit contribution by $16,000 if the components were
acquired externally. If cost minimization is the major consideration and the company would
prefer to buy the components, what is the maximum external price that May Company
would be willing to accept to acquire the 1,000 units externally?
a. $86,000.
b. $110,000.
c. $96,000.
d. $104,000.
9-8
56.
A company has a process that results in 9,000 pounds of Product A that can be sold for $8
per pound. An alternative would be to process Product A further at a cost of $60,000 and
then sell it for $14 per pound. Should management sell Product A now or should Product
A be processed further and then sold? What is the effect of the action?
a. Process further, the company will be better off by $6,000.
b. Sell now, the company will be better off by $6,000.
c. Process further, the company will be better off by $54,000.
d. Sell now, the company will be better off by $60,000.
57.
The decision rule on whether to sell or process further

a. varies from situation to situation.
b. is process further as long as total revenue exceeds present revenues.
c. is process further if incremental revenue from such processing exceeds incremental
fixed costs.
d. is process further if incremental revenue from such processing exceeds the
incremental processing costs.
58.
Beal Company is starting business and is unsure of whether to sell its product assembled
or unassembled. The unit cost of the unassembled product is $40 and Beal Company
would sell it for $90. The cost to assemble the product is estimated at $18 per unit and
Beal Company believes the market would support a price of $116 on the assembled unit.
What is the correct decision using the sell or process further decision rule?
a. Sell before assembly, the company will be better off by $18 per unit.
b. Sell before assembly, the company will be better off by $26 per unit.
c. Process further, the company will be better off by $26 per unit.
d. Process further, the company will be better off by $8 per unit.
59.
The focus of a sell or process further decision is

a. incremental revenue.
b. incremental cost.
c. both incremental revenue and incremental cost.
d. neither incremental revenue nor incremental cost.
60.
Kimble Company gathered the following data about the three products that it produces:
Product
A
B
C
Present
Sales Value
$ 9,000
15,000
11,000
Estimated Additional
Processing Costs
$ 6,000
5,000
3,000
Which of the products should not be processed further?

a. Product A
b. Product B
c. Product C
d. Products A and C
61.
All costs incurred prior to the split-off point are called

a. relevant costs.
b. split-off costs.
c. opportunity costs.
d. joint costs.
Estimated Sales
if Processed Further
$ 16,000
18,000
16,000
9-9
62.
Each of the following statements about the amount of joint costs allocated to multiple
products is correct except that it is
a. a sunk cost.
b. irrelevant in deciding whether to sell or process further.
c. allocated to the individual products based on their relative sales value.
d. Each of the options is correct.
63.
End-products produced from a single raw material and a common production process are
referred to as
a. final products.
b. joint products.
c. split-off products.
d. common products.
64.
A company is considering replacing old equipment with new equipment. Which of the
following is a relevant cost for incremental analysis?
a. Annual depreciation charge on the old equipment
b. Book value of the old equipment
c. Estimated annual depreciation of the new equipment
d. Cost of the new equipment
65.
In a retain or replace equipment decision, trade-in allowance available on old equipment

a. increases the cost of the new equipment.
b. is relevant because it will not be realized if the old equipment is retained.
c. is not relevant to the decision.
d. reduces the cost of the old equipment.
66.
Which of the following is not relevant information in a decision whether old equipment
presently being used should be replaced by new equipment?
a. The cash price of the new equipment
b. The salvage value of the old equipment
c. The book value of the old equipment
d. The cost savings if the new equipment is purchased
67.
Book value of old equipment is considered to be a

a. relevant cost.
b. semi-relevant cost.
c. sunk cost.
d. cost that can be changed by a present or future decision.
68.
A company is deciding on whether to replace some old equipment with new equipment.
Which of the following is not a relevant cost for incremental analysis?
a. Annual operating cost of the new equipment
b. Annual operating cost of the old equipment
c. Net cost of the new equipment
d. Accumulated depreciation on the old equipment
69.
Which of the following is a sunk cost in a retain or replace equipment decision?

a. Cost of the new equipment
b. Cost savings from the purchase of the new equipment
c. Salvage value of the old equipment
d. Cost of the old equipment
9-10
70.

A company has three product lines, one of which reflects the following results:
Sales
Variable expenses
Contribution margin
Fixed expenses
Net loss
$170,000
100,000
70,000
110,000
$(40,000)
If this product line is eliminated, 60% of the fixed expenses can be eliminated and the
other 40% will be allocated to other product lines. If management decides to eliminate this
product line, the company's net income will
a. increase by $40,000.
b. decrease by $70,000.
c. decrease by $4,000.
d. increase by $4,000.
71.
A company is considering eliminating a product line. The fixed costs currently allocated to
the product line will be allocated to other product lines upon discontinuance. If the product
line is discontinued,
a. total net income will increase by the amount of the product line's fixed costs.
b. total net income will decrease by the amount of the product line's fixed costs.
c. the contribution margin of the product line will indicate the net income increase or
decrease.
d. the company's total fixed costs will decrease.
72.
In deciding whether to eliminate an unprofitable business segment, the key is to focus on

a. fixed costs.
b. opportunity costs.
c. relevant costs.
d. sunk costs.
73.
In deciding on the future of an unprofitable segment, management should compare the

lost contribution margin to the segments
a. variable costs.
b. fixed costs.
c. sunk costs.
d. opportunity costs.
74.
A segment has the following data:

Sales
Variable expenses
Fixed expenses
$420,000
180,000
330,000
What will be the incremental effect on net income if this segment is eliminated, assuming
the fixed expenses will be allocated to profitable segments?
a. $240,000 increase
b. $240,000 decrease
c. $330,000 decrease
d. Cannot be determined from the data provided.
75.
9-11
Barkley Company sells two products with the following per unit data:
Standard
Deluxe
Selling price/unit
$75
$120
Variable costs/unit
45
60
Contribution margin/unit
$30
$ 60
Sales mix
3
2
If fixed costs are $630,000, the number of standard and deluxe units that Barkley must
sell to break even is
a. 1,800 standard and 1,200 deluxe.
b. 3,600 standard and 2,400 deluxe.
c. 9,000 standard and 6,000 deluxe.
d. 21,000 standard and 14,000 deluxe.
76.
Logan Company sells two products, A and B. Their contribution margins per unit are $60
and $120 respectively, and their sales mix is 3:1. What is Logans weighted average unit
contribution margin?
a. $300
b. $150
c. $90
d. $75
77.
Total contribution margin divided by the number of units in the sales mix is the
a. contribution margin per unit.
b. contribution margin ratio.
c. weighted average unit contribution margin.
d. weighted average contribution margin ratio.
78.
The break-even point in units for multiple products is computed by dividing fixed costs by
the
c. weighted average unit contribution margin.
d. weighted average contribution margin ratio.
79.
Which one of the following is correct?

a. CVP analysis cannot be used if there is more than one product.
b. A shift from low margin sales to high margin sales will increase net income only if
sales volume increases.
c. A shift from high to low margin sales may result in a decrease in net income even if
total sales volume increases.
d. The weighted average contribution margin is greater than the individual contribution
margins of each product in the sales mix.
80.
Klesko Company developed the following information for the year ended December 31,
2002:
Product A
Product B
Total
Units Sold
4,000
6,000
10,000
Sales
$12,000
$27,000
$39,000
Variable costs
6,000
15,000
21,000
Contribution margin
$ 6,000
$12,000
18,000
Fixed costs
12,600
Net income
$ 5,400
9-12
80.
(cont.)
If the sales mix changes in 2003 to 5,000 units of Product A and 5,000 units of Product B,
the effect on the companys break-even point would be
a. to increase it by 200 units.
b. to decrease it by 200 units.
c. to increase it by 1,200 units.
d. no change.
81.
A company can sell all the units it can produce of either Product A or Product B but not both.
Product A has a unit contribution margin of $36 and takes two machine hours to make and
Product B has a unit contribution margin of $45 and takes three machine hours to make. If
there are 1,000 machine hours available to manufacture a product, income will be
a. $3,000 more if Product A is made.
b. $3,000 less if Product B is made.
c. $3,000 less if Product A is made.
d. the same if either product is made.
82.
If a company has limited resources, the key factor in performing incremental analysis is
a. contribution margin.
b. limited resources required.
c. contribution margin per unit of limited resource.
d. none of these.
83.
Limited resources for a manufacturing company include all of the following except
a. direct labor hours.
b. floor space.
c. machine capacity.
d. raw materials.
84.
A company can produce and sell only one of the following two products:
Product 1
Product 2
Machine
Hours Required
3
2
Contribution
Margin Per Unit
$30
$25
If the company has machine capacity of 4,000 hours, what is the total contribution margin
of the product it should produce to maximize net income?
a. $40,000.
b. $48,000.
c. $50,000.
d. $32,000.
85.
When a company has limited resources, management must decide which products to sell
in order to maximize
c. net income.
d. weighted average unit contribution margin.
9-13
Answers to Multiple Choice Questions

Item
Ans.
26.
27.
28.
29.
30.
31.
32.
33.
34.
b
b
c
b
c
b
b
c
a
Item
35.
36.
37.
38.
39.
40.
41.
42.
43.
Ans.
Item
d
b
d
d
b
a
d
b
d
44.
45.
46.
47.
48.
49.
50.
51.
52.
Ans.
d
b
a
c
d
b
b
c
a
Item
53.
54.
55.
56.
57.
58.
59.
60.
61.
Ans.
Item
a
b
d
b
d
d
c
b
d
62.
63.
64.
65.
66.
67.
68.
69.
70.
Ans.
d
b
d
b
c
c
d
d
c
Item
71.
72.
73.
74.
75.
76.
77.
78.
79.
Ans.
c
c
b
b
c
d
c
c
c
Item
80.
81.
82.
83.
84.
85.
Ans.
a
a
c
b
c
c
EXERCISES
Ex. 86
Alder Company produced and sold 30,000 units of product and is operating at 80% of plant
capacity. Unit information about its product is as follows:
Sales Price
Variable manufacturing cost
Fixed manufacturing cost ($300,000 30,000)
Profit per unit
$70
$45
10
55
$15
The company received a proposal from a foreign company to buy 6,000 units of Alder Company's
product for $50 per unit. This is a one-time only order and acceptance of this proposal will not
affect the company's regular sales. The president of Alder Company is reluctant to accept the
proposal because he is concerned that the company will lose money on the special order.
Instructions
Prepare a schedule reflecting an incremental analysis of this proposal and indicate the effect the
acceptance of this order might have on the company's income.
Solution 86
(913 min.)
ALDER COMPANY
Proposal to buy 6,000 units at $50
Revenues (6,000 $50)

Costs (6,000 $45)
Net Income
Reject Order
$ -0-0$ -0-
Accept Order
$300,000
(270,000)
$ 30,000
Net Income
Increase (Decrease)
$300,000
(270,000)
$ 30,000
9-14
Alder Company would increase its income by $30,000 in accepting the special order.
Ex. 87
Dixon Company manufactures cappuccino makers. For the first eight months of 2002 the
company reported the following operating results while operating at 80% of plant capacity:
Sales (500,000 units)
Cost of goods sold
Gross profit
Operating expenses
Net income
$90,000,000
54,000,000
36,000,000
24,000,000
$12,000,000
An analysis of costs and expenses reveals that variable cost of goods sold is $95 per unit and
variable operating expenses are $35 per unit.
In September, Dixon Company receives a special order for 40,000 machines at $145 each from a
major coffee shop franchise. Acceptance of the order would result in $10,000 of shipping costs
but no increase in fixed expenses.
Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Dixon Company accept the special order? Justify your answer.
Solution 87
(1217 min.)
(a)
Revenues
Cost of Goods Sold
Operating Expense
Net Income
Reject Order
$ -0-0-0$ -0-
Accept Order
$5,800,000
3,800,000*
1,410,000**
$ 590,000
Net Income
Increase (Decrease)
$5,800,000
(3,800,000)
(1,410,000)
$ 590,000
*Variable cost of goods sold = 40,000 $95 = $3,800,000.

**Variable operating expenses = 40,000 $35 = $1,400,000 + $10,000 = $1,410,000.
(b) The incremental analysis shows Dixon Company should accept the special order because
incremental revenues exceed incremental costs. This recommendation assumes that
acceptance of the special order will not affect relations with existing customers.
Ex. 88
Vincent Company supplies schools with floor mattresses to use in physical education classes.
Vincent has received a special order from a large school district to buy 400 mats at $45 each.
Acceptance of the special order will not affect fixed costs but will result in $1,200 of shipping
costs.
9-15
For the first 6 months of 2002, the company reported the following operating results while
operating at 70% capacity:
Ex. 88 (cont.)
Sales (100,000 units)
Cost of goods sold
Gross profit
Operating expenses
Net income
$7,000,000
4,200,000
2,800,000
2,000,000
$ 800,000
Cost of goods sold was 80% variable and 20% fixed; operating expenses were 75% variable and
25% fixed.
Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Vincent Company accept the special order? Justify your answer.
Solution 88
(1318 min.)
(a)
Revenues
Cost of Goods Sold
Operating Expense
Net Income
Reject Order
$ -0-0-0$ -0-
Accept Order
$18,000
13,440
7,200
$(2,640)
Net Income
Increase (Decrease)
$18,000
(13,440)
(7,200)
$(2,640)
Variable costs of goods sold = $4,200,000 80% = $3,360,000.

Variable cost of goods sold per unit sold = $3,360,000 100,000 = $33.60.
Variable cost of goods sold for the special order = 400 $33.60 = $13,440.
Variable operating expenses = $2,000,000 75% = $1,500,000
Variable operating expenses per unit = $1,500,000 100,000 = $15.00
Variable operating expenses for the special order = 400 $15.00 = $6,000 + $1,200
= $7,200
(b)
The incremental analysis shows Vincent Company should not accept the special order
because incremental costs exceed incremental revenues.
Ex. 89
Carlsen Company manufactured 6,000 units of a component part that is used in its product and
incurred the following costs:
Direct materials
$ 70,000
Direct labor
Variable manufacturing overhead
Fixed manufacturing overhead
30,000
20,000
40,000
$160,000
9-16
Another company has offered to sell the same component part to the company for $24.00 per
unit. The fixed manufacturing overhead consists mainly of depreciation on the equipment used to
manufacture the part and would not be reduced if the component part was purchased from the
outside firm. If the component part is purchased from the outside firm, Carlsen Company has the
opportunity to use the factory equipment to produce another product which is estimated to have a
contribution margin of $30,000.
Ex. 89 (cont.)
Instructions
Prepare an incremental analysis report for Carlsen Company which can serve as informational
input into this make or buy decision.
Solution 89
(1318 min.)
Direct materials
Direct labor
Purchase price (6,000 $24.00)
Total annual cost
Opportunity cost
Total cost
Make
$ 70,000$
30,000
20,000
40,000
-0160,000
30,000
$190,000
Buy
Increase (Decrease)
-0- $ 70,000
-030,000
-020,000
40,000
-0144,000
(144,000)
184,000
(24,000)
-030,000
$184,000
$ 6,000
Income is expected to increase by $6,000 if the component part is purchased from the outside
firm and the new product is manufactured.
Ex. 90
Kuhn Bicycle Company has been manufacturing its own seats for its bicycles. The company is
currently operating at 100% capacity, and variable manufacturing overhead is charged to
production at the rate of 60% of direct labor cost. The direct materials and direct labor cost per
unit to make the bicycle seats are $5.00 and $6.00, respectively. Normal production is 50,000
bicycles per year.
A supplier offers to make the bicycle seats at a price of $13 each. If the bicycle company accepts
this offer, all variable manufacturing costs will be eliminated, but the $20,000 of fixed manufacturing overhead currently being charged to the bicycle seats will have to be absorbed by other
products.
Instructions
(a) Prepare the incremental analysis for the decision to make or buy the bicycle seats.
(b) Should Kuhn Bicycle Company buy the seats from the outside supplier? Justify your answer.
Solution 90
9-17
(1520 min.)
(a)
Direct Materials (50,000 $5)
Direct Labor (50,000 $6)
Variable Manufacturing Costs
($300,000 60%)
Fixed Manufacturing Costs
Purchase Price (50,000 $13)
Total annual cost
Make
$250,000
300,000
180,000
20,000
-0$750,000
Buy
-0-0-
Net Income
Increase (Decrease)
$250,000
300,000
-020,000
650,000
$670,000
180,000
-0(650,000)
$ 80,000
Solution 90 (cont.)
(b) The seats should be purchased from the outside supplier. As indicated, the company's net
income would increase $80,000 by purchasing the seats.
Ex. 91
United Chemical Corporation produces an oil-based chemical product which it sells to paint
manufacturers. In 2002, the company incurred $430,000 of costs to produce 40,000 gallons of the
chemical. The selling price of the chemical is $14.00 per gallon. The costs per unit to
manufacture a gallon of the chemical are presented below:
Direct materials
Direct labor
Total manufacturing costs
$ 7.50
1.50
1.00
.75
$10.75
The company is considering manufacturing the paint itself. If the company processes the
chemical further and manufactures the paint itself, the following additional costs per gallon will be
incurred: Direct materials $2.10, Direct labor $.75, Variable manufacturing overhead $.60. No
increase in fixed manufacturing overhead is expected. The company can sell the paint at $19.00
per gallon.
Instructions
Determine the incremental per gallon increase in net income and the total increase in net income
if the company manufactures the paint.
Solution 91
(1520 min.)
Sales price per unit

Cost per unit:
Direct materials (A)
Sell Chemical
$14.00
7.50
Process Further
$19.00
9.60
Net Income
Increase (Decrease)
$5.00
(2.10)
9-18

Direct labor (B)
Variable manufacturing overhead (C)
Total
Net income per unit
1.50
1.00
.75
10.75
$ 3.25
2.25
1.60
.75
14.20
$ 4.80
(.75)
(.60)
(3.45)
$1.55
(A) $7.50 + $2.10

(B) $1.50 + .75
(C) $1.00 + .60
Assuming the company sells all 40,000 gallons that it produces, the incremental net income
would be $62,000 (40,000 gallons $1.55).
Ex. 92
Franke Timber Corporation uses a machine which removes the bark from its cut timber. The
machine is unreliable and results in a significant amount of downtime and excessive labor costs.
The management is considering replacing the machine with a more efficient one which will
minimize downtime and excessive labor costs. Data are presented below for the two machines:
Original purchase cost
Accumulated depreciation
Estimated life
Old Machine
$410,000
280,000
5 years
New Machine
$520,000
5 years
It is estimated that the new machine will produce annual cost savings of $115,000. The old
machine can be sold to a scrap dealer for $10,000. Both machines will have a salvage value of
zero if operated for the remainder of their useful lives.
Instructions
Determine whether the company should purchase the new machine.
Solution 92
(1116 min.)
Cost savings
New machine cost
Proceeds from sale of old machine
Net incremental net income
(A)
Retain
Equipment
$ -0-0$ -0$ -0-
Replace
Net Income
Equipment
Increase/(Decrease)
$575,000 (A)
$575,000
(520,000)
(520,000)
10,000
(10,000)
$ 65,000
$ 65,000
$115,000 5 = $575,000.
The company should purchase the new machine because there will be an increase in net income
of $65,000.
9-19
Ex. 93
Munroe Enterprises relies heavily on a copier machine to process its paperwork. Recently the
copy clerk has not been able to process all the necessary copies within the regular work week.
Management is considering updating the copier machine with a faster model.
Original purchase cost
Accumulated depreciation
Estimated operating costs (annual)
Useful life
Current Copier
$8,000
6,000
6,500
5 years
New Model
$15,000
3,000
5 years
If sold now, the current copier would have a salvage value of $1,000. If operated for the
remainder of its useful life, the current machine would have zero salvage value. The new machine
is expected to have zero salvage value after five years.
Instructions
Prepare an analysis to show whether the company should retain or replace the machine.
Solution 93
(1216 min.)
Operating costs
New machine cost
Salvage value
Totals
Retain Machine
$32,500
-0-0$32,500
Replace Machine
$15,000
15,000
(1,000)
$29,000
Net Income
Increase (Decrease)
$17,500
(15,000)
1,000
$ 3,500
The current copier should be replaced. The incremental analysis shows that net income for the
five-year period will be $3,500 higher by replacing the current copier.
Ex. 94
Sam Washington, manager of the Laundry Department at St. Anthonys Hospital, is considering
the purchase of an automated dryer that turns off immediately when laundry is dry. The new dryer
will replace the dryer currently in operation, which must be monitored to determine when laundry
is dry. Selected information on the two machines is given below:
Automatic
Standard Dryer
Turn-off Dryer
Original cost new
$12,000
$14,500
Accumulated depreciation to date
4,400
-0Current salvage value
3,600
-0Estimated cost per year to operate
6,500
3,500
Remaining years of useful life
5 years
5 years
9-20
Instructions
Prepare a computation covering the five-year period that will show the net advantage or
disadvantage of purchasing the automatic dryer. Ignore income taxes, and use only relevant
costs in your analysis.
Solution 94
(6-8 min.)
Cost of new dryer

Salvage value of old dryer
Estimated cost savings to operate [($6,500 $3,500) 5)]
Cost savings associated with buying the new dryer
$(14,500)
3,600
15,000
$ 4,100
Ex. 95
Simon Forest Corporation operates two divisions, the Timber Division and the Consumer Division.
The Timber Division manufactures and sells logs to paper manufacturers. The Consumer Division
operates retail lumber mills which sell a variety of products in the do-it-yourself homeowner
market. The company is considering disposing of the Consumer Division since it has been
consistently unprofitable for a number of years. The income statements for the two divisions for
the year ended December 31, 2002 are presented below:
9-21
Ex. 95 (cont.)
Sales
Cost of goods sold
Gross profit
Selling & administrative expenses
Net income
Timber Division
$1,500,000
900,000
600,000
250,000
$ 350,000
Consumer Division
$500,000
350,000
150,000
180,000
$(30,000)
Total
$2,000,000
1,250,000
750,000
430,000
$ 320,000
In the Consumer Division, 70% of the cost of goods sold are variable costs and 30% of selling
and administrative expenses are variable costs. The management of the company feels it can
save $60,000 of fixed cost of goods sold and $50,000 of fixed selling expenses if it discontinues
operation of the Consumer Division.
Instructions
(a)
(b)
Determine whether the company should discontinue operating the Consumer Division.
If the company had discontinued the division for 2002, determine what net income would
have been.
Solution 95
(2025 min.)
(a)
CONSUMER DIVISION
Sales
Variable expenses:
Cost of goods sold
Selling and admin. exp.
Contribution margin
Fixed expenses:
Cost of goods sold
Selling and admin. exp.
Net income
(A)
(B)
Continue
$500,000
Eliminate
$
-0-
245,000 (A)
54,000 (B)
201,000
105,000 (C)
126,000 (D)
$ (30,000)
$350,000 70% = $245,000

$180,000 30% = $54,000
(C)
(D)
-0-0-045,000
76,000
$(121,000)
Net Income
Increase (Decrease)
$(500,000)
245,000
54,000
(201,000)
60,000
50,000
$ (91,000)
$350,000 $245,000 = $105,000

$180,000 $54,000 = $126,000
The company should continue the Consumer Division because contribution margin, $201,000, is
greater than the avoidable fixed costs, $110,000.
(b)
Net income for the total company would have been $259,000:
Timber Division +
Decrease in Net Income
$350,000
+
$(91,000)
= $259,000
9-22
9-23
Ex. 96
A recent accounting graduate from Missouri State University evaluated the operating performance of Boswell Company's four divisions. The following presentation was made to Boswell's
Board of Directors. During the presentation, the accountant made the recommendation to
eliminate the Southern Division stating that total net income would increase by $40,000. (See
analysis below.)
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Net Income
Other Three Divisions

$2,000,000
950,000
1,050,000
800,000
$ 250,000
Southern Division
$480,000
400,000
80,000
120,000
$ (40,000)
Total
$2,480,000
1,350,000
1,130,000
920,000
$ 210,000
For the other divisions, cost of goods sold is 80% variable and operating expenses are 70%
variable. The cost of goods sold for the Southern Division is 25% fixed, and its operating
expenses are 75% fixed. If the division is eliminated, only $4,000 of the fixed operating costs will
be eliminated.
Instructions
Do you concur with the new accountant's recommendation? Present a schedule to support your
answer.
Solution 96
(2025 min.)
Sales
Variable Expenses
Cost of goods sold
Operating expenses
Total Variable
Contribution Margin
Fixed Expenses
Cost of goods sold
Operating expenses
Net Income (Loss)
Net Income
Increase (Decrease)
$(480,000)
Continue
$480,000
Eliminate
$ -0-
300,000
30,000
330,000
150,000
-0-0-0-0-
300,000
30,000
330,000
(150,000)
100,000
90,000
$(40,000)
100,000
86,000
$(186,000)
-04,000
$(146,000)
The accountant is not correct. If the Southern Division is eliminated, the net income will be
$146,000 less, not $40,000 greater.
The reduction in income is the result of the loss of the contribution margin less the avoidable fixed
costs of $4,000.
9-24
Ex. 97
Snooty Fox operates three upscale boutiques in three fashionable areas of the city. The following
information is available for the three boutiques for the past year:
Revenue
Variable costs
Contribution margin
Fixed costs
Net income (loss)
Andover
$125,000
65,000
60,000
85,000
$(25,000)
Heartland
$160,000
70,000
90,000
40,000
$ 50,000
Beaumont
$175,000
65,000
110,000
60,000
$ 50,000
Total
$460,000
200,000
260,000
185,000
$ 75,000
Instructions
Answer each of the following independently.
(a) Fixed costs are all allocated and unavoidable. What will happen to profit if Snooty Fox
discontinues operations at Beaumont?
(b) Suppose now that $25,000 of the fixed costs shown for the boutique in Andover are
avoidable. What will happen to profits if Snooty Fox discontinues operations at Andover?
(c) Explain the general rule for deciding whether to eliminate an unprofitable division.
Solution 97
(11-13 min)
(a)
If Snooty Fox discontinues operations at Beaumont, profits for the company as a whole will
decrease by the contribution marginor by $110,000. Remember, all fixed costs are
allocated and unavoidable.
(b)
If the $25,000 of fixed costs are avoidable and Snooty Fox discontinues operations at
Andover, net income for the company as a whole will increase by $25,000.
(c)
In deciding whether to eliminate an unprofitable division, a company must compare the

divisions contribution margin to its avoidable fixed costs. An unprofitable division should be
eliminated only when its avoidable fixed costs are greater than its contribution margin.
Ex. 98
Barker Company sells three models of dishwashing machines. Selling price and variable costs for
the three models are as follows:
Economy
Standard
Deluxe
Unit selling price
$600
$700
$800
Unit variable costs
$330
$420
$450
Expected sales volume in units
1,000
600
400
Instructions
(a) Compute the break-even point in units, assuming fixed costs are $289,000.
(b) Indicate the units of each product that should be sold at the break-even point and prove the
correctness of your answer.
Solution 98
9-25
(2025 min.)
(a)
Determine the unit contribution margin
Unit selling price
Unit variable costs
Contribution margin (a)
Determine weighted contribution margin
Expected sales volume in units
Sales mix ratio (b)
Weighted contribution margin (a) (b)
Economy
Standard
Deluxe
$600
$330
$270
$700
$420
$280
$800
$450
$350
1,000
10
$2,700
600
6
$1,680
400
4
$1,400
Determine the weighted average contribution margin

$2,700 + $1,680 + $1,400
= $289
20
$289,000
Break-even sales in units = = 1,000 units
$289
(b)
Product
Economy (50% 1,000)
Standard (30% 1,000)
Deluxe (20% 1,000)
Unit Sales
500
300
200
1,000
Unit CM
$270
280
350
Total CM
$135,000
84,000
70,000
$289,000
Ex. 99
Neagle Company has 6,000 machine hours available to use to produce either Product A or
Product B. The cost accounting department developed the following unit information for each of
the products:
Product A
Product B
Sales price
$54
$65
Direct materials
22
21
Direct labor
15
18
8
12
4
8
Machine hours required
.6
1.0
Management desires to make a decision regarding which product to produce in order to maximize
the company's income.
Instructions
Taking into consideration the constraint under which the company operates, prepare a report to
show which product should be produced and sold.
9-26
Solution 99
9-27
(2025 min.)
NEAGLE COMPANY
Contribution Margin per Unit Limited Resource
Contribution margin per unit:

Sales price
Variable costs
Direct material
Direct labor
Variable overhead
Contribution margin
Product A
Product B
$54
$22
15
8
45
$ 9
Machine hours required:

Contribution margin per unit of limited resource
($9 .6)
($14 1.0)
Machine hours available
Contribution margin
.6 hrs.
$
$65
$21
18
12
51
$14
1.0 hrs.
15
$
6,000
$90,000
14
6,000
$84,000
The company should produce and sell Product A.
Ex. 100
Dannon Company manufactures and sells two products. Relevant per unit data concerning each
product are given below:
Product
Standard
Deluxe
Selling price
$42
$48
Variable costs
$16
$18
Machine hours
4
5
Instructions
(a) Compute the contribution margin per unit of the limited resource for each product.
(b) If 1,000 additional machine hours are available, which product should be manufactured?
(c) Prepare an analysis showing the total contribution margin if the additional hours are
(1) Divided equally among the products.
(2) Allocated entirely to the product identified in (b) above.
Solution 100
(2530 min.)
(a)
Contribution margin per unit (a)
Machine hours required (b)
Contribution margin per unit of limited resource (a) (b)
Product
Standard
Deluxe
$26
$30
4
5
$6.50
$6.00
9-28
9-29
Solution 100 (cont.)

(b) The Standard product should be manufactured because it results in the highest contribution
margin per machine hour.
(c)
Product
Standard
500
4
125
$26
$3,250
Machine hours 1,000 2 (a)

Machine hours per unit (b)
Units produced (a) (b)
Contribution margin per unit
Total contribution margin
Machine hours (a)

Machine hours per unit (b)
Units produced (a) (b)
Contribution margin per unit
Total contribution margin
Product
Standard
1,000
4
250
$26
$6,500
Deluxe
500
5
100
$30
$3,000
9-30
COMPLETION STATEMENTS
101. An important purpose of management accounting is to provide management with
______________________ for decision making.
102. The process used to identify the financial data that change under alternative courses of
action is called __________________ analysis.
103. In a decision on whether an order should be accepted at a special price when there is
plant capacity available, a major consideration is whether the special price exceeds
__________________.
104. The potential benefit that may be obtained by following an alternative course of action is
called an _________________ cost.
105. A decision whether to sell a product now or to process it further, depends on whether the
incremental _____________ from processing further are greater than the incremental
processing ______________.
106. The ______________ value of old equipment is irrelevant in a decision to replace that
equipment and is often referred to as a _____________ cost.
107. Total net income may decrease if an unprofitable segment is eliminated because the
______________ allocated to that segment will have to be absorbed by the other
segments.
108. Break-even sales can be computed for a mix of two or more products by determining the
______________ unit contribution margin of all the products.
109. In an environment where there are limited resources, the products with the highest
contribution per unit of ______________ should identify the products to be produced.
Answers to Completion Statements

101.
102.
103.
104.
105.
106.
107.
108.
109.
relevant information
incremental
variable costs (incremental costs)
opportunity
revenues, costs
book, sunk
fixed expenses
weighted average
limited resource
9-31
MATCHING
110. Match the items below by entering the appropriate code letter in the space provided.
A.
B.
C.
D.
Incremental analysis
Book value of old asset
Opportunity cost
Weighted average unit
contribution margin
E.
F.
G.
H.
Relevant cost
Sales mix
Sunk cost
Financial information
____
1. The potential benefit that may be obtained from following an alternative course of
action.
____
2. The relative combination in which a companys products are sold.
____
3. Data related to revenues and costs and their effect on the companys overall
profitability.
____
4. The process of identifying the financial data that change under alternative courses of
action.
____
5. A cost that cannot be changed by any present or future decision.
____
6. A sunk cost that is not relevant in incremental analysis.
____
7. Used to compute the break-even point for a mix of two or more products.
____
8. Those costs and revenues that differ across alternatives.
Answers to Matching
1.
2.
3.
4.
C
F
H
A
5.
6.
7.
8.
G
B
D
E
9-32
SHORT-ANSWER ESSAY QUESTIONS

S-A E 111
Management is often faced with the alternative of continuing to make a product or component
internally, or go to an external source and purchase the product or component. In gathering
relevant information for these two alternatives, briefly identify the quantitative factors that should
be considered. Are there any qualitative factors that should also be considered?
Solution 111
The quantitative factors to be considered in a make or buy decision include the incremental costs
to make the product, the incremental costs of buying the product, and the opportunity cost
(potential benefit foregone) if the product is made. Generally, all variable production costs are
relevant in a make or buy decision, but only some fixed costs, or no fixed costs, are relevant
because many fixed costs will be incurred regardless of whether the decision is to make or buy.
Qualitative factors include the possible adverse effect on employees and the stability of the
supplier's price and quality.
S-A E 112
A number of different types of decisions involve incremental analysis. Two of the more common
types of decisions are whether to (1) accept an order at a special price and (2) sell products or
process them further. Identify the relevant costs/data to be considered in making these types of
decisions.
Solution 112
The relevant data in accepting an order at a special price is the difference between the variable
manufacturing costs to produce the special order and the expected revenues. If the special order
units can be produced within existing plant capacity, the special order will not increase fixed
costs.
The relevant data in deciding whether to sell or process products further is the difference between
the incremental revenue from processing and the incremental processing costs. The products
should be processed further as long as the incremental revenue exceeds the incremental costs.

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INCREMENTAL ANALYSIS

An important step in management's decision-making process is to determine and evaluate

In making decisions, management ordinarily considers both financial and nonfinancial

Accountants are mainly involved in developing nonfinancial information for management's

Decision-making involves choosing among alternative courses of action.

A decision whether to continue to make a product or buy it externally, depends on the

An opportunity cost is the potential benefit obtained by using resources in an alternative

It is better not to replace old equipment if it is not fully depreciated.

From a quantitative standpoint, a segment should be eliminated if its contribution margin

When a company has limited resources to manufacture products, it should manufacture

Answers to True-False Statements

MULTIPLE CHOICE QUESTIONS

A major accounting contribution to the managerial decision-making process in evaluating

Which of the following stages of the management decision-making process is improperly

Incremental analysis is synonymous with

Test Bank for Managerial Accounting, Second Edition

Incremental analysis is most useful

The source of data to serve as inputs in incremental analysis is generated by

Which of the following is not a true statement?

Incremental analysis would not be appropriate for

Incremental analysis would be appropriate for

A company is considering the following alternatives:

Which of the following are relevant in choosing between the alternatives?

If a plant is operating at full capacity and receives a one-time opportunity to accept an

Test Bank for Managerial Accounting, Second Edition

Opportunity cost must be considered in decisions involving

Opportunity cost is usually

Use the following information for questions 5152.

If Sam's Manufacturing Company purchases the component externally, $20,000 of the

Test Bank for Managerial Accounting, Second Edition

The decision rule on whether to sell or process further

The focus of a sell or process further decision is

Which of the products should not be processed further?

All costs incurred prior to the split-off point are called

In a retain or replace equipment decision, trade-in allowance available on old equipment

Book value of old equipment is considered to be a

Which of the following is a sunk cost in a retain or replace equipment decision?

Test Bank for Managerial Accounting, Second Edition

In deciding whether to eliminate an unprofitable business segment, the key is to focus on

In deciding on the future of an unprofitable segment, management should compare the

A segment has the following data:

Which one of the following is correct?

Test Bank for Managerial Accounting, Second Edition

Answers to Multiple Choice Questions

Revenues (6,000 $50)

Test Bank for Managerial Accounting, Second Edition

*Variable cost of goods sold = 40,000 $95 = $3,800,000.

Variable costs of goods sold = $4,200,000 80% = $3,360,000.

Test Bank for Managerial Accounting, Second Edition

Sales price per unit

Test Bank for Managerial Accounting, Second Edition

(A) $7.50 + $2.10

Test Bank for Managerial Accounting, Second Edition

Cost of new dryer

$350,000 70% = $245,000

$350,000 $245,000 = $105,000

Test Bank for Managerial Accounting, Second Edition

Other Three Divisions

Test Bank for Managerial Accounting, Second Edition

In deciding whether to eliminate an unprofitable division, a company must compare the

Determine the weighted average contribution margin

Test Bank for Managerial Accounting, Second Edition