Chapter 4
Short-Term Decision Making
Questions
1. What type of cost is incurred to obtain or manufacture a product?
2. What type of cost is related to selling the products and services or administering the company?
3. What type of cost varies with the number of batches regardless of how many units are in each batch?
4. What type of cost is incurred to maintain the company’s capacity to operate?
5. What type of cost varies with the number of units?
6. What type of cost varies with the number of product lines?
7. The study of how costs and profits change in response to changes in the volume of goods and services provided to customers is known as what type of analysis?
8. What is the point where the total cost line intersects with the total revenue line?
9. What is the difference between the incremental revenues and incremental costs of a particular alternative?
10. What cost is a past cost and, therefore, never relevant in short-term operating decisions?
Exercises
E4.1 Use the following information to determine the profit equation:
Selling price per unit $ 222
Variable cost per unit 130
Fixed cost per year 50,600
E4.2 Ward’s Inc. sells a product for $75 per unit. The variable cost per unit is $47. The fixed cost per year is $250,000.
A. What is the contribution margin per unit?
B. What is the breakeven point in units?
C. What is the contribution margin ratio?
D. What is the breakeven point in dollars?
E4.3 The Bryant Company has produced a new product. The management of Bryant Company must determine a selling price; however, the variable costs are unknown. The fixed costs are $450,000. Management plans to set the selling price so that variable cost is 45% of the selling price.
A. What is the contribution margin ratio?
B. What is the breakeven point in dollars?
C. If management desires a profit of $100,000, what will total sales be?
E4.4 Calihan Company has a product contribution margin of $50. The fixed costs are $300,000. Calihan Company desires a target profit before taxes of $150,000 per year.
A. What is the breakeven point in units?
B. How many units must be sold to achieve the target profit?
C. If fixed costs increase 5 percent, how many units must be sold to achieve the target profit?
E4.5 Ambert Apparel makes lightweight jackets. Each jacket sells for $17.50. The variable cost per jacket is $11.00. The fixed costs are $175,000. The after-tax target profit level is $25,000. Ambert Apparel is subject to a 30% income tax rate.
A. What is the breakeven point in units?
B. What is the breakeven point in dollars?
C. To achieve the profit goal, what must the before-tax profit be?
D. How many units must be sold to achieve the profit goal after taxes?
E4.6 Rush Company has the following cost-volume-profit relationships:
Breakeven point in units 20,000
Variable cost per unit $7.50
Fixed cost per period $50,000
A. What is the contribution margin per unit?
B. What is the selling price per unit?
C. What is the total profit if 20,001 units are sold?
E4.7 Backpackers, Inc. plans to manufacture packs for hiking and camping. The following costs are expected to be incurred in the manufacturing process. Determine whether each of the following costs is a product cost or a nonproduct cost. Use P for product cost and NP for nonproduct cost.
______A. Cost of fabric
______B. Cost of the factory building
______C. Cost of advertising in various outdoor magazines
______D. Cost of leather for trim
______E. Cost of thread used to sew packs together
______F. Cost of shelving to store production supplies
______G. Salary of the chief executive officer
______H. Cost of zippers
______I. Wages of sales personnel (salary plus commission)
______J. Cost of delivery vehicle
______K. Cost of utilities used in the factory building
______L. Cost of utilities used in the corporate office
______M. Production supervisor’s salary
______N. Setup costs to change production from one style pack to another
______O. Research costs to design and develop pack
______P. Property taxes on factory building
E4.8 Chavez Co. produces and sells duffel bags that are priced at $60 each. Chavez has received a request for a special order for 500 duffel bags at a price of $48 each. The current unit cost to produce a bag is $32 (direct material, $20; direct labor, $8; and unit-related overhead, $4). Chavez Co. has the capacity to produce the special order; however, one additional production run will be required costing $2,000. Should the order be accepted? Why or why not.
E4.9 Whitney, Inc. manufactures a unique hand lotion formulated for extremely dry weather. It also makes the containers the lotion is sold in. Production costs for the 15,000 containers needed annually are as follow:
Direct materials $35,000
Direct labor 15,000
Unit-related overhead 5,000
Product-sustaining overhead 6,000
Allocated facility-sustaining overhead 14,000
A supplier has offered to provide all 15,000 containers at a price of $4.50 per container. If Whitney, Inc. accepts the offer, it will rent the released space for an annual rental fee of $12,000. Should Whitney, Inc. make or buy the containers?
E4.10 In addition to selling custom-designed jewelry, Darrah’s Jewelry Store also offers repair and appraisal services. After reading the following profit report, decide whether Darrah’s should drop the appraisal service.
Jewelry Sales
/Repair Service
/Appraisals
Revenues / $90,000 / $45,000 / $5,000Cost of sales (service) / 45,000 / 25,000 / 1,000
Product margin / $45,000 / $20,000 / $4,000
Facility-sustaining costs / 15,000 / 15,000 / 15,000
Profit / $20,000 / $ 5,000 / $(11,000)
Problems
P4.1 Thompson Time Masters produced and sold 30,000 alarm clocks last year. Thompson’s profit report follows:
Sales $600,000
Less:
Direct materials 210,000
Direct labor 150,000
Unit-related overhead 90,000
Selling costs per unit __30,000
Contribution margin $120,000
Less:
Batch-related costs 12,000
Product-sustaining costs 10,000
Facility-sustaining costs __94,000
Profit $ 4,000
This year Thompson again expects to sell 30,000 alarm clocks through normal channels. In addition a hotel management company wants to place an order for 5,000 clocks for a new hotel being built; however, the company wants a 20 percent discount on the normal selling price. The selling cost per unit will not be incurred on this order because no commission will be paid. One additional production run will be required at a cost of $2,000. Product-sustaining costs will not be incurred. Thompson has the capacity to produce the additional 5,000 clocks.
Required:
A. What is the relevant cost of the special order?
B. Should Thompson accept or reject the special order?
C. Discuss additional factors Thompson should consider before accepting or rejecting this offer.
P4.2 Wooden Treasures manufactures a variety of wooden accessories. One item produced is a mirror with a decorative wooden frame. Wooden Treasures currently makes the mirrors but is considering the possibility of purchasing the mirrors from an outside supplier for $3.30 per mirror. Manufacturing costs per unit for the wooden frame and mirror for 50,000 units are as follows:
Direct materials $5.00
Direct labor 3.50
Unit-related overhead 2.00
Batch-related overhead 25,000
The facility-sustaining overhead of $32,000 is allocated to each product line produced by the company based on relative sales in dollars. Batch-related overhead consists of 50 production runs. Each production run consists of 1,000 units and costs $500 per run. If Wooden Treasures decides to purchase 50,000 mirrors, the cost of each production run will drop to $350 per run. In addition, it is estimated that direct materials, direct labor, and unit-related overhead will decrease by 50%, 10%, and 20%
Required:
A. What is the relevant cost of the make alternative?
B. What is the relevant cost of the buy alternative?
C. Should Wooden Treasures make or buy the mirrors?
D. If the supplier raises the price of the mirrors to $3.50 per mirror, should Wooden Treasures make or buy the mirrors?
E. Refer to part (D). If Wooden Treasures can rent the space needed for producing the mirrors to another company for $20,000, should it make or buy the mirrors?
F. What factors other than cost should Wooden Treasures consider before making this decision?
P4.3 Palomo Products sells coffee mugs for $4 each. For the month of September, Palomo Products sold 12,000 mugs and reported variable costs of $24,000 and fixed costs of $30,000. Assume that Palomo Products increased its selling price by 25 percent on October 1.
Required:
A. How many mugs have to be sold in October to break even?
B. How many mugs have to be sold to earn a before-tax profit of $12,000?
C. If Palomo Products is subject to an income tax rate of 30 percent, how many mugs have to be sold to earn an after-tax profit of $12,000?
D. How many mugs have to be sold to earn a before-tax profit of 10 percent of sales? ( Hint: Define the desired profit as a percentage of sales rather than a dollar amount).
E. How many mugs have to be sold to earn an after-tax profit of 10 percent of sales?
P4.4 Hanson Company has projected its income before taxes as follows:
Sales (50,000 units) $700,000
Variable costs 210,000
Contribution margin $490,000
Fixed costs 294,000
Income before taxes $196,000
Required:
A. What is the selling price per unit?
B. What is the variable cost per unit?
C. What is the contribution margin per unit?
D. What is the contribution margin ratio?
E. What is the breakeven point in units?
F. What is the breakeven point in dollars?
P4.5 Partridge Patio Furniture sells cedar and redwood patio sets. The profit report for the most recent quarter is listed below.
Cedar Redwood
Units produced and sold 400 1,600
Sales $120,000 $320,000
Cost of goods sold _84,000 _250,400
Gross margin $ 36,000 $ 69,600
Selling and administrative costs _27,500 __74,000
Profit $ 8,500 $(4,400)
The owner of Partridge is concerned by these results because sales of redwood patio sets increased over the past quarter due to spending $28,000 on advertising. An investigation of the cost structure revealed the following information about the redwood product line.
Cost of goods sold consists of unit-related, batch-related, product-sustaining, and allocated facility-sustaining costs. Unit-related costs are $80 per unit, batch-related costs are $1,500 per batch (batch size is 200 units), and on-going research and development costs are $10,400 per quarter. Facility-sustaining costs of $125,000 per quarter are allocated to the product lines based on the number of units produced.
Selling and administrative costs consist of unit-related, product-sustaining, and facility-sustaining costs. Unit-related costs are $10 per unit. Advertising is the only product-sustaining cost and facility-sustaining costs of $37,500 per quarter are allocated to the product lines based on the number of units sold.
Required:
A. Should the Redwood product line be discontinued? Why?
B. What other factors should Partridge consider before making this decision?
Case
Select a company that is featured in this week’s issue of BusinessWeek. Based on your knowledge of the company, which of the decisions discussed in this chapter might the company you chose face? Is there any specific information in the annual report about any such decisions? Using your knowledge of this company and what you have learned in this chapter, classify the expenses on the income statement as fixed, variable, or mixed costs. You may need to read some of the notes to gain a better understanding of the income statement items.