Chapter 25

Inman Construction Company is considering selling excess machinery with a book value of \(\$ 280,000\) (original cost of \(\$ 400,000\) less accumulated depreciation of \(\$ 120,000\) ) for \(\$ 292,000\), less a \(5 \%\) brokerage commission. Alternatively, the machinery can be leased for a total of \(\$ 312,000\) for five years, after which it is expected to have no residual value. During the period of the lease, Inman Construction Company's costs of repairs, insurance, and property tax expenses are expected to be \(\$ 36,000\). a. Prepare a differential analysis report, dated January 3, 2010, for the lease or sell decision. b. On the basis of the data presented, would it be advisable to lease or sell the machinery? Explain.

A condensed income statement by product line for British Beverage Inc. indicated the following for Royal Cola for the past year: \(\begin{array}{lr}\text { Sales } & \$ 254,000 \\ \text { Cost of goods sold } & 122,000 \\ \text { Gross profit } & \$ 132,000 \\ \text { Operating expenses } & 156,000 \\ \text { Loss from operations } & \$(24,000)\end{array}\) It is estimated that \(16 \%\) of the cost of goods sold represents fixed factory overhead costs and that \(20 \%\) of the operating expenses are fixed. Since Royal Cola is only one of many products, the fixed costs will not be materially affected if the product is discontinued. a. Prepare a differential analysis report, dated March 3, 2010, for the proposed discontinuance of Royal Cola. Should Royal Cola be retained? Explain.

The Theater Arts Guild of Chicago (TAG-C) employs five people in its Publication Department. These people lay out pages for pamphlets, brochures, and other publications for the TAG-C productions. The pages are delivered to an outside company for printing. The company is considering an outside publication service for the layout work. The outside service is quoting a price of \(\$ 15\) per layout page. The budget for the Publication Department for 2010 is as follows: \begin{tabular}{lr} Salaries & \(\$ 220,000\) \\ Benefits & 35,000 \\ Supplies & 30,000 \\ Office expenses & 25,000 \\ Office depreciation & 30,000 \\ Computer depreciation & 22,000 \\ \hline Total & \(\$ 362,000\) \\ \hline \end{tabular} The department expects to lay out 20,000 pages for 2010 . The computers used by the department have an estimated residual value of \(\$ 7,000\). The Publication Department office space would be used for future administrative needs, if the department's function were purchased from the outside. a. Prepare a differential analysis report, dated December 15,2009 , for the make-or-buy decision, considering the 2010 differential revenues and costs. b. On the basis of your analysis in part (a), should the page layout work be purchased from an outside company? c. What additional considerations might factor into the decision making?

A company is considering replacing an old piece of machinery, which cost \(\$ 600,000\) and has \(\$ 350,000\) of accumulated depreciation to date, with a new machine that costs \(\$ 450,000\). The old equipment could be sold for \(\$ 72,000\). The annual variable production costs associated with the old machine are estimated to be \(\$ 165,000\) for eight years. The annual variable production costs for the new machine are estimated to be \(\$ 112,750\) for eight years. a. Determine the total and annualized differential income or loss anticipated from replacing the old machine. b. What is the sunk cost in this situation?

Bunyon Lumber Company incurs a cost of \(\$ 490\) per hundred board feet in processing certain "rough-cut" lumber, which it sells for \(\$ 635\) per hundred board feet. An alternative is to produce a "finished cut" at a total processing cost of \(\$ 565\) per hundred board feet, which can be sold for \(\$ 840\) per hundred board feet. What is the amount of (a) the differential revenue, (b) differential cost, and (c) differential income for processing rough-cut lumber into finished cut?

Seattle Roast Coffee Company produces Columbian coffee in batches of 8,000 pounds. The standard quantity of materials required in the process is 8,000 pounds, which cost \(\$ 5.00\) per pound. Columbian coffee can be sold without further processing for \(\$ 10.80\) per pound. Columbian coffee can also be processed further to yield Decaf Columbian, which can be sold for \(\$ 12.50\) per pound. The processing into Decaf Columbian requires additional processing costs of \(\$ 10,500\) per batch. The additional processing will also cause a \(5 \%\) loss of product due to evaporation. a. Prepare a differential analysis report for the decision to sell or process further. b. Should Seattle Roast sell Columbian coffee or process further and sell Decaf Columbian? c. Determine the price of Decaf Columbian that would cause neither an advantage or disadvantage for processing further and selling Decaf Columbian.

Down Home Jeans Co. has an annual plant capacity of 65,000 units, and current production is 45,000 units. Monthly fixed costs are \(\$ 40,000\), and variable costs are \(\$ 22\) per unit. The present selling price is \(\$ 35\) per unit. On March 18,2010 , the company received an offer from Fields Company for 18,000 units of the product at \(\$ 29\) each. Fields Company will market the units in a foreign country under its own brand name. The additional business is not expected to affect the domestic selling price or quantity of sales of Down Home Jeans Co. a. Prepare a differential analysis report for the proposed sale to Fields Company. b. Briefly explain the reason why accepting this additional business will increase operating income. c. What is the minimum price per unit that would produce a contribution margin?

Power Serve Company expects to operate at 85% of productive capacity during April. The total manufacturing costs for April for the production of 30,000 batteries are budgeted as follows: $$ \begin{array}{lr} \text { Direct materials } & \$ 285,000 \\ \text { Direct labor } & 104,000 \\ \text { Variable factory overhead } & 31,000 \\ \text { Fixed factory overhead } & 58,000 \\ \cline { 2 } \text { Total manufacturing costs } & \$ 478,000 \\ \hline \end{array} $$ The company has an opportunity to submit a bid for 2,000 batteries to be delivered by April 30 to a government agency. If the contract is obtained, it is anticipated that the additional activity will not interfere with normal production during April or increase the selling or administrative expenses. What is the unit cost below which Power Serve Company should not go in bidding on the government contract?

Roadworthy Tire and Rubber Company has capacity to produce 170,000 tires. Roadworthy presently produces and sells 130,000 tires for the North American market at a price of \(\$ 90\) per tire. Roadworthy is evaluating a special order from a European automobile company, Euro Motors. Euro is offering to buy 25,000 tires for \(\$ 75\) per tire. Roadworthy's accounting system indicates that the total cost per tire is as follows: Direct materials \(32 Direct labor 8 Factory overhead (60% variable) 25 Selling and administrative expenses (35% variable) 20 ____ Total \)85 ____ ____ Roadworthy pays a selling commission equal to \(5 \%\) of the selling price on North American orders, which is included in the variable portion of the selling and administrative expenses. However, this special order would not have a sales commission. If the order was accepted, the tires would be shipped overseas for an additional shipping cost of \(\$ 6.00\) per tire. In addition, Euro has made the order conditional on receiving European safety certification. Roadworthy estimates that this certification would cost \(\$ 125,000\). a. Prepare a differential analysis report dated May 4, 2010, for the proposed sale to Euro Motors. b. What is the minimum price per unit that would be financially acceptable to Roadworthy?

Toyota Motor Corporation uses target costing. Assume that Toyota marketing personnel estimate that the competitive selling price for the Camry in the upcoming model year will need to be \(\$ 22,000\). Assume further that the Camry's total unit cost for the upcoming model year is estimated to be \(\$ 18,100\) and that Toyota requires a \(20 \%\) profit margin on selling price (which is equivalent to a \(25 \%\) markup on total cost). a. What price will Toyota establish for the Camry for the upcoming model year? b. What impact will target costing have on Toyota, given the assumed information?

Laser Cast, Inc., manufactures color laser printers. Model A200 presently sells for \(\$ 400\) and has a total product cost of \(\$ 320\), as follows: \begin{tabular}{lrr} & Direct materials & \(\$ 230\) \\ & Direct labor & 60 \\ & Factory overhead & \(\frac{30}{\$ 320}\) \\ \hline \end{tabular} It is estimated that the competitive selling price for color laser printers of this type will drop to \(\$ 380\) next year. Laser Cast has established a target cost to maintain its historical markup percentage on product cost. Engineers have provided the following cost reduction ideas: 1\. Purchase a plastic printer cover with snap-on assembly. This will reduce the amount of direct labor by nine minutes per unit. 2\. Add an inspection step that will add six minutes per unit of direct labor but reduce the materials cost by \(\$ 8\) per unit. 3\. Decrease the cycle time of the injection molding machine from four minutes to three minutes per part. Thirty percent of the direct labor and \(42 \%\) of the factory overhead is related to running injection molding machines. The direct labor rate is \(\$ 25\) per hour. a. Determine the target cost for Model A200 assuming that the historical markup on product cost is maintained. b. Determine the required cost reduction. c. Evaluate the three engineering improvements to determine if the required cost reduction (drift) can be achieved.

Cardio Care Inc. manufactures stationary bicycles and rowing machines. The products are produced in the Fabrication and Assembly production departments. In addition to production activities, several other activities are required to produce the two products. These activities and their associated activity rates are as follows: $$ \begin{array}{ll} \text { Activity } & \multicolumn{1}{c}{\text { Activity Rate }} \\ \hline \text { Fabrication } & \$ 24 \text { per machine hour (mh) } \\ \text { Assembly } & \$ 12 \text { per direct labor hour (dlh) } \\ \text { Setup } & \$ 40 \text { per setup } \\ \text { Inspecting } & \$ 22 \text { per inspection } \\ \text { Production scheduling } & \$ 14 \text { per production order } \\ \text { Purchasing } & \$ 6 \text { per purchase order } \end{array} $$ The activity-base usage quantities and units produced for each product were as follows: $$ \begin{array}{lrr} & \text { Stationary Bicycle } & \text { Rowing Machine } \\ \hline \text { Machine hours } & 1,950 & 975 \\ \text { Direct labor hours } & 436 & 162 \\ \text { Setups } & 48 & 15 \\ \text { Inspections } & 725 & 375 \\ \text { Production orders } & 68 & 20 \\ \text { Purchase orders } & 166 & 126 \\ \text { Units produced } & 1,000 & 1,000 \end{array} $$ Use the activity rate and usage information to compute the total activity costs and the activity costs per unit for each product.