Chapter 21

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University of Memphis *

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7080

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Business

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Apr 3, 2024

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Chapter 21 Assignments: 1. Costs identified as important with regard to making a particular business decision are referred to as ___ costs. Relevant 2. Which of the following would likely be a relevant nonfinancial consideration in the decision of whether to hire a catering service to provide food for a New Year's Eve party in your home or to prepare the food yourself? the quality of the food preparation 3. Which of the following statements is/are true regarding the relevance of information required to make business decisions? Relevant financial information focuses primarily upon costs and revenues; The only information relevant to a particular business decision is that which varies among possible outcomes; Identifying relevant information requires judgment 4. As part of the convergence project, the IASB now requires that borrowing costs must be ___ in a manner consistent with U>S GAAP requirements. Capitalized 5. A company must choose between 2 short-term courses of action. Alternative #1 will result in incremental operating costs of $9,000 and incremental operating revenue of $4,000. Alternative #2 will result in incremental operating costs of $6,000 and incremental operating revenue of $5,000. The incremental operating income of Alternative #2 over that of Alternative #1 is $___. $4,000 6. Which of the following are common concepts used in making short-run decisions? opportunity costs; incremental costs (and revenues); out-of-pocket costs; sunk costs 7. Benefits forgone (given up) by choosing one alternative over another are referred to as ___ costs. Opportunity 8. Identify the statements considered relevant in deciding whether to mow your own lawn or hire someone else to mow it for you. the additional time you would have to play golf by having someone else perform the service; the savings in gasoline costs realized from having someone else perform the service 9. A(n) ___ cost is one that has already been incurred and cannot be changed by future actions. Sunk 10. True or False: The only information relevant to a business decision is that which varies among possible courses of outcomes to be considered. TRUE 11. Thompson Corporation sells regulators at a normal selling price of $50 per unit. The variable cost per unit of each regulator is $20, and the company's total fixed cost is $500,000 per month. The company has an excess capacity of 75,000 units per month. Management was recently contacted by a potential buyer with whom they had no prior experience. The buyer offered to buy a special order of 30,000 regulators at a discount

price of $40 per unit. The special nature of the order would increase the variable costs associated with it by $5 per unit over the normal variable cost. The special order would have no impact on fixed costs. If the special order is accepted, operating income will increase by $___. $450,000 12. Prior to the FASB/IASB convergence project, interest costs incurred on funds borrowed to bring assets into marketable condition (such as money borrowed to finance construction costs) were not ___ under international standards (IFRS). Capitalized 13. When production is constrained by a limited input resource, incremental analysis involves the use of: the contribution margin per unit of limited input resource 14. Factors relevant to various short-term decisions often involve differences in costs incurred and revenue earned under alternative courses of action. As the title of this chapter implies, these differences are referred to as ___ (differential) costs and revenue. Incremental 15. Products for which sales of one contribute to the sales of another are called ___ products. Complementary 16. Which of the following statements is/are true regarding opportunity costs? The opportunity costs of particular decisions are sometimes not known at the time those decisions are made; Opportunity costs are benefits that could have been obtained by pursuing an alternative decision 17. Bentley Corporation currently makes Part #332, used in its manufacturing of engines. At 15,000 units, the total cost of making Part #332 is $97,000, computed as follows: Direct Labor = $15,000 ($1 per unit); Direct Materials = $30,000 ($2 per unit); Variable Overhead = $12,000 ($0.80 per unit); Fixed Overhead = $40,000. An outside vendor has offered to supply Bentley with 15,000 units of Part #332 for $75,000. If the company accepts the offer, its fixed overhead costs will be reduced by $3,000. 1. If Bentley buys the parts instead of continuing to manufacture them, its costs increase by $___. 2. At a total purchase price of $___, he company would be indifferent between making or buying 15,000 units of the part. $15,000; $60,000 18. Which of the following statements is/are true? Sunk costs represent irreversible cash outflows that have already occurred; Many businesses fail due to poor cash planning related to short-run business decisions 19. Elsworth has been approached by an outside vendor that wishes to sell the company a particular part that is currently manufactured internally. If Elsworth accepts the vendor's offer, the production space currently used to manufacture the part could instead be used to manufacture a new product that would generate incremental operating income of $50,000 per year. If Elsworth rejects the vendor's offer, the $50,000 would be viewed as a(n) ___ ___. Opportunity cost

20. Wilson Corporation sells an industrial solvent at a normal selling price of $100 per barrel. The variable cost per barrel is $40, and the company's total fixed cost is $900,000 per month. The company has an excess capacity of 30,000 barrels per month. Management was recently contacted by a potential buyer with whom they had no prior experience. The buyer offered to buy a special order of 5,000 barrels at a discount price of $80 per barrel. The special nature of the order would increase the variable costs associated with it by $10 per barrel over the normal variable cost. The special order would also increase fixed costs by $60,000. If the special order is accepted, operating income will increase by $___. $90,000 21. Pan Corporation incurs costs of $1.8 million building a custom piece of machinery for one of its customers. The machine is 90% complete when Pan receives notice that the customer has declared bankruptcy. As a result, the customer is not able to accept delivery or pay anything for the machinery it ordered. Due to the custom design of the machine, there are no other potential buyers. Pan can sell the machine as scrap for $80,000 or it can redesign and complete the machine for $900,000, after which it could be sold for $1 million. Given the above information and assuming Pan's cost and revenue estimates pertaining to scrapping or rebuilding the machine are accurate, answer the following questions: 1. Costs irrelevant to this decision total $___. 2. If Pan sells the machine as scrap, its incremental income will increase by $___. 3. If Pan rebuilds and then sells the machine, its incremental income will increase by $___. $1,800,000; $80,000; $100,000 22. Mac manufactures 2 products: pants and shirts. Pants have a selling price of $60 and a variable cost per unit of $40. Shirts have a selling price of $50 and a variable cost per unit of $30. Pants require 0.20 machine-hours per unit, whereas shirts require 0.25 machine- hours per unit. The company's fixed costs average $200,000 per month. Monthly demand for pants is 14,000 units, whereas monthly demand for shirts is 15,000 units. If the company has only 3,000 machine-hours (MH) available per month, the maximum amount of operating income it can earn is $___. $96,000 23. True or false: Plant capacity issues often play an important role in making scrap or rebuild decisions. TRUE 24. Which of the following are likely to be complementary products to home-brewing beer kits? brewing yeast; reusable bottles 25. Joint product decisions involve two basic issues. First, managers must decide how to___ joint costs among the various joint products being manufactured. Second, they must apply___ analysis to decide which joint products to___ further to create additional products. Allocate; incremental; process

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26. True or false: When analyzing make or buy decisions, it is important to realize that not all variable costs are incremental and that some fixed costs may be incremental in a given situation. TRUE 27. Pacific Lumber produces two products from a shared production process: wood pellets and fiberboard. Up to the split-off point for these two products, the joint costs associated with their shared processes total $10 million per year. Wood pellets generate $5 million in annual revenue, and fiberboard generates $20 million in annual revenue. The company allocates joint costs to the two products on the basis of their relative sales value. 1. The amount of joint costs allocated to wood pellets is $___ million per year. 2. The amount of joint costs allocated to fiberboard is $___ million per year. $2 million, $8 million 28. Which of the following are nonfinancial concerns pertaining to make or buy decisions? Will the decision to use an external vendor impact product quality?; Will the decision to use an external vendor impact long-term product availability?; Will the decision to use an external vendor impact production scheduling and flexibility? 29. True or false: Nonfinancial considerations can result in choosing a course of action that is not necessarily the most profitable. TRUE 30. Wilcox Manufacturing is experiencing problems with its production process. Recently, 50,000 defective units were produced at a cost of $250,000 before the company discovered the issue and shut down its production line. The defective products can be sold as scrap for $4 per unit. As an alternative, the defects can be corrected at a cost of $5 per unit, after which they can be sold for $8 per unit. 1. Costs irrelevant to this scrap or rebuild decision total $___. 2. If the units are scrapped, incremental income will increase by $___. 3. If the units are rebuilt, incremental income will increase by $___. $250,000; $200,000; $150,000 31. If a decision to rebuild defective units and sell them at regular prices, as opposed to scrapping them at reduced prices, interferes with the production space required to fulfill other orders, the revenue lost while the defective units are being rebuilt is considered a(n)___ cost. Opportunity 32. Which of the following types of businesses typically produces multiple products from common raw materials and shared production processes? oil refineries; meat processing companies; lumber and steel mills 33. In most cases, joint products will be processed further beyond the split-off point when the___ revenue exceeds the incremental ___ of doing so. Incremental; cost 34. The profitability of a particular business decision depends on its ___ revenue and expenses. Judgment also plays an important role in performing incremental analysis, such as assessing the ___ costs that result from forgoing benefits by selecting one alternative over another. Incremental; opportunity

35. Ames Manufacturing recently upgraded its production equipment at a cost of $500,000. During the testing phase of the new equipment, calibrations were set incorrectly, and 10,000 defective units were produced at a cost of $100,000 before the company discovered the issue. Recalibrating the equipment will cost $8,000. The defective products can be sold as scrap for $2 per unit. As an alternative, the defects can be corrected at a cost of $6 per unit, after which they can be sold for $14 per unit. 1. Costs irrelevant to this scrap or rebuild decision total $ ___. 2. If the units are scrapped, incremental income will increase by $___. 3. If the units are rebuilt, incremental income will increase by $___. $608,000; $20,000; $80,000 36. In most cases, joint products will not be processed further beyond the split-off point when the incremental ___ exceeds the ___ revenue of doing so. cost; incremental 37. Myron Chemical produces two products from a shared production process: cleansers and solvents. Up to the split-off point for these two products, the joint costs associated with their shared processes total $5 million per year. Cleansers generate $18 million in annual revenue, and solvents generate $12 million in annual revenue. The company allocates joint costs to the two products on the basis of their relative sales value. 1. The amount of joint costs allocated to cleansers is $___ million per year. 2. The amount of joint costs allocated to solvents is $___ million per year. $3million; $2million Homeworks: 1. True or False: In determining whether to scrap or to rebuild defective units of product, prior costs incurred to produce the defective units are not relevant. Group starts. TRUE 2. Direct material costs are always considered relevant costs in a make or buy decision. TRUE 3. It’s Alarming! produces alarm systems for cars and trucks. The company is trying to decide whether to outsource its Installation Department to A-One Technicians for $40 per installation. Although the company estimates that its current costs are only $32 per vehicle, it could likely use the idle space currently occupied by the Installation Department to earn an additional $9,600 per year. The company performs approximately 64 installations per month. Should it outsource its Installation Department operation to A-One Technicians? TRUE (The annual incremental cost to outsource is: (64 installations per month × 12 months) × ($40 − $32) = $6,144. The incremental contribution from the alternative use of space is $9,600 per year. Thus, the net annual benefit of outsourcing is $3,456 ($9,600 − $6,144)

4. It’s Alarming! produces alarm systems for cars and trucks. The company is trying to decide whether to outsource its Installation Department to A-One Technicians for $40 per installation. Although the company estimates that its current costs are only $32 per vehicle, it could likely use the idle space currently occupied by the Installation Department to earn an additional $9,600 per year. The company performs approximately 64 installations per month. What nonfinancial factors should be considered? The reputation for quality service of the outsourcing company; Current employees would have to be fired 5. Which factor is not relevant in deciding whether to accept a special order? The average cost of production if the special order is accepted 6. In deciding whether to accept a special order, what is the opportunity cost of using machinery for which the firm has sufficient excess capacity to accept the order? Zero 7. True or False: Incremental revenue and incremental costs are relevant to nearly all business decisions. TRUE 8. Which of the following types of cost are always relevant to a decision? Incremental costs 9. Which of the following are sunk, out-of-pocket, or opportunity costs?

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Chapter 21

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