Short-Term Business Decisions

Top managers of Video Avenue are alarmed by their operating losses. They are considering dropping the DVD product line. Company accountants have prepared the following analysis to help make this decision:

VIDEO AVENUE

Income Statement

For the Year Ended December 31, 2018

                                                            Total              Blu-ray Discs           DVD Discs 

Net Sales Revenue                                    \(437,000       \)308,000                   \(129,000

Variable Costs                                250,000          154,000                      96,000

Contribution Margin                      187,000          154,000                      33,000

Fixed Costs:

Manufacturing                                 132,000          76,000                        56,000

Selling & Administrative               65,000            51,000                        14,000

Total Fixed Expenses                   197,000          127,000                      70,000

Operating Income (Loss)             \)(10,000)       \(27,000                      \)(37,000)

Total fixed costs will not change if the company stops selling DVDs.

Requirements 

1. Prepare a differential analysis to show whether Video Avenue should drop the DVD product line. 

2. Will dropping DVDs add $37,000 to operating income? Explain.

Refer to Exercise E25-13. Assume that Video Avenue can avoid $39,000 of direct fixed costs by dropping the DVD product line. Prepare a differential analysis to show whether Video Avenue should stop selling DVDs.

Tread Light produces two types of exercise treadmills: regular and deluxe. The exercise craze is such that Tread Light could use all its available machine hours to produce either model. The two models are processed through the same production departments. Data for both models are as follows:

                                                                                                            Per Unit         

                                                                                                Deluxe                       Regular 

Sales price                                                                           \(1,030                        \)610

Costs:

Direct materials                                                                   320                             130

Direct labor                                                                          88                                180

Variable manufacturing overhead                                 270                             90

Fixed manufacturing overhead*                                                102                             34

Variable operating expenses                                          121                             63

Total costs                                                                           901                             497     

Operating income                                                              \(129                           \)113

*allocated on the basis of machine hours

Requirements 

1. What is the constraint? 

2. Which model should Tread Light produce? (Hint: Use the allocation of fixed manufacturing overhead to determine the proportion of machine hours used by each product.) 

3. If Tread Light should produce both models, compute the mix that will maximize operating income.

Moore Company sells both designer and moderately priced fashion accessories. Top management is deciding which product line to emphasize. Accountants have provided the following data:

                                                                                                            Per Item 

                                                                                    Designer                   Moderately Priced

Average sales price                                               \(185                           \)87

Average variable costs                                         105                             22

Average contribution margin                              80                                65

Average fixed costs (allocated)                          20                                10

Average operating income                                  \(60                             \)55

The Moore Company store in Grand Junction, Colorado, has 14,000 square feet of floor space. If Moore Company emphasizes moderately priced goods, it can display 840 items in the store. If Moore Company emphasizes designer wear, it can display only 560 designer items. These numbers are also the average monthly sales in units. 

Prepare an analysis to show which product the company should emphasize.

Each morning, Max Smith stocks the drink case at Max’s Beach Hut in Myrtle Beach, South Carolina. The drink case has 120 linear feet of refrigerated drink space. Each linear foot can hold either six 12-ounce cans or three 20-ounce bottles. 

Max’s Beach Hut sells three types of cold drinks:

1. Licious-Ade in 12-oz. cans for \(1.40 per can 

2. Licious-Ade in 20-oz. bottles for \)1.90 per bottle 

3. Pep-Cola in 20-oz. bottles for \(2.20 per bottle

Max’s Beach Hut pays its suppliers:

1. \)0.20 per 12-oz. can of Licious-Ade 

2. \(0.35 per 20-oz. bottle of Licious-Ade 

3. \)0.55 per 20-oz. bottle of Pep-Cola

Max’s Beach Hut’s monthly fixed costs include:

Hut rental                                                      \(355

Refrigerator rental                                      65

Max’s salary                                                 1,700

Total fixed costs                                         \)2,120

Max’s Beach Hut can sell all the drinks stocked in the display case each morning. 

Requirements 

1. What is Max’s Beach Hut’s constraining factor? What should Max stock to maximize profits? 

2. Suppose Max’s Beach Hut refuses to devote more than 80 linear feet to any individual product. Under this condition, how many linear feet of each drink should Max’s stock? How many units of each product will be available for sale each day?

Cool Systems manufactures an optical switch that it uses in its final product. The switch has the following manufacturing costs per unit:

Direct materials                                                       \(5.00

Direct labor                                                              3.00

Variable overhead                                                  6.00

Fixed overhead                                                       7.00

Manufacturing product cost                               \)21.00

Another company has offered to sell Cool Systems the switch for $15.00 per unit. If Cool Systems buys the switch from the outside supplier, the idle manufacturing facilities cannot be used for any other purpose, yet none of the fixed costs are avoidable. 

Prepare an outsourcing analysis to determine whether Cool Systems should make or buy the switch.

Refer to Exercise E25-18. Cool Systems needs 79,000 optical switches. By outsourcing them, Cool Systems can use its idle facilities to manufacture another product that will contribute $225,000 to operating income.

Requirements 

1. Identify the expected net costs that Cool Systems will incur to acquire 79,000 switches under three alternative plans: make the switches, buy the switches and leave facilities idle, buy the switches and use the idle facilities to make another product. 

2. Which plan makes the best use of Cool System’s facilities? Support your answer.

NaturalMaid processes organic milk into plain yogurt. NaturalMaid sells plain yogurt to hospitals, nursing homes, and restaurants in bulk, one-gallon containers. Each batch, processed at a cost of \(840, yields 300 gallons of plain yogurt. NaturalMaid sells the one-gallon tubs for \)5 each and spends \(0.14 for each plastic tub. NaturalMaid has recently begun to reconsider its strategy. NaturalMaid wonders if it would be more profitable to sell individual-size portions of fruited organic yogurt at local food stores. NaturalMaid could further process each batch of plain yogurt into 6,400 individual portions (3/4 cup each) of fruited yogurt. A recent market analysis indicates that demand for the product exists. NaturalMaid would sell each individual portion for \)0.58. Packaging would cost \(0.10 per portion, and fruit would cost \)0.11 per portion. Fixed costs would not change. 

Should NaturalMaid continue to sell only the gallon-size plain yogurt (sell as is) or convert the plain yogurt into individual-size portions of fruited yogurt (process further)? Why?

Sea Blue manufactures flotation vests in Charleston, South Carolina. Sea Blue’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

SEA BLUE

Income Statement

For the Month Ended December 31, 2018

Sales in units                                                                                         32,000

Net Sales Revenue                                                                                \(608,000

Variable Costs:

          Manufacturing                                                                             96,000

          Selling and Administrative                                                          108,000

Total Variable Costs                                                                              204,000

Contribution Margin                                                                              404,000

Fixed Costs:

          Manufacturing                                                                             124,000

          Selling and Administrative                                                           94,000

Total Fixed Costs                                                                                   218,000

Operating Income                                                                                   \)186,000

Suppose Overboard wishes to buy 4,600 vests from Sea Blue. Sea Blue will not incur any variable selling and administrative expenses on the special order. The Sea Blue plant has enough unused capacity to manufacture the additional vests. Overboard has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements 

1. Identify each cost in the income statement as either relevant or irrelevant to Sea Blue’s decision. 

2. Prepare a differential analysis to determine whether Sea Blue should accept this special sales order. 

3. Identify long-term factors Sea Blue should consider in deciding whether to accept the special sales order.

Snappy Plants operates a commercial plant nursery where it propagates plants for garden centers throughout the region. Snappy Plants has \(5,100,000 in assets. Its yearly fixed costs are \)650,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total \(1.90. Snappy Plants’s volume is currently 500,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)4.25 each. Garden centers then mark them up to sell to the public for \(9 to \)12, depending on the type of plant.

Requirements 

1. Snappy Plants’s owners want to earn a 11% return on investment on the company’s assets. What is Snappy Plants’s target full product cost? 

2. Given Snappy Plants’s current costs, will its owners be able to achieve their target profit? 

3. Assume Snappy Plants has identified ways to cut its variable costs to \(1.75 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit? 

4. Snappy Plants started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Snappy Plants does not expect volume to be affected, but it hopes to gain more control over pricing. If Snappy Plants has to spend \)105,000 this year to advertise and its variable costs continue to be $1.75 per unit, what will its cost-plus price be? Do you think Snappy Plants will be able to sell its plants to garden centers at the cost-plus price? Why or why not?

Members of the board of directors of Security Check have received the following operating income data for the year ended May 31, 2018:

Members of the board are surprised that the industrial systems product line is not profitable. They commission a study to determine whether the company should drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by \(80,000 and decrease fixed selling and administrative expenses by \)12,000.

Requirements 

1. Prepare a differential analysis to show whether Security Check should drop the industrial systems product line. 

2. Prepare contribution margin income statements to show Security Check’s total operating income under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternatives’ income numbers to your answer to Requirement 1.

3. What have you learned from the comparison in Requirement 2?

Brinn, located in Port St. Lucie, Florida, produces two lines of electric toothbrushes: deluxe and standard. Because Brinn can sell all the toothbrushes it can produce, the owners are expanding the plant. They are deciding which product line to emphasize. To make this decision, they assemble the following data:

                                                                                Per Unit

                                                  Deluxe Toothbrush          Standard Toothbrush

Sales price                                          \(86                                             \)56

Variable costs                                     20                                              18

Contribution margin                            \(66                                             \)38     

Contribution margin ratio                    76.7%                                         67.9%

After expansion, the factory will have a production capacity of 4,100 machine hours per month. The plant can manufacture either 50 standard electric toothbrushes or 35 deluxe electric toothbrushes per machine hour.

Requirements 

1. Identify the constraining factor for Brinn. 

2. Prepare an analysis to show which product line to emphasize.

Snow Ride manufactures snowboards. Its cost of making 1,900 bindings is as follows:

Direct materials                                                       \(17,590

Direct labor                                                              3,200

Variable overhead                                                   2,080

Fixed overhead                                                        6,300

Total manufacturing costs for 1,900 bindings         \)29,170

Suppose Livingston will sell bindings to Snow Ride for \(13 each. Snow Ride would pay \)3 per unit to transport the bindings to its manufacturing plant, where it would add its own logo at a cost of \(0.50 per binding. 

Requirements 

1. Snow Ride’s accountants predict that purchasing the bindings from Livingston will enable the company to avoid \)2,100 of fixed overhead. Prepare an analysis to show whether Snow Ride should make or buy the bindings. 

2. The facilities freed by purchasing bindings from Livingston can be used to manufacture another product that will contribute $3,100 to profit. Total fixed costs will be the same as if Snow Ride had produced the bindings. Show which alternative makes the best use of Snow Ride’s facilities: (a) make bindings, (b) buy bindings and leave facilities idle, or (c) buy bindings and make another product.

Oak Petroleum has spent \(202,000 to refine 63,000 gallons of petroleum distillate, which can be sold for \)6.00 per gallon. Alternatively, Oak can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Oak must pay a sales commission of \(0.12 per gallon and a transportation charge of \)0.19 per gallon.

Requirements 

1. Diagram Oak’s decision alternatives, using Exhibit 25-18 as a guide. 

2. Identify the sunk cost. Is the sunk cost relevant to Oak’s decision? 

3. Should Oak sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.

Nautical manufactures flotation vests in Tampa, Florida. Nautical’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

NAUTICAL

Income Statement

For the Month Ended December 31, 2018

Sales in Units                                                                    29,000

Net Sales Revenue                                                            \(551,000

Variable Costs:                

          Manufacturing                                                         116,000

          Selling and Administrative                                      111,000

Total Variable Costs                                                          227,000

Contribution Margin                                                          324,000

Fixed Costs:

          Manufacturing                                                         123,000

          Selling and Administrative                                      92,000

Total Fixed Expenses                                                        215,000

Operating Income                                                              \)109,000

Suppose Water Works wishes to buy 4,800 vests from Nautical. Nautical will not incur any variable selling and administrative expenses on the special order. The Nautical plant has enough unused capacity to manufacture the additional vests. Water Works has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements 

1. Identify each cost in the income statement as either relevant or irrelevant to Nautical’s decision. 

2. Prepare a differential analysis to determine whether Nautical should accept this special sales order. 

3. Identify long-term factors Nautical should consider in deciding whether to accept the special sales order.

Green Thumb operates a commercial plant nursery, where it propagates plants for garden centers throughout the region. Green Thumb has \(5,300,000 in assets. Its yearly fixed costs are \)625,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total \(1.70. Green Thumb’s volume is currently 490,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)4.00 each. Garden centers then mark them up to sell to the public for \(9 to \)12, depending on the type of plant.

Requirements 

1. Green Thumb’s owners want to earn an 10% return on the company’s assets. What is Green Thumb’s target full product cost? 

2. Given Green Thumb’s current costs, will its owners be able to achieve their target profit?

3. Assume Green Thumb has identified ways to cut its variable costs to \(1.55 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit? 

4. Green Thumb started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Green Thumb does not expect volume to be affected, but it hopes to gain more control over pricing. If Green Thumb has to spend \)135,000 this year to advertise and its variable costs continue to be $1.55 per unit, what will its cost-plus price be? Do you think Green Thumb will be able to sell its plants to garden centers at the cost-plus price? Why or why not?

Members of the board of directors of Security Team have received the following operating income data for the year ended March 31, 2018:

Members of the board are surprised that the industrial systems product line is losing money. They commission a study to determine whether the company should drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by \(81,000 and decrease fixed selling and administrative expenses by \)15,000. 

Requirements 

1. Prepare a differential analysis to show whether Security Team should drop the industrial systems product line. 

2. Prepare contribution margin income statements to show Security Team’s total operating income under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternatives’ income numbers to your answer to Requirement 1. 

3. What have you learned from this comparison in Requirement 2?

Brik, located in San Antonio, Texas, produces two lines of electric toothbrushes: deluxe and standard. Because Brik can sell all the toothbrushes it can produce, the owners are expanding the plant. They are deciding which product line to emphasize. To make this decision, they assemble the following data:

                                                                                Per Unit 

                                                  Deluxe Toothbrush          Standard Toothbrush 

Sales price                                          \(88                                   \)54

Variable expense                                 22                                    18                          

Contribution margin                            \(66                                   \)36     

Contribution margin ratio                    75.0%                               66.7%

After expansion, the factory will have a production capacity of 4,900 machine hours per month. The plant can manufacture 65 standard electric toothbrushes or 27 deluxe electric toothbrushes per machine hour. 

Requirements 

1. Identify the constraining factor for Brik. 

2. Prepare an analysis to show which product line the company should emphasize.

Cold Sports manufactures snowboards. Its cost of making 2,000 bindings is as follows:

Direct materials                             \(17,510

Direct labor                                2,600

Variable overhead                            2,060

Fixed overhead                            7,000

Total manufacturing costs for 2,000 bindings        \)29,170

Suppose Topnotch will sell bindings to Cold Sports for \(15 each. Cold Sports would pay \)3 per unit to transport the bindings to its manufacturing plant, where it would add its own logo at a cost of \(0.50 per binding.

Requirements 

1. Cold Sports’s accountants predict that purchasing the bindings from Topnotch will enable the company to avoid \)2,300 of fixed overhead. Prepare an analysis to show whether Cold Sports should make or buy the bindings. 

2. The facilities freed by purchasing bindings from Topnotch can be used to manufacture another product that will contribute $3,100 to profit. Total fixed costs will be the same as if Cold Sports had produced the bindings. Show which alternative makes the best use of Cold Sports’s facilities: (a) make bindings, (b) buy bindings and leave facilities idle, or (c) buy bindings and make another product.

Elm Petroleum has spent \(204,000 to refine 61,000 gallons of petroleum distillate, which can be sold for \)6.30 per gallon. Alternatively, Elm can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Elm must pay a sales commission of \(0.10 per gallon and a transportation charge of \)0.16 per gallon.

Requirements 

1. Diagram Elm’s decision alternatives, using Exhibit 25-18 as a guide. 

2. Identify the sunk cost. Is the sunk cost relevant to Elm’s decision? 

3. Should Elm sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.

This problem continues the Piedmont Computer Company situation from Chapter 24. Piedmont Computer Company’s payroll accountant has submitted her resignation and will be leaving the company in two weeks. The company must decide if it will hire a replacement or outsource the payroll position. The current employee earns a salary of \(40,000. Medical insurance, employer payroll taxes, and contributions to the pension plan for this position cost \)7,600. The company has already invested \(22,000 in payroll software. Required annual updates to remain in compliance with all state and federal laws are \)495. The company also spends \(1,750 per year in professional development for this position to ensure the employee stays up-to-date with payroll changes. Piedmont Computer Company pays its employees weekly. Payroll Professionals will process the company’s weekly payroll for \)1,000 per week. This fee also includes preparing all necessary payroll tax returns, reports, and W-2s. 

Requirements 

1. Prepare a differential analysis to determine if Piedmont Computer Company should replace the employee or outsource the payroll function. 

2. What other factors should Piedmont Computer Company consider in making this decision?

Mary Tan is the controller for Duck Associates, a property management company in Portland, Oregon. Each year, Tan and payroll clerk Toby Stock meet with the external auditors about payroll accounting. This year, the auditors suggest that Tan consider outsourcing Duck Associates’s payroll accounting to a company specializing in payroll processing services. This would allow Tan and her staff to focus on their primary responsibility: accounting for the properties under management. At present, payroll requires 1.5 employee positions—payroll clerk Toby Stock and a bookkeeper who spends half her time entering payroll data in the system.

Tan considers this suggestion, and she lists the following items relating to outsourcing payroll accounting:

1. The current payroll software that was purchased for \(4,000 three years ago would not be needed if payroll processing were outsourced.

2. Duck Associates’ bookkeeper would spend half her time preparing the weekly payroll input form that is given to the payroll processing service. She is paid \)450 per week.

3. Duck Associates would no longer need payroll clerk Toby Stock, whose annual salary is \(42,000.

4. The payroll processing service would charge \)2,000 per month.

Requirements 

1. Would outsourcing the payroll function increase or decrease Duck Associates’ operating income? 

2. Tan believes that outsourcing payroll would simplify her job, but she does not like the prospect of having to lay off Stock, who has become a close personal friend. She does not believe there is another position available for Stock at his current salary. Can you think of other factors that might support keeping Stock, rather than outsourcing payroll processing? How should each of the factors affect Tan’s decision if she wants to do what is best for Duck Associates and act ethically?