Accounting 210 Chapter 7 Notes
Accounting 210 Chapter 7 Notes ACCT210
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This 8 page Class Notes was uploaded by Kristin Koelewyn on Sunday March 6, 2016. The Class Notes belongs to ACCT210 at University of Arizona taught by Heather Altman in Spring 2016. Since its upload, it has received 38 views. For similar materials see Managerial Accounting in Accounting at University of Arizona.
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Date Created: 03/06/16
Accounting 210: Chapter 7 Notes Incremental Analysis - Making decisions is an important management function. o Does not always follow a set pattern. o Decisions vary in scope, urgency, and importance. o Steps usually involved in process include: o o In making business decisions, o Considers both financial and non-financial information. ▯ ►Revenues and costs, and ▯ ►Effect on overall profitability. ▯ ►Effect on employee turnover ▯ ►The environment o Overall company image. - Incremental Analysis Approach o Process used to identify the financial data that change under alternative courses of action. ▯ ►Both costs and revenues may vary or ▯ ►Only revenues may vary or ▯ ►Only costs may vary o o Incremental revenue is $15,000 less under Alternative B. o Incremental cost savings of $20,000 is realized. o Alternative B produces $5,000 more net income. o Sometimes involves changes that seem contrary to intuition. o Variable costs sometimes do not change under alternatives. o Fixed costs sometimes change between alternatives. - Types of Incremental Analysis o Common types of decisions involving incremental analysis: o 1.Accept an order at a special price. o 2.Make or buy component parts or finished products. o 3.Sell or process further them further o 4.Repair, retain, or replace equipment. o 5.Eliminate an unprofitable business segment or product. - Accept an Order at a Special Price o Obtain additional business by making a major price concession to a specific customer. o Assumes that sales of products in other markets are not affected by special order. o Assumes that company is not operating at full capacity. o o Fixed costs do not change since within existing capacity – thus fixed costs are not relevant. o Variable manufacturing costs and expected revenues change – thus both are relevant to the decision. o DO IT! Cobb Company incurs costs of $28 per unit ($18 variable and $10 fixed) to make a product that normally sells for $42. A foreign wholesaler offers to buy 5,000 units at $25 each. Cobb will incur additional shipping costs of $1 per unit. Compute the increase or decrease in net income Cobb will realize by accepting the special order, assuming Cobb has excess operating capacity. Should Cobb Company accept the special order? o Illustration: Baron Company incurs the following annual costs in producing 25,000 ignition switches for motor scooters. ▯ Total manufacturing cost is $1 higher per unit than purchase price. ▯ Must absorb at least $50,000 of fixed costs under either option. - Opportunity Cost o Illustration: Assume that through buying the switches, Baron Company can use the released productive capacity to generate additional income of $38,000 from producing a different product. This lost income is an additional cost of continuing to make the switches in the make-or-buy decision. o DO IT! Juanita Company must decide whether to make or buy some of its components for the appliances it produces. The costs of producing 166,000 electrical cords for its appliances are as follows. Direct materials $90,000 Variable overhead $32,000 Direct labor 20,000 Fixed overhead 24,000 Instead of making the electrical cords at an average cost per unit of $1.00 ($166,000 ÷ 166,000), the company has an opportunity to buy the cords at $0.90 per unit. If the company purchases the cords, all variable costs and one-fourth of the fixed costs will be eliminated. (a) Prepare an incremental analysis showing whether the company should make or buy the electrical cords. (b) Will your answer be different if the released productive capacity will generate additional income of $5,000? o Yes, net income will be increased by $3,600 if Juanita Company purchases the electrical cords rather than making them. - Sell or Process Further o May have option to sell product at a given point in production or to process further and sell at a higher price. o Decision Rule: o Process further as long as the incremental revenue from such processing exceeds the incremental processing costs. - Single Product Case o Illustration: Woodmasters Inc. makes tables. The cost to manufacture an unfinished table is $35. The selling price per unfinished unit is $50. Woodmasters has unused capacity that can be used to finish the tables and sell them at $60 per unit. For a finished table, direct materials will increase $2 and direct labor costs will increase $4. Variable manufacturing overhead costs will increase by $2.40 (60% of direct labor). No increase is anticipated in fixed manufacturing overhead. - Multiple Product Case o Joint product situation for Marais Creamery. Cream and skim milk are products that result from the processing of raw milk. o Joint product costs are sunk costs and thus not relevant to the sell-or-process further decision. o Cost and revenue data per day for skim milk. - DO IT: Easy Does It manufactures unpainted furniture for the do-it- yourself (DIY) market. It currently sells a child’s rocking chair for $25. Production costs are $12 variable and $8 fixed. Easy Does It is considering painting the rocking chair and selling it for $35. Variable costs to paint each chair are expected to be $9, and fixed costs are expected to be $2.Prepare an analysis showing whether Easy Does It should sell unpainted or painted chairs. - Illustration: Jeffcoat Company is considering replacing a factory machine with a new machine. Jeffcoat Company has a factory machine that originally cost $110,000. It has a balance in Accumulated Depreciation of $70,000, so its book value is $40,000. It has a remaining useful life of four years. The company is considering replacing this machine with a new machine. A new machine is available that costs $120,000. It is expected to have zero salvage value at the end of its four-year useful life. If the new machine is acquired, variable manufacturing costs are expected to decrease from $160,000 to $125,000 and the old unit could be sold for $5,000. The incremental analysis for the four-year period is as follows. - Repair, Retain, or Replace Equipment o Additional Considerations ▯ The book value of old machine does not affect the decision. • ►Book value is a sunk cost. • ►Costs which cannot be changed by future decisions (sunk cost) are not relevant in incremental analysis. o However, any trade-in allowance or cash disposal value of the existing asset is relevant. - DO IT! Rochester Roofing is faced with a decision. The company relies very heavily on the use of its 60-foot extension lift for work on large homes and commercial properties. Last year, the company spent $60,000 refurbishing the lift. It has just determined that another $40,000 of repair work is required. Alternatively, Rochester Roofing has found a newer used lift that is for sale for $170,000. The company estimates that both the old and new lifts would have useful lives of 6 years. However, the lift is more efficient and thus would reduce operating expenses by about $20,000 per year. The company could also rent out the new lift for about $2,000 per year. The old lift is not suitable for rental. The old lift could currently be sold for $25,000 if the new lift is purchased. Prepare an incremental analysis that shows whether the company should repair or replace the equipment. - The analysis indicates that purchasing the new machine would increase net income for the 6-year period by $27,000. o Key: Focus on Relevant Costs. o Consider effect on related product lines. o Fixed costs allocated to the unprofitable segment must be absorbed by the other segments. o Net income may decrease when an unprofitable segment is eliminated. o Decision Rule: Retain the segment unless fixed costs eliminated exceed contribution margin lost. - Eliminate an Unprofitable Segment or Product o Illustration: Venus Company manufactures three models of tennis rackets: o Profitable lines: Pro and Master o Unprofitable line: Champ o Prepare income data after eliminating Champ product line. Assume fixed costs are allocated 2/3 to Pro and 1/3 to Master. o Incremental analysis of Champ provided the same results: ▯ Do Not Eliminate Champ o Assume that $22,000 of the fixed costs attributed to the Champ line can be eliminated if the line is discontinued. ▯ Eliminate Champ - DO IT! Lambert, Inc. manufactures several types of accessories. For the year, the knit hats and scarves line had sales of $400,000, variable expenses of $310,000, and fixed expenses of $120,000. Therefore, the knit hats and scarves line had a net loss of $30,000. If Lambert eliminates the knit hats and scarves line, $20,000 of fixed costs will remain. Prepare an analysis showing whether the company should eliminate the knit hats and scarves line.
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