Short-Term Business Decisions

What questions should managers answer when considering dropping a product or segment?

Doherty Company is considering replacing the individual printers each employee in the corporate office currently uses with a network printer located in a central area. The network printer is more efficient and would, therefore, cost less to operate than the individual printers. However, most of the office staff think having to use a centralized printer would be inconvenient. They prefer to have individual printers located at each desk. Identify the following information as financial or nonfinancial and relevant or irrelevant. The first item has been completed as an example.

Thomas Company makes a product that regularly sells for \(12.50 per unit. The product has variable manufacturing costs of \)8.50 per unit and fixed manufacturing costs of \(2.00 per unit (based on \)200,000 total fixed costs at current production of 100,000 units). Therefore, the total production cost is \(10.50 per unit. Thomas Company receives an offer from Wesley Company to purchase 5,000 units for \)9.00 each. Selling and administrative costs and future sales will not be affected by the sale, and Thomas does not expect any additional fixed costs. 

1. If Thomas Company has excess capacity, should it accept the offer from Wesley? Show your calculations. 

2. Does your answer change if Thomas Company is operating at capacity? Why or why not?

McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.

                                                                              MCCOLLUM COMPANY

                                                                                    Income Statement

                                                                             Month Ended June 30, 2018

                                                                     Total               Product A                   Product B

Net Sales Revenue                                    \(150,000       \)75,000                      \(75,000

Variable Costs                                            90,000            55,000                        35,000

Contribution Margin                                  60,000            20,000                        40,000

Fixed Costs                                                 50,000            5,000                          45,000

Operating Income/(Loss)                         \)10,000          \(15,000                      \)(5,000)

1. If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
2. If 50% of Product B’s fixed costs are avoidable, should McCollum drop Product B? Why or why not?

 McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.

MCCOLLUM COMPANY

Income Statement

Month Ended June 30, 2018

Total              Product A                 Product B

Net Sales Revenue                                                \(150,000       \)75,000                      \(75,000

Variable Costs                                            90,000            55,000                        35,000

Contribution Margin                                  60,000            20,000                        40,000

Fixed Costs                                                 50,000            5,000                          45,000

Operating Income/(Loss)                         \)10,000          \(15,000                      \)(5,000)

1. If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
2. If 50% of Product B’s fixed costs are avoidable, should McCollum drop Product B? Why or why not?

Grimm Company makes decorative wedding cakes. The company is considering buying the cakes rather than baking them, which will allow it to concentrate on decorating. The company averages 100 wedding cakes per year and incurs the following costs from baking wedding cakes:

Direct materials                                                               \(500

Direct labor                                                                      1,000

Variable manufacturing overhead                                 200

Fixed manufacturing overhead                                      1,200

Total manufacturing cost                                                \)2,900

Number of cakes                                                              ÷ 100

Cost per cake                                                                    \(29 

Fixed costs are primarily the depreciation on kitchen equipment such as ovens and mixers. Grimm expects to retain the equipment. Grimm can buy the cakes for \)25.

1. Should Grimm make the cakes or buy them? Why?
2. If Grimm decides to buy the cakes, what are some qualitative factors that Grimm should also consider?

Grimm Company makes decorative wedding cakes. The company is considering buying the cakes rather than baking them, which will allow it to concentrate on decorating. The company averages 100 wedding cakes per year and incurs the following costs from baking wedding cakes:

Direct materials                                                                   \(500

Direct labor                                                                          1,000

Variable manufacturing overhead                                 200

Fixed manufacturing overhead                                      1,200

Total manufacturing cost                                                            \)2,900

Number of cakes                                                                ÷ 100

Cost per cake                                                                      \(29 

Fixed costs are primarily the depreciation on kitchen equipment such as ovens and mixers. Grimm expects to retain the equipment. Grimm can buy the cakes for \)25.

1. Should Grimm make the cakes or buy them? Why? 
2. If Grimm decides to buy the cakes, what are some qualitative factors that Grimm should also consider?

What are sunk costs? Give an example.

When is nonfinancial information relevant?

What is differential analysis?

What is differential analysis?

What are the two keys in short-term decision making?

What are the two keys in short-term decision making?

What questions should managers answer when setting regular prices?

What questions should managers answer when setting regular prices?

Question: Explain the difference between price-takers and price-setters.

Explain the difference between price-takers and price-setters.

List the four steps in short-term decision making. At which step are managerial accountants most involved?

What makes information relevant to decision making?

What makes information irrelevant to decision making?

What are sunk costs? Give an example.

When is nonfinancial information relevant?

What is target pricing? Who uses it?

What does the target full product cost include?

What is cost-plus pricing? Who uses it?

What questions should managers answer when considering special pricing orders?

When completing a differential analysis, when are the differences shown as positive amounts? As negative amounts?

When should special pricing orders be accepted?

What is a constraint?

Explain why a segment with an operating loss can cause the company to have a decrease in total operating income if the segment is dropped.

What questions should managers answer when facing constraints?

Skiable Acres operates a Rocky Mountain ski resort. The company is planning its lift ticket pricing for the coming ski season. Investors would like to earn a 10% return on investment on the company’s \(270,000,000 of assets. The company primarily incurs fixed costs to groom the runs and operate the lifts. Skiable Acres projects fixed costs to be \)31,000,000 for the ski season. The resort serves about 725,000 skiers and snowboarders each season. Variable costs are about \(8 per guest. Currently, the resort has such a favorable reputation among skiers and snowboarders that it has some control over the lift ticket prices. 

Requirements 

1. Would Skiable Acres emphasize target pricing or cost-plus pricing? Why? 

2. If other resorts in the area charge \)85 per day, what price should Skiable Acres charge?

Refer to details about Skiable Acres from Short Exercise S25-2. Assume that Skiable Acres’s reputation has diminished and other resorts in the vicinity are charging only \(85 per lift ticket. Skiable Acres has become a price-taker and will not be able to charge more than its competitors. At the market price, Skiable Acres managers believe they will still serve 725,000 skiers and snowboarders each season.

Requirements 

1. If Skiable Acres cannot reduce its costs, what profit will it earn? State your answer in dollars and as a percent of assets. Will investors be happy with the profit level? 

2. Assume Skiable Acres has found ways to cut its fixed costs to \)30,000,000. What is its new target variable cost per skier/snowboarder?

What is the decision rule concerning products to emphasize when facing a constraint?

What is the most common constraint faced by merchandisers?

What is outsourcing?

What questions should managers answer when considering outsourcing?

What questions should managers answer when considering selling a product as is or processing further?

What are joint costs? How do they affect the sell or process further decision?

What is the decision rule for selling a product as is or processing it further?

You are trying to decide whether to trade in your inkjet printer for a more recent model. Your usage pattern will remain unchanged, but the old and new printers use different ink cartridges. 

Indicate if the following items are relevant or irrelevant to your decision:

a. The price of the new printer 

b. The price paid for the old printer 

c. The trade-in value of the old printer 

d. Paper cost 

e. The difference between ink cartridges’ costs

Edna Fashions operates three departments: Men’s, Women’s, and Accessories. Departmental operating income data for the third quarter of 2018 are as follows:

                                        EDNA FASHIONS

                                        Income Statement

                   For the Quarter Ended September 30, 2018

                                                Department

                                         Men’s                   Women’s      Accessories      Total

Net Sales Revenue      \(101,000              \)59,000          \(102,000    \)262,000      

Variable Costs             65,000                  35,000            91,000          191,000   

Contribution Margin   36,000                  24,000            11,000         71,000        

Fixed Costs                 27,000                  19,000            29,000         75,000

Operating Income       \(9,000                  \)5,000            \((18,000)    \)(4,000) 

Assume that the fixed costs assigned to each department include only direct fixed costs of the department: 

• Salary of the department’s manager 

• Cost of advertising directly related to that department 

If Edna Fashions drops a department, it will not incur these fixed costs. Under these circumstances, should Edna Fashions drop any of the departments? Give your reasoning.

StoreAll produces plastic storage bins for household storage needs. The company makes two sizes of bins: large (50 gallon) and regular (35 gallon). Demand for the products is so high that StoreAll can sell as many of each size as it can produce. The company uses the same machinery to produce both sizes. The machinery can be run for only 3,300 hours per period. StoreAll can produce 10 large bins every hour, whereas it can produce 17 regular bins in the same amount of time. Fixed costs amount to \(115,000 per period. Sales prices and variable costs are as follows:

                                                                                    Regular                     Large

Sales price per unit                                               \)8.00                          $10.40

Variable cost per unit                                           3.50                            4.40    

Requirements 

1. Which product should StoreAll emphasize? Why? 

2. To maximize profits, how many of each size bin should StoreAll produce? 

3. Given this product mix, what will the company’s operating income be?

Heavenly Dessert processes cocoa beans into cocoa powder at a processing cost of \(9,700 per batch. Heavenly Dessert can sell the cocoa powder as is, or it can process the cocoa powder further into either chocolate syrup or boxed assorted chocolates. Once processed, each batch of cocoa beans would result in the following sales revenue:

Cocoa powder                           \)14,500

Chocolate syrup                        103,000

Boxed assorted chocolates       204,000

The cost of transforming the cocoa powder into chocolate syrup would be \(72,000. Likewise, the company would incur a cost of \)183,000 to transform the cocoa powder into boxed assorted chocolates. The company president has decided to make assorted boxed chocolates due to their high sales value and to the fact that the cocoa bean processing cost of $9,700 eats up most of the cocoa powder profits. Has the president made the right or wrong decision? Explain your answer. Be sure to include the correct financial analysis in your response.

Suppose Roasted Pepper restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include \(0.52 of ingredients, \)0.27 of variable overhead (electricity to run the oven), and \(0.79 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor, Roasted Pepper assigns \)0.96 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $1.78 per loaf.

Requirements 

1. What is the full product unit cost of making the bread in-house? 

2. Should Roasted Pepper bake the bread in-house or buy from the local bakery? Why? 

3. In addition to the financial analysis, what else should Roasted Pepper consider when making this decision?

Priscilla Smiley manages a fleet of 250 delivery trucks for Daniels Corporation. Smiley must decide whether the company should outsource the fleet management function. If she outsources to Fleet Management Services (FMS), FMS will be responsible for maintenance and scheduling activities. This alternative would require Smiley to lay off her five employees. However, her own job would be secure; she would be Daniels’s liaison with FMS. If she continues to manage the fleet, she will need fleet management software that costs \(9,500 per year to lease. FMS offers to manage this fleet for an annual fee of \)300,000. Smiley performed the following analysis:

                                                Retain in-house   Outsource to FMS   Difference 

Annual leasing fee for      \(9,500                                                          \)9,500   

Software 

Annual maintenance of

Trucks                                   147,000                                                       147,000

Total annual salaries of

Five laid-off employees    185,000                                                         185,000

Fleet management

Service’s annual fee                                              \(300,000           (300,000)

Total differential cost of 

Outsourcing                        \)341,500                   \(300,000             \)41,500

Requirements

1. Which alternative will maximize Daniels’s short-term operating income? 

2. What qualitative factors should Daniels consider before making a final decision?

Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of \(3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another \)4,500,000. Jacobs is afraid to bring this new equipment to the company president’s attention because he convinced the president to invest $3,000,000 in the machinery last year. 

Explain what is relevant and irrelevant to Jacobs’s dilemma. What should he do?

Suppose the Baseball Hall of Fame in Cooperstown, New York, has approached Collector-Cardz with a special order. The Hall of Fame wishes to purchase 56,000 baseball card packs for a special promotional campaign and offers \(0.38 per pack, a total of \)21,280. Collector-Cardz’s total production cost is \(0.58 per pack, as follows:

Variable costs:

            Direct materials                  \)0.11

            Direct labor                          0.09

            Variable overhead             0.08

            Fixed overhead                   0.30

            Total cost                             \(0.58

Collector-Cardz has enough excess capacity to handle the special order.

Requirements 

1. Prepare a differential analysis to determine whether Collector-Cardz should accept the special sales order.

2. Now assume that the Hall of Fame wants special hologram baseball cards. Collector-Cardz will spend \)5,700 to develop this hologram, which will be useless after the special order is completed. Should Collector-Cardz accept the special order under these circumstances, assuming no change in the special pricing of $0.38 per pack?

Newtown Sunglasses sell for about \(154 per pair. Suppose that the company incurs the following average costs per pair:

Direct materials                                                                  \)39

Direct labor                                                                          15

Variable manufacturing overhead                                6

Variable selling expenses                                               3

Fixed manufacturing overhead                                      20*

Total cost                                                                             \(83

* \)2,050,000 Total fixed manufacturing overhead / 102,500 Pairs of sunglasses

Newtown has enough idle capacity to accept a one-time-only special order from Water Shades for 17,000 pairs of sunglasses at \(80 per pair. Newtown will not incur any variable selling expenses for the order. 

Requirements 

1. How would accepting the order affect Newtown’s operating income? In addition to the special order’s effect on profits, what other (longer-term qualitative) factors should Newtown’s managers consider in deciding whether to accept the order?

2. Newtown’s marketing manager, Peter Kyler, argues against accepting the special order because the offer price of \)80 is less than Newtown’s $83 cost to make the sunglasses. Kyler asks you, as one of Newtown’s staff accountants, to explain whether his analysis is correct. What would you say?

Johnson Builders builds 1,500-square-foot starter tract homes in the fast-growing suburbs of Atlanta. Land and labor are cheap, and competition among developers is fierce. The homes are a standard model, with any upgrades added by the buyer after the sale. Johnson Builders’s costs per developed sublot are as follows:

Land                                                                                      \(50,000

Construction                                                                       123,000

Landscaping                                                                       9,000

Variable selling costs                                                       8,000

Johnson Builders would like to earn a profit of 14% of the variable cost of each home sold. Similar homes offered by competing builders sell for \)207,000 each. Assume the company has no fixed costs.

Requirements 

1. Which approach to pricing should Johnson Builders emphasize? Why? 

2. Will Johnson Builders be able to achieve its target profit levels? 

3. Bathrooms and kitchens are typically the most important selling features of a home. Johnson Builders could differentiate the homes by upgrading the bathrooms and kitchens. The upgrades would cost \(16,000 per home but would enable Johnson Builders to increase the sales prices by \)28,000 per home.

(Kitchen and bathroom upgrades typically add about 175% of their cost to the value of any home.) If Johnson Builders makes the upgrades, what will the new cost-plus price per home be? Should the company differentiate its product in this manner?