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CHAPTER 6

DECISION MAKING IN THE SHORT TERM


TRUE/FALSE
1. A temporary gap between the demand and supply of available capacity results
because, in the short term, businesses have a fixed supply of capacity but
confront changing demand.
LO1 True
2. An example of a decision that deals with excess supply is altering the product
mix to focus on the most profitable ones.
LO1 False An example of a decision that deals with excess demand is altering the
product mix to focus on the most profitable ones.
3. The decision of how much capacity to put in place is a long-term decision.
LO1 True
4. In the short term, businesses can alter capacity that they have when dealing
with fluctuations in demand.
LO1 False In the short term, businesses must do the best with the capacity that
they have when dealing with fluctuations in demand.
5. With proper planning, businesses can match supply and demand exactly all the
time.
LO1 False Despite adjustments, businesses can rarely match supply and demand
exactly all the time.
6. One reason it might be profitable for a caterer to accept a catering job for
Wednesday but reject it for Saturday is because the caterer has excess capacity
on Wednesdays.
LO2 True
7. When picking the best decision option from among a set of available options, we
could consider controllable costs and benefits or relevant costs and benefits.
LO2 True
8. Relevant cost analysis involves focusing on only those costs and revenues that
differ from a benchmark option.
LO2 True
9. An approach that includes controllable and non-controllable costs and benefits to
construct a contribution margin statement for each decision option is referred to
as an incremental product approach.
LO2 False An approach that includes controllable and non-controllable costs and
benefits to construct a contribution margin statement for each decision
option is referred to as a totals (gross) approach.

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10.In general, analysis that considers only controllable or relevant costs is less
efficient when decision options differ only with respect to a few benefit and cost
items.
11.
LO2 False In general, analysis that considers only controllable or
relevant costs is more efficient when decision options differ only with
respect to a few benefit and cost items.
12.
13.Price gouging occurs when a firm exploits temporary excess demand to raise
prices to unreasonable levels.
14.LO3 True
15.
16.Our ultimate decision will differ when we use incremental analysis versus
construct a contribution margin statement for each option.
17.LO3 False We get the same answer with both approaches.
18.
19.Using the gross approach to choose the best decision option is preferable to the
incremental method when the decision option involves many costs and benefits.
20.
LO3 True.
21.
22.A sunk cost is a relevant cost in decision making under the gross approach.
23.LO3 False A sunk cost is not a relevant cost in decision making under the
gross approach.
24.
25.A differential approach is an approach for framing and solving decisions that
involves expressing the benefits and costs of the various decision options
relative to one of the options.
26.LO3 True
27.
28.When demand is high and a scarce resource is in short supply, a company should
decide how much of each product to produce by ranking products by the
contribution margin per unit of the product.
29.
LO4 False When demand is high and a resource is in short supply, a
company should decide how much of each product to produce by
ranking products by the contribution margin per unit of the resource.
30.
31.For a resource in short supply, the opportunity cost of the resource is positive.
32.LO4 True
33.
34.To maximize profit when capacity is in short supply, minimize the contribution
margin per unit of capacity.
35.
LO4 False To maximize profit when capacity is in short supply,
maximize the contribution margin per unit of capacity.
36.
37.When faced with a situation where supply is limited for multiple resources
managers use linear and integer programming to evaluate decision options.
38.LO4 True
39.
40.When demand is high and a resource is in short supply, the contribution margin
per unit of the resource from its best possible use should exceed that forgone by
putting it to the next best use.

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Decision Making in the Short Term


41.LO4 True
42.
43.Because potential longer-term effects could vary across short-term decision
options, they might be relevant.
44.
LO5 True
45.
46.Quantifying the longer-term implications of short-term actions is relatively
simple.
47.LO5 False Quantifying the longer-term implications of short-term actions is
difficult.
48.
49.Because quantitative analysis of different decision options is extremely
important, it should be the only input into final decision.
50.
LO5 False Quantitative analysis of different decision options is
extremely important, yet it constitutes just one input into decision
making.
51.
52.It is important for effective managers to consider the longer-term implications of
short-term decisions because of potential tradeoffs between short-term and
long-term interests.
53.LO5 True
54.
55.Managers often use the term real options to denote the flexibility associated
with different options and use advanced mathematical techniques to value the
real options.
56.LO5 True
57.
58.Products that are produced in a joint process where it is not possible to produce
one product without producing the others as well are called joint products.
59.Appendix A True
60.
61.Split-off point is the step in a joint process after which the products are
completely processed.
62.
Appendix A False Split-off point is the step in a joint process
after which we can identify and process the joint products
separately.
63.
64.Joint costs are incurred after the split-off point.
65.
Appendix A False Costs incurred before the split-off point are
joint costs that we cannot trace to individual products.
66.
67.Joint cost is not relevant for product-related decisions beyond the split-off point.
68.Appendix A True.
69.
70.Usually, firms do not process individual products further beyond the split-off
point.
71.Appendix A False Usually firms process individual products further beyond
the split-off point.
72.

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Balakrishnan/Managerial Accounting, 2e
73.Managers should not rely on income statements that allocate common costs to
product lines or sections to evaluate the effect on short-term profit because such
statements mingle controllable and non-controllable costs.
74.Appendix B True
75.
76.Avoidable fixed costs are costs that need not be incurred if an option is not
chosen.
77.
Appendix B True
78.
79.Avoidable fixed costs are also referred to as non-controllable fixed costs.
80.Appendix B False Avoidable fixed costs are also referred to as controllable
fixed costs.

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Decision Making in the Short Term


81.The segmented income statement offers a convenient way to evaluate shortterm profit effects.
82.Appendix B True
83.
84.An example of a an avoidable cost over the short term is the lease payments for
a building
85.
Appendix B False Lease payment for the building is not
avoidable or controllable over the short term.
86.
87.

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Balakrishnan/Managerial Accounting, 2e
88.

MULTIPLE CHOICE

89.Most short-term decisions deal with temporary gaps between:


A. A flexible supply of capacity and a fixed demand.
B. The inability to change selling price and the ability to estimate controllable
costs.
C. The amount of fixed costs that can be avoided and the contribution margin.
D. The demand of and the supply of available capacity.
E. Company goals and employee goals.
90.LO1 D
91.
92.Capacity is the maximum volume of activity that a company can sustain with
available:
A. Resources.
B. Discretionary orders.
C. Inventory.
D. Employees.
E. None of the above.
93.LO1 A
94.
95.Which of the following is an example of utilizing capacity effectively?
A. Building a plant large enough so that production can be increased as demand
increases.
B. Hiring extra temporary employees to work extended hours during Christmas
season at a retail store.
C. Having all employees of a donut shop work a regular 8-hour shift every day.
D. A caterer having a limited number of chefs working during the week and on
weekends.
E. An airline selling 20% more tickets for a flight than their airplane has available
seats.
96.LO1 B
97.
98.One way businesses may manage demand is:
A. Building a plant large enough so that production can be increased as demand
increases.
B. Rent additional office space.
C. Decreasing variable costs.
D. Raising prices during periods of high demands.
E. None of the above.
99.LO1 D
100.
101. Most short-term decisions can be classified as decisions that:
A. Deal with excess supply.
B. Deal with excess demand.
C. Deal with limited capacity.
D. Both A and B.
E. A, B and C.
F. None of the above.
102.
LO1 D
103.

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Decision Making in the Short Term


104. The Owens Company budgeted sales of 20,000 printers at $90 per unit last
year. Variable manufacturing costs were budgeted at $46 per unit, and fixed
manufacturing costs at $12 per unit. A special order for 1,000 printers at $72
each was received by Owens in April. There is enough plant capacity to meet
these additional units without incurring any additional fixed manufacturing costs;
however, the production would have to be done on an overtime basis at an
estimated additional cost of $5 per printer. Acceptance of the special order
would not affect Owens normal sales and no selling expenses would be incurred.
What would be increase to net operating income if the special order were
accepted?
A.$21,000
B.$9,000
C.$14,000
D.$10,000
105.
LO1 Self-test A
106.
107. When making a decision regarding a special order management must
consider:
A. Whether there is enough capacity to meet the order.
B. Additional costs associated with the order.
C. Whether the selling price of the special order covers the variable costs of
making the product.
D. All of the above.
108.
LO1 Self-test D
109.
110. Warner Company has some material that originally cost $41,500. The
material has a scrap value of $21,600 as is, but if reworked at a cost of $4,600, it
could be sold for $29,100. What would be the incremental effect on the
company's overall profit if it is reworked?
a. $17,000 decrease.
b. $38,600 decrease.
c. $2,900 increase.
d. $24,500 increase.
111. LO1 Self-test C
112.
113. When management must decide whether to offer special promotions in order
to reduce excess inventory, which of the following is not relevant?
A. The cost of offering the promotion.
B. The selling price of the product during the promotion.
C. The unit product cost of the inventory being sold.
D. The regular selling price of the product when not on promotion.
114.
LO1 Self-test D
115.

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Balakrishnan/Managerial Accounting, 2e
116. The Huffman Tire Company has 3,000 tires in its inventory which are
considered obsolete. Each unit originally cost the company $35. Management
is considering options to reduce these inventory levels. Units can be sold
directly to car dealerships for $30 per tire as opposed to the normal selling price
of $45 per tire. The other option is to offer their current customers a $10 per tire
rebate on their purchase. In addition to the $10 rebate, the program would cost
the company approximately $24,000 to manage. They predict that either option
will rid them completely of their excess inventory. The decision to sell directly to
the car dealerships over offering the rebate will result in:
A. A $21,000 increase in profits.
B. A $9,000 increase in profits.
C. A $15,000 decrease in profits.
D. A $24,000 decrease in profits.
117.
LO1 Self-test B
118.
119. Which of the following short-term decisions deal with excess capacity?
a. Special order.
b. Product mix.
c. Make or buy.
d. Increasing prices.
120.
LO1 Post-test A
121.
122. Beach Surf Boards is making a decision on whether to add long boards as a
new product line to complement its short boards. A recent analysis determined
that the average long board can be sold for $300.00 with unit variable costs of
$225. Fixed costs are currently $51,000 per month but would be increased to
$69,000 if long boards are added. How much is incremental profit or (loss) if long
boards are added and its sales volume is expected to be 250?
a. $750
b. $18,750
c. ($32,250)
d. ($50,250)
123.
LO1 Post-test A
124.
125. Which of the following options might a consultant choose when making a
decision to accept or reject a new client when capacity is limited? (That is, the
consultant already has all the clients her present circumstances can handle.)
A. Refer the client to a competitor, but charge a referral fee to the competitor.
B. Reject the client.
C. Accept the client knowing that the consulting job cannot be completed.
D. A and B only.
E. A, B and C.
126.
LO2 D
127.

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Decision Making in the Short Term


128. The excess supply/excess demand classification is a helpful way for us to
evaluate which of the following decision problems?
A. Whether to accept a special order.
B. Whether to make or buy an item.
C. What product mix to adopt.
D. B and C only.
E. A, B and C.
129.
LO2 E
130.
131. If selling price is $25, unit contribution margin equals $15 and fixed costs are
$12,000, then breakeven volume is:
A. 300 units.
B. 1,200 units.
C. 800 units.
D. 2,500 units.
E. 1,500 units.
132.
LO2 C
133.
134. Consider the following decision option data:
135.
136. O 137. O
ption
ption
#1
#2
138. Number of units
139. 1 140. 20
50
0
141. Revenue per unit
142. $ 143. $2
25
5
144. Variable cost per unit
145. $ 146. $1
12
2
147. Lost revenue from
148. ($ 149. ($
choosing option
500)
4,000)
150. Cost savings from
151. $ 152. $1
choosing option
0
,000
153. Avoidable fixed cost
154. $ 155. $0
0
156.
157.
What is the incremental profit for Option #2?
a. $5,600
b. ($2,400)
c. $2,600
d. ($400)
e. $1,400
158.
LO2 D
159.

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Balakrishnan/Managerial Accounting, 2e
160.

Consider the following decision option data:


161.
162. O 163. O
ption
ption
#1
#2
164. Number of units
165. 1 166. 20
50
0
167. Revenue per unit
168. $ 169. $2
25
5
170. Cost per unit
171. $ 172. $1
12
2
173. Lost Revenue from
174. ($ 175. ($
choosing option
500)
4,000)
176. Cost savings from
177. $ 178. $1
choosing option
0
,000
179. Avoidable Fixed Cost
180. $ 181. $0
0
182.
183.
What is the best choice?
a. Option #1
b. Option #2
c. Option #1 and Options #2 are equally good choices.
d. Neither Option #1 nor Option #2 should be chosen
184.
LO2 A
185.
186. Brand X Computers makes and sells computers. Each computer sells for
$400. The following cost data per computer are based on a full capacity of
10,000 computers each period:
187. Direct materials
188.
$150
189. Direct labor
190.
$100
191. Variable
192.
manufacturing overhead
$38
193. Unavoidable fixed
194.
overhead
$12
195.
196.
Brand X is considering a special order for a sale of 2,500 computers to
an overseas customer. The only selling costs that would be incurred for the
order would be shipping charges of $15 per computer. Brand X is currently
selling 7,500 computers through its regular orders. What should be the
minimum selling price per computer in negotiating a price for the special
order?
a. $303
b. $250
c. $300
d. $265
e. $315
197.
LO3 A
198.

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Decision Making in the Short Term


199. In a make-or-buy decision relevant costs would include all of the following
except:
A. Depreciation expense on the plant equipment currently used to make the part
B. Direct labor costs of the employees in that department which makes the part
C. Direct material costs of the part
D. The cost of buying the part from an outside company
200.
LO1 Self-test A
201.
202. Which of the following would be relevant in a make-or-buy decision?
203. 204.
Vari
able
205.
206. 207.
cost
208.
Co
s assigned
st to buy
209. 210.
to
the item
when
made
211.
212.
A
214.
Ye
213.
No
s
215.
B
216.
Yes
217.
No
218.
C
220.
Ye
219.
Yes
s
221.
D
222.
No
223.
No
224.
LO3 Self-test C
225.
226. Gecko Company is evaluating the use of a supplier versus making the wheels
for its skateboards internally. The currently manufactured wheels have a variable
unit cost of $2. Fixed costs are $16,000 per month, however, 25% can be
eliminated if wheels are no longer produced. A supplier has offered to produce
this part for $3 per wheel and can produce the 3,200 wheels for the 800
skateboards needed monthly. Should Gecko outsource wheels or make them
internally?
a. Outsource because the incremental cost savings is $12,800.
b. Make the product because the incremental cost savings is $3,200.
c. Outsource because the incremental cost savings is $800.
d. Outsource because the incremental cost savings is $8,800.
227.
LO3 Post-test C

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Balakrishnan/Managerial Accounting, 2e
228. Which of the following is not a short-term decision that is a reaction to excess
capacity?
a. Management makes the decision to emphasize sales in a particular market to
boost poor sales.
b. Management makes the decision to issue a rebate, offering customers a
rebate of $0.50 for every widget sold, because inventory is too large.
c. Management makes the decision to close a plant because of increased
competition.
d. Management accepts a special order at a reduced selling price since the
orders relevant costs will be less than the special orders sales price.
e. All of the above are short-term decisions that are reactions to excess
capacity.
229.
LO3 C
230.
231. Which of the following is a short-term decision that is a reaction to excess
demand?
a. Management makes the decision to emphasize sales in a certain market to
boost poor sales.
b. Management makes the decision to close a plant because of increased
competition.
c. Management makes the decision to buy parts rather than make them after
calculating a positive opportunity cost for capacity.
d. Management makes the decision to make parts rather than buy them after
calculating a positive opportunity cost for capacity.
e. All of the above a short-term decisions that are reactions to excess demand.
232.
LO3 C
233.
234. Hobbs Electronics makes and sells portable DVD players. Each DVD player
has a selling price of $100. The following cost data per DVD player is based on a
capacity of 5,000 DVD players per period.
235.
Direct Material
$30
236.
Direct Labor
$20
237.
Manufacturing Overhead
238.
(70% variable; 30% fixed)
$10
239.
Hobbs receives a special order for 100 DVD players. The only
additional costs Hobbs will incur are $2 shipping charges per item. Hobbs has
sufficient idle capacity to produce the additional DVD players. What is the
minimum price Hobbs should charge per DVD player for the special order?
a. $60
b. $59
c. $57
d. $55
e. $62
240.
LO3 B
241.

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Decision Making in the Short Term


242. Spikes Company manufactures 5,000 high-end racing bicycles each period.
Spikes has been making all the components for the bikes, but a supplier has
approached Spikes with an offer to sell her bicycle seats at a price of $40. The
cost per unit of manufacturing one bicycle seat is computed as follows:
243.
Direct Material
$10
244.
Direct Labor
$18
245.
Manufacturing overhead
246.
(100% fixed)
$10
247.
248.
If the bicycle seats are purchased from the outside supplier, $1 per unit
of the fixed manufacturing overhead costs can be avoided. If Spikes purchases
the seats, the facility used to manufacture the seats would be rented for $20,000
per period. If Spikes chooses to purchase the bicycle seats, then the change in
annual net operating income is an:
a. $35,000 decrease.
b. $35,000 increase.
c. $5,000 decrease.
d. $5,000 increase.
e. $10,000 increase.
249.
LO3 A
250.
251. The Pleasantville Company makes 20,000 units per year of a part used in
production. The unit product cost is as follows:
252.
Direct materials
$ 6.20
253.
Direct labor
2.30
254.
Variable Manufacturing Overhead
1.20
255.
Fixed Manufacturing Overhead
.80
256.
Unit product cost
$10.50
257.
An outside supplier has offered to sell the company the same part at a
cost of $9.00 per unit. If the company purchases the part only half of the fixed
overhead would be avoided. How much of the unit product cost is relevant in
making this decision?
A. $9.70
B. $10.50
C. $2.30
D. $10.10
258.
LO3 Self-test D
259.
260. Augusta Company manufactures stereo components. One of its most popular
products is the LoudBoom Speaker. Data concerning this product are given
below:
261.
262. Normal Selling Price
$50.00
263. Direct materials
$12.20
264. Direct labor
$3.60
265. Variable Manufacturing Overhead
$1.80
266. Fixed Manufacturing Overhead
$2.00
267. Variable Selling Expense
$1.90
268. Fixed Selling & Administrative Expense $.80
269.
The above per unit data are based on annual production of 3,000 units

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Balakrishnan/Managerial Accounting, 2e
of the component. The company has received a special, one-time-only order for
200 units of the speaker. There would be no selling expenses on this special
order and the total fixed manufacturing overhead and fixed selling and
administrative expenses of the company would not be affected by the order.
Assuming that Augusta Company has excess capacity and can fill the order
without any production disruptions, what is the minimum price per unit on the
special order the company should charge?
A. $50.00
B. $19.60
C. $17.60
D. $22.30
270.
LO3 Self-test C
271.
272. Shickman Company makes the widgets it uses in one of its products at a cost
of $8 per unit. This cost includes $2 of fixed overhead. The company needs
10,000 of these plugs annually, and Orlando Company has offered to sell them
at $5 per unit. If Shickman Company purchases the plugs, the company would:
a. Increase profits by $30,000.
b. Decrease profits by $10,000.
c. Increase profits by $10,000.
d. Decrease profits by $30,000.
273.
LO3 Self-test C
274.
275. Little Toy Company makes and sells miniature doll houses. Little produces
two kinds of houses: Standard and Deluxe. The demand for doll houses is
highest in November and December. Expecting this trend to continue Little is
interested in how to best utilize available capacity. Given the following
information, what combination of doll houses should Little produce?
276.
277. S 278. D
tandar
eluxe
d
279. Demand
280. 8, 281. 3
000
,000
282. Unit Price
283. $ 284. $
60
80
285. Unit variable cost
286. $ 287. $
25
35
288. Unit contribution
289. $ 290. $
margin
35
45
291. Production rate (units
292. 2 293. 1
per hour)
294. Available production
295.
296. 5
hours
,000
hrs
297. Total fixed costs
298.
299. $
40,000

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Decision Making in the Short Term


a. 8,000 Standard; 3,000 Deluxe.
b. 8,000 Standard; 1,000 Deluxe.
c. 5,000 Standard; 3,000 Deluxe.
d. 3,636 Standard; 7,364 Deluxe.
e. 3,636 Standard; 1,363 Deluxe.
300.
LO4 B
301.
302. The general rule to apply to maximize profit when capacity is in short supply
is:
a. Minimize the contribution margin per unit of capacity.
b. Maximize the margin of safety per unit of capacity.
c. Maximize the contribution margin per unit of capacity.
d. Minimize the margin of safety per unit of capacity.
e. Maximize the unit contribution margin.
303.
LO4 C
304.
305. Handi-Tool Company manufactures and sells lawn and garden tools. Handi
manufactures three kinds of pruning shears: Snip-It, Deluxe Clipper, and LimbAway. The demand for the pruning shears is highest in April. Expecting this
trend to continue, Handi is interested in how to best utilize available capacity.
Given the following information, what combination of pruning shears should
Handi-Tool produce?
306.
308. D 309. Li
eluxe
mb307. Sn Clipp
Away
ip-It
er
310. Demand
311. 20 312. 1 313. 6
0,000 00,00
0,000
0
314. Unit Price
315. $2 316. $ 317. $
0
30
50
318. Unit variable cost
319. $1 320. $ 321. $
0
15
20
322. Unit contribution
323. $1 324. $ 325. $
margin
0
15
30
326. Production rate (units
327. 50 328. 2 329. 1
per hour)
5
5
330. Available production
331.
332.
333. 8,
hours
000 hrs
334. Total fixed costs
335.
336.
337. $
400,000
a. 200,000 Snip-It; 100,000 Deluxe Clipper, 0 Limb-Away.
b. 200,000 Snip-It; 60,000 Limb-Away; 0 Deluxe Clipper.
c. 100,000 Deluxe Clipper; 60,000 Limb-Away; 0 Snip-It.
d. 200,000 Snip-It; 100,000 Deluxe Clipper; 60,000 Limb-Away.
e. 150,000 Snip-It; 75,000 Deluxe Clipper; 45,000 Limb-Away.
338.
LO4 B
339.

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Balakrishnan/Managerial Accounting, 2e
340. When capacity is limited, which of the following are alternative courses of
action to consider?
a. Produce the items with the largest contribution margin per unit of capacity.
b. Purchase some components from outside suppliers.
c. Produce the items with the largest selling price to maximize revenue.
d. A and B only.
e. A, B and C.
341.
LO4 D
342.
343. The Southeast Company makes three products in one manufacturing facility.
Data regarding these products are as follows:
344. A
B
C
345. Direct Materials
$5.70
$6.20
$8.90
346. Direct Labor
2.05
1.90
2.20
347. Variable Overhead
.70
.80
.90
348. Fixed Overhead
1.10
1.40
1.60
349. Unit Product Cost
$9.55
$10.30
$13.60
350.
351. Machine Hours Per Unit
.5
1
.25
352. Selling Price per Unit
$16.00
$18.00
$20.00
353. Demand (units)
1,200
1,400
800
354.
How many machine hours would be required to meet the demand for
all products?
A. 3,400
B. 2,200
C. 1,700
D. 850
355.
LO4 Self-test B
356.
357. The Southeast Company makes three products in one manufacturing facility.
Data regarding these products are as follows:
358. A
B
C
359. Direct Materials
$5.70
$6.20
$8.90
360. Direct Labor
2.05
1.90
2.20
361. Variable Overhead
.70
.80
.90
362. Fixed Overhead
1.10
1.40
1.60
363. Unit Product Cost
$9.55
$10.30
$13.60
364.
365. Machine Hours Per Unit
.5
1
.25
366. Selling Price per Unit
$16.00
$18.00
$20.00
367. Demand (units)
1,200
1,400
800
368.
If there are only 2,000 machine hours available, which is the MOST
profitable product?
A. Product A
B. Product B
C. Product C
D. Cannot be determined
369.
LO4 Self-test C
370.

6-16

Decision Making in the Short Term


371. The Southeast Company makes three products in one manufacturing facility.
Data regarding these products are as follows:
372. A
B
C
373. Direct Materials
$5.70
$6.20
$8.90
374. Direct Labor
2.05
1.90
2.20
375. Variable Overhead
.70
.80
.90
376. Fixed Overhead
1.10
1.40
1.60
377. Unit Product Cost
$9.55
$10.30
$13.60
378.
379. Machine Hours Per Unit .5
1
.25
380. Selling Price per Unit
$16.00
$18.00
$20.00
381. Demand (units)
1,200
1,400
800
382.
If there are only 2,000 machine hours available, how much is the profit
per machine hour for product A?
A. $12.90
B. $6.45
C. $7.70
D. $6.40
383. LO4 Self-test A
384.
385. When there is a production constraint, the company should first produce the
product with:
A. The highest contribution margin per unit
B. The highest contribution margin ratio
C. The highest revenue per unit
D. The highest contribution margin per unit of the constrained resource
386.
LO4 Self-test D
387.
388. The Jackson Company produces 2 different products, each of which has
unlimited demand. If there are 4,000 total available labor hours, and the
company desires to maximize its contribution margin, how many units of each
product should be produced?
390.
Pr
389..........................................
oduct
392.
394.
391..........................................
X
393. Z
396.
398.
$
$
395.........Selling price per unit
397.
400.
402.
$
$
399........Variable cost per unit
401.
404.
406.
403..........Labor hours per unit
2
405. 4
407.
A. 2,000 units of Product X and 0 units of Product Z
B. 0 units of Product X and 1,000 units of Product Z
C. 0 units of Product X and 4,000 units of Product Z
D. 2,000 units of Product X and 4,000 units of Product Z
408.
LO4 Self-test A

6-17

Balakrishnan/Managerial Accounting, 2e
409.
410. The production of two products has the same selling prices per unit. If total
fixed costs will be $5,000 for product A and $4,500 for product B, what factors
are relevant in determining which of the two products to produce and sell?
a. Selling and variable costs per unit, and the fixed cost savings.
b. Variable costs per unit and total fixed costs.
c. Total variable and fixed costs and total sales revenue
d. .Variable costs per unit and the fixed cost savings
411.
LO4 Post-test D
412.
413. Which of the following is in the context of a short-term decision?
a. Special order.
b. Product promotion.
c. Product mix.
d. A and B only.
e. A, B and C.
414.
LO4 E
415.
416. Which of the following statements is not true?
a. Quantifying longer-term implications of short-term actions is relatively simple.
b. It is important to consider longer-term implications of short term decisions
because of potential tradeoffs between short-term and long-term interests.
c. Many managers follow a peel the onion approach to assessing decision
effects, first by estimating the short-term effects, and then expanding the
range of considered factors.
d. For longer-term actions, in many cases, qualitative assessments are the only
ones possible, and large estimations errors accompany such assessments.
e. All of the above statements are true.
417.
LO5 A
418.
419. Quantifying the longer-term implications of short-term actions is difficult.
Consequently:
a. It is impossible to make an informed decision.
b. Frequently, only qualitative assessments are possible.
c. Long-term implications should be ignored in the decision-making process.
d. A and B only.
e. A, B, and C are consequences.
420.
LO5 B
421.
422. Which consideration is most relevant for a startup manufacturing company?
a. Short-term decisions regarding production.
b. Implications that arise from people outside the firm such as customers,
suppliers, and suppliers.
c. Qualitative aspects of decisions.
d. Decisions that cause profit to be highest in the short-run
423.
LO5 Post-test B
424.

6-18

Decision Making in the Short Term


425. A cost that is common to two or more products is a:
a. Split-off cost.
b. Incremental cost.
c. Joint cost.
d. Opportunity cost.
e. Fixed cost.
426.
Appendix A C
427.
428. Which of the following is not an example of a joint product?
a. Mined zinc and lead from the same ore.
b. Kerosene and aviation fuel from crude oil.
c. Goats milk and cows milk.
d. Pine bark and pine cones from a pine tree.
429.
Appendix A C
430.
431. Which of the following statements is true?
a. Joint costs occur after the split-off point.
b. Joint costs occur before the split-off point.
c. Joint costs can be traced to specific outputs.
d. Joint costs are considered relevant costs beyond the split-off point.
e. None of the above statements are true.
432.
Appendix A B
433.
434. A joint product costs $20 (including $8 allocated joint cost) and sells for $15.
Which of the following statements is true?
a. The production of the product should be discontinued since it creates a loss
of $5.
b. The product should be processed further so the joint cost can be allocated to
additional products.
c. The product should be analyzed further to determine its profitability since the
joint cost will be incurred whether or not the product is discontinued.
d. Profit will be increased if the product is discontinued.
e. Both A and D are true statements.
435.
Appendix A C
436.
437. Which of the following is not relevant to make a decision to process further
or sell as is?
a. Selling price if processed further.
b. Cost incurred to produce the product after the split-off point.
c. Joint costs.
d. Costs incurred to process further.
438.
Appendix A Post-test C
439.

6-19

Balakrishnan/Managerial Accounting, 2e
440. Which of the following statements is not true?
a. Common costs are not relevant in determining whether to drop a product
line.
b. If a segment of a company has been losing money for several periods
because a competitor has opened in the area, the segment should be
dropped.
c. Neither of the above statements if true.
d. Both of the above statements are true.
441.
Appendix B B

6-20

Decision Making in the Short Term


442.
Problems
443.
1. Robin offers Christmas tree decorating services six days per week during late
November and December. She charges $50 per live tree regardless of the size of
the tree. Robins clients provide all the decorations. Her variable cost, solution
to keep the tree fresh, is $10 per tree and the fixed costs per month total $100.
Robin has had more calls by the end of October than she had expected and is
considering hiring a helper. She will pay the helper $8 per hour. Robin estimates
that she can decorate 8 trees in a 10-hour day (before hiring a helper) during the
holiday season (25 days.)
444.
445.
Required:
a. Does Robins decision deal with excess supply or excess demand?
446.
447.
448.
b. If Robin decides not to hire a helper, list three alternatives she should
consider.
449.
450.
451.
452.
453.
c. List three long-term effects of Robins decision alternative courses of action.
454.
455.
456.
457.

6-21

Balakrishnan/Managerial Accounting, 2e
2. Trisha Hardin owns Ice Flavors, a small business selling fruit-flavored slush
drinks. Each drink sells for $2.50. Trisha derived her price as follows:
458.
459. Drink mixture and crushed
460. $
ice
0.60
461. Labor per drink ($8 per hour 462. $
20 drinks per hour)
0.40
463. Variable overhead per drink
464. $
(cups, etc)
0.35
465. Fixed overhead per drink
466. $
0.40
467. Total cost per drink
468. $
1.75
469.
470.
Trisha is considering a special order for a sale of 100 drinks for a local
birthday party. The hostess is willing to pay $1.50 per drink. The party will
be in the evening, which is not during Trishas regular business hours. Trisha
will provide the drink mixture, ice and labor. Her only additional expense will
be one employee for two hours ($8 per hour), travel to and from the party
location (estimated to be $15). Since the party is not at Trishas business, her
fixed overhead will not change. The party hostess will furnish all cups,
napkins and other variable cost items.
471.
472.
Required:
a. What is the incremental cost associated with accepting the special order?
473.
474.
475.
b. List the costs that are not relevant to the decision.
476.
477.
478.
c. Should Trisha accept the special order? Why?
479.

6-22

Decision Making in the Short Term


3. Outdoor Flames manufactures 5,000 outdoor gas fireplaces each period. The
company has been manufacturing the ignition system for the fireplaces. The
unit cost of each ignition is as follows:
480.
481. Direct Material
482.
$12
483. Direct Labor
484.
5
485. Variable manufacturing 486.
overhead
2
487. Fixed manufacturing
488.
overhead
14
489. Unit product cost
490.
$33
491.
492.
A local supplier has offered to sell the company the ignition system for
$30 each. If the ignition systems are purchased from the outside supplier,
the facilities now being used to make them can be used to make other units
of a product that is in high demand. The additional contribution margin on
the other unit would be $42,000 per year. If the ignition systems are
purchased from an outside supplier, all the direct labor would be avoided, but
$8 of the fixed cost would continue and be applied to the remaining products
even if the part is purchased.
493.
494.
Required:
a. How much of the unit product cost of $33 is relevant to the decision to
make or buy the ignition systems?
495.
496.
497.
b. What is the net total dollar advantage or disadvantage of purchasing the
ignition systems rather than making them?
498.
499.
500.
c. List three qualitative characteristics that the owner of Outdoor Flames
should consider in looking at the long-term effect of purchasing the
ignition systems.
501.

6-23

Balakrishnan/Managerial Accounting, 2e
4. The Gant Company produces three items in its manufacturing plant. The plant
has a total capacity of 9,600 minutes per month for production. The following
information is provided for the products:
502.
503. Products
504.
505.
506. 507.
X
Y
Z
508. Direct material
509.
510. 511.
$16 $10 $14
512. Direct labor (all
513.
514. 515.
variable)
15
14
15
516. Variable overhead
517.
518. 519.
2
3
4
520. Fixed overhead
521.
522. 523.
20
23
30
524. Unit cost
525.
526. 527.
$53 $50 $63
528.
529.
530. 531.
532. Minutes required per 533.
534. 535.
unit
5
4
6
536. Selling price per unit 537.
538. 539.
$70 $65 $80
540. Variable selling
541.
542. 543.
expense per unit
$5
$4
$2
544. Monthly demand in
545.
546. 547.
units
2,200 1,00 800
0
548.
549.
Required:
a. How many minutes would be required to meet the demand for all three
products?
550.
551.
552.
553.
b. How many units of each product should Gant product to maximize profit?
Show your calculations.
554.

6-24

Decision Making in the Short Term


5. Hermitage Farms produces two products, X and Y, in a joint process. The
products may each be sold at the split-off point or processed further. The selling
price $1.10 for X and $0.80 for Y if the products are sold without further
processing. Data for the two products, if processed further, is presented below:
555.
556.
557. Pr 558. Pro 559. T
oduct X
duct Y
otal
560. Sales volume
561. 28, 562. 16,0
563.
000 units
00 units
564. Revenues
565. $4 566. $18, 567. $
2,000
400 60,400
568. Traceable
569. 12, 570. 5,00 571. 1
processing cost
000
0
7,000
572. Segment
573. $3 574. $13, 575. $
Margin
0,000
400 43,400
576. Joint costs
577.
578.
579. $
35,000
580. Profit before
581.
582.
583. $
Taxes
6,000
584.
585.
Required: What is the monetary advantage (disadvantage) of further
processing the products? Show calculations.
586.
587.
588.
6. Creative Lawn Ornaments sells three categories of lawn structures:
Fountains, Bird and Butterfly Houses, and Obelisks. For the current year,
Creative reported the following results:
589.
590.
591. Fo 592. Hou 593. Ob 594. Tot
untains
ses
elisks
al
595. Revenue
596. $1 597. $14
598. $9
599. $4
75,000
5,000
5,000
15,000
600. Variable
601.
602.
4 603.
4
604.
1
costs
85,000
3,000
5,000
73,000
605. Contribution
606. $ 607. $10
608. $5
609. $2
margin
90,000
2,000
0,000
42,000
610. Traceable
611. 30 612. 33,0 613. 30, 614. 93,
fixed costs
,000
00
000
000
615. Common
616.
617.
3
618.
3
619.
1
fixed costs
35,000
5,000
5,000
05,000
620. Profit
621. $
622. $ 623. ($1
624. $
25,000
34,000
5,000)
44,000

6-25

Balakrishnan/Managerial Accounting, 2e
625.
626.
Creatives owner is pleased with the overall profit, but is concerned
about the loss on the Obelisks line and is considering eliminating it. The
owner believes that if the Obelisk sales are discontinued he will be able to
display more Fountains and increase the revenues by 5% without increasing
any fixed costs. If the Obelisk line is discontinued, all of its traceable fixed
costs will be avoided, but its common fixed costs will be allocated to the
Fountains.
627.
628.
Required:
629.
Evaluate whether Creative Lawn Ornaments should discontinue
its line of Obelisk structures. Show all calculations.
630.
631.
632.
633.
634.

6-26

Decision Making in the Short Term


635.

Solutions to Problems

1. Short-term decision (LO1)


a. Robins decision deals with excess demand.
636.
b. Answers may vary. Some alternative courses of action include:
Instead of hiring a helper, work longer hours.
Instead of hiring a helper, extend business from six days to seven days
per week.
Increase the price per tree, and thereby, reduce the number of clients.
Limit the size of tree, thereby being able to complete more trees in the
same amount of time.
Instead of hiring a helper paid per hour, outsource some work for a fixed
fee per tree.
Begin decorating a few days earlier in November.
637.
c. Answers may vary. Some long-term effects include:
If Robin increases the price per tree, in the long-run she may lose
clients.
By hiring a helper and accepting additional clients, in the long run
Robin may have to consider hiring additional employees.
If Robin increases business and hires helpers, in the long-run she may
wish to offer additional services such as decorating mantels, doorways,
dining rooms, etc.
With increased business, Robin should consider the long-term effect on
her health.
With increased business, Robin should consider the long-term effect on
her personal and family obligations.
638.
639.
2. Special Order (LO2)
a. Incremental cost associated with accepting the order:
640.
641. Acce 642. Rej
pt Order
ect Order
643. Revenue
644. $150
645. $0
646. Drink mix and
647. $ 60
648. $0
ice
649. Labor ($8 per hr
650. $ 16
651. $0
x 2 hrs)
652. Transportation
653. $ 15
654. $0
655.
656.
657.

6-27

Balakrishnan/Managerial Accounting, 2e
658.
Total Incremental costs: $60 + $16 + $15 = $91
659.
b. Non-relevant costs:
660.
Fixed overhead
$0.40 per drink
661.
Variable overhead $0.35 per drink
662.
c. Trisha should accept the order:
663. Incremental
664.
Revenue
$15
0
665. Incremental
666.
Costs
$
91
667. Incremental
668.
profit
$
59
669.
670.
671.
Because Trishas incremental revenue exceeds her incremental
costs and she has the capacity to accept the order (it does not interfere
with regular business), it would be profitable to accept the special order.
672.
673.
3. Make or buy decision (LO2, LO3, LO5))
674.
a. Relevant unit product cost:
675.
$12 + $5 + $2 + $6 = $25
676.
b. Net total dollar advantage (disadvantage) of purchasing:
677.
678. Relevant cost
679. $1
25,000
680. Additional contribution
681. 42
margin
,000
682. Cost of purchasing
683. (1
50,000)
684. Net advantage
685. $
17,000
686.
c. Qualitative considerations:
Will the supplier continue to sell the ignition systems at the $30 price?
Over the long run, will the company be able to absorb all the
employees from the ignition system into other areas of the company?
What are the alternatives if the purchased ignition systems turn out to
be a lower quality than expected?
Does the high-demand item expected to use the space formerly used
for making the ignition systems have a long-range high demand?
687.
688.
689.
6-28

Decision Making in the Short Term


4. Best use of resources in short supply( LO4)
690.
a. Total minutes required to meet demand:
691.
(2,200 units x 5 minutes) + (1,000 x 4 minutes) + (800 x 6
minutes) = 16,600 minutes
692.
b. Production to maximize profit:
693.
694. Products
695.
696.
697. 698.
X
Y
Z
699. Selling price per unit 701.
702. 703.
700.
$70 $65
$80
704. Direct material
705.
706. 707.
$16 $10
$14
708. Direct labor (all
709.
710. 711.
variable)
15
14
15
712. Variable overhead
713.
714. 715.
2
3
4
716. Variable selling
717.
718. 719.
expense per unit
5
4
2
720. Total variable cost
721.
722. 723.
$38 $31
$35
724.
725. Contribution
726.
727. 728.
margin per unit
$32 $34
$45
729. Minutes required per 730.
731. 732.
unit
5
4
6
733. Contribution margin 734.
735. 736.
per minute
$160 $13 $270
6
737.
738.
739. 740.
741.
Gant should produce the following units to maximize profit:
742. Optimal Units
743. Min
744. Availab
utes Used le Minutes
745.
746.
747. 9,600
748. Product Z
800 units
749. 4,80
750. 4,800
@ 6 minutes
0
751. Product X
1,000
752. 4,00
753.
800
units @4 minutes
0
754. Product Y
160units
755.
80
756.
-0@ 5 minutes
0
757.
758.

6-29

Balakrishnan/Managerial Accounting, 2e
5.

Joint costs (Appendix A)


759.
760.
764.
768.

Process Further:
Sales volume

772.

Revenues

776. Traceable
processing cost
780. Segment Margin
784.
788.
792.

Sell at Split-Off
Revenue

796. Traceable
processing costs
800. Segment Margin

761. Pr
762. Pro 763. T
oduct X
duct Y
otal
765.
766.
767.
769. 28, 770. 16,0
771.
000 units
00 units
773. $4 774. $18, 775. $
2,000
400 60,400
777.
1 778.
5, 779.
2,000
000 17,000
781. $3 782. $13, 783. $
0,000
400 43,400
785.
786.
787.
789.
790.
791.
793. $3 794. $12, 795. $
0,800
800 43,600
797.
798.
799.
0
0
0
801. $3 802. $12, 803. $
0,800
800 43,600

804.
a. The disadvantage of processing Product X further is $800.
805. ($30,000 - $30,800)
806.
b. The advantage of processing Product Y further is $600.
807.
($13,400 - $12,800)
808.
809.
6. Dropping product line (Appendix B
810.
811.
812.
813. Fo 814. Hou 815. Ob 816. Tot
untains
ses
elisks
al
817. Revenue
818. $1 819. $14
820. $9
821. $4
75,000
5,000
5,000
15,000
822. Variable
823.
824.
4 825.
4
826.
1
costs
85,000
3,000
5,000
73,000
827. Contribution 828. $9 829. $10
830. $5
831. $2
margin
0,000
2,000
0,000
42,000
832. Traceable
833.
834.
3
835.
3
836.
fixed costs
30,000
3,000
0,000
93,000
837. Segment
838. $
839. $ 840. $2 841. $1
Profit
60,000
69,000
0,000
49,000
842. Increased
843.
844.
845.
846.
revenue if Obelisk
847.
848.
849.
850.
851.
852.
853.
854. Continue
855. Discontinue
856.
857. F 858. O 859. T 860. F 861. O 862. T

6-30

Decision Making in the Short Term

863.

Revenue

870. Variable
costs
877. Traceable
fixed costs
884. Common
fixed costs
891. Net
Income

ountain
864. $
175,000

belisk
865. $
95,000

871. 8
5,000
878. 3
0,000
885.
35,000
892. $
25,000

872. 4
5,000
879. 3
0,000
886. 3
5,000
893. (
$15,00
0)

otal
ountain belisk
otal
866. $ 867. $ 868. 0 869. $
270,000 183,750
183,75
0
873. 1 874. 8 875. 0 876. 8
30,000
9,250
9,250
880. 6 881. 3 882. 0 883. 3
0,000
0,000
0,000
887.
888. 7 889. 0 890.
70,000
0,000
70,000
894. $ 895. ($ 896. 0 897. (
10,000
5,500)
$5,500)

898.
899.
Creatives owner should not discontinue its Obelisk line of products.
The increase in revenue from the additional fountain sales does not offset the
portion of common fixed costs that the Obelisk absorbs.

6-31

Balakrishnan/Managerial Accounting, 2e
900.

End of Chapter Content

901.

Short Answer

1. What do short-term decisions deal with in most business environments?


902.
2. What does the term capacity mean?
903.
3. Why is the decision of how much capacity to put in place a long-term decision?
904.
4. What are the two broad classifications of short-term decisions? List two
examples of each.
905.
5. Briefly describe the incremental or differential method approach to making shortterm decisions.
906.
6. Briefly describe the totals or the gross approach to making short-term decisions.
907.
7. Which approach, incremental or totals, requires more computations? Why?
908.
8. When might the gross approach be preferable to the incremental approach for
making short-term decisions?
909.
9. Are sales promotion decisions typically responses to an excess supply situation
or an excess demand situation?
910.
10.What is a make-or-buy decision?
911.
11.When does it make sense to compute the contribution margin per unit of a
particular resource in making short-term decisions?
912.
12.What is the general rule for allocating a scarce resource to making multiple
products?
913.
13. How might managers deal with the possible long-term implications that may
arise from short-run decisions?

6-32

Decision Making in the Short Term


914.

Solutions to Short Answer

1. (LO1)
The temporary gaps between the demand and supply of available
capacity.
915.
2. (LO-1)
The maximum volume of activity that a company can sustain with
available resources.
916.
3. (LO-1)
Because organizations make capacity decisions based on the expected
volume of operations over a horizon spanning many years. They build plants,
buy equipment, rent office space, and hire salaried personnel in anticipation of
the demand for their products and services.
917.
4. (LO-1)
(1) Decisions that deal with excess supply. Examples include reducing
prices to stimulate demand, running special promotions, processing special
orders, and using extra capacity to make production inputs in-house; (2)
Decisions that deal with excess demand. Examples include increasing prices to
take advantage of favorable demand conditions, meeting additional demand by
outsourcing production, and altering the product mix to focus on the most
profitable ones.
918.
5. (LO-2)
This method focuses only on those costs and revenues that differ from
the benchmark option.
919.
6. (LO-2)
This method considers the gross revenues and costs associated with
each option, rather than the incremental amounts relative to the benchmark
option.
920.
7. (LO-2)
The totals approach requires more computations because it includes
some noncontrollable benefits and costs.
921.
8. (LO-2)
In decisions involving many costs and benefits it helps us ensure that
we do not forget to include a relevant cost or benefit.
922.
9. (LO-3)
Excess supply usually, the firm cuts prices to stimulate demand.
923.
10.(LO-3)
In a make or buy decision, the firm is deciding whether to make a
product, or piece thereof, internally or outsource and buy them from a supplier.
924.
11.(LO-4)
When demand is high and a resource is in short supply.
925.
12.(LO-4)
To maximize profit when capacity is in short supply, maximize the
contribution margin per unit of capacity.
926.
13.(LO-5)
Typically on a qualitative basis by considering how customers,
suppliers, and competitors might respond to the decision being made.

6-33

Balakrishnan/Managerial Accounting, 2e
927.

Short Essay

1. The definition of short-term depends on the business context. What would


General Motors consider as short-term? Is this period longer than what a bakery
would consider as short-term? Why?
928.
2. Automobile dealers frequently advertise sales because their lots are
overflowing. The ads suggest a shortage of storage capacity but the pricecutting action indicates a demand shortfall. How can you reconcile these
seemingly contradictory inferences?
929.
3. Identify the one resource whose daily supply is fixed for each person. How could
we improve the effectiveness with which we consume this resource?
930.
4. Some people argue that the gross method is also, at some level, incremental.
Evaluate this argument.
931.
5. When faced with a sudden spurt in demand, why does it sometimes make sense
for a company to increase prices? For example, why do airlines raise fares during
peak travel periods? Why might it not be a good idea for consulting companies?
932.
6. In periods of excess capacity, does it make sense for a manufacturing company
to produce some products to stock (i.e., build up inventory) for sale in future
periods of high demand? Give two examples of industries where this might be a
good idea. Give two examples where it might be a bad idea.
933.
7. How does holding inventory help reduce the expected gap between available
capacity and uncertain demand?
934.
8. Inventory is one mechanism that a firm could use to protect itself from the
impact of fluctuating demand. What are other long-term strategies a company
could adopt to insulate itself against uncertain demand?
935.
9. Often, the capacity of the most expensive machine defines a plants capacity.
That is, firms will deliberately install excess capacity in cheap resources. Why
might this practice be optimal?
936.
10.The general allocation procedure in the text assumes few constraints on how we
could use resources. Why might this general rule not hold when individual uses
require a minimum amount of the resource? (For example, if we are allocating
space, each use might need a minimum of 10 units of space.) How might we
modify our approach to incorporate lumpy uses of capacity?
937.
11.How does the notion of maximizing the contribution per unit of the scarce
resource apply when some products have minimum production quantities?
938.

6-34

Decision Making in the Short Term


12.Outsourcing is the practice of having an external party take over some business
and/or manufacturing processes. How does outsourcing change a firms cost
structure and, therefore, its ability to be nimble in responding to competition?
What are some long-term costs and benefits of outsourcing?
939.
13.Suppose that buying a component is estimated to save $50,000 annually over
making it in-house. However, outsourcing the component means that 20 longterm employees would be laid off, adversely affecting employee morale. How
might a manager trade off these two factors?

6-35

Balakrishnan/Managerial Accounting, 2e
940.

Solutions to Short Essay

1. (LO-1)
Yes, the definition of what is short-term and what is long-term depends
on the business context. For General Motors anywhere from few weeks to a few
months may be considered short-term, as pricing and promotion decisions
depend on how fast different models of cars and trucks are moving from the
dealers inventories. For a baker, a day or two days may be too long as baked
goods do not retain their freshness for long. Thus, product characteristics
often play a critical role in determining how long the short-term horizon is.
941.
2. (LO-1)
The reason why the lots are overflowing is that vehicles are not being
sold at the expected rate. Unsold vehicles occupy space in the lot. Thus, it is not
correct to define capacity in terms of the lot space available. Rather, capacity
should be defined in terms the number of vehicles that can potentially be sold
per day. When demand falls short of supply based on the anticipated number of
vehicles to be sold per day, lots overflow, and price-cutting and other promotions
become necessary to move the vehicles.
942.
3. (LO-1)
Most of us drive to work, and so the demand for gasoline is fairly
stable. One way to economize on gasoline consumption is to car pool.
943.
4. LO-2)
Yes, it is. The gross method considers all cash inflows and cash
outflows that are associated with the options being considered in the context of
a particular decision, even though some of them may be non-controllable. But, it
does not consider cash flows associated with many other decisions that the
companies may be considering. From an overall organizational standpoint, each
decision has an incremental effect, and, therefore, the gross method is also
incremental when viewed in this context.
944.
5. (LO-3, LO-5)
Increasing prices is a natural way of decreasing demand. In fact,
in most market settings, demand for a product decreases as its price increases.
When a firm does not have enough capacity to meet a sudden spurt in demand,
it can reduce the demand by increasing prices and turning away some
customers to a point where the demand can be met. The airline industry is a
good example. In peak times, an increase in airfare induces some travelers to
seek other means of travel or postpone their travels. Only those that are able to
afford the higher prices, or have rigid and noncancelable schedules, will continue
to travel. Airline companies usually face no long-term adverse implications from
increasing prices to deal with peak demand situations. Air travelers usually
understand this behavior and plan their travel accordingly. On the other hand,
consulting companies rely on longstanding relationships with their customers.
Raising their rates when their business is good usually backfires because it hurts
reputation and goodwill in the long-run.
945.
6. (LO-3)
Yes, it does. This is typically referred to as production smoothing and
makes good business sense as long the product is storable for sale in the future
period, and as long as inventory carrying costs are manageable. The toy industry
and the apparels industry are good examples.
946.

6-36

Decision Making in the Short Term


7. (LO-3)
Companies can produce and stock up during periods of lean demand to
be ready for peak periods whenever demand outstrips capacity. However, such
use of inventory is beneficial when demand follows reasonably predictable cycles
of high and low demand. On the other hand, whenever demand is low and there
is considerable uncertainty as to whether demand would rise again, producing
and stocking for future may backfire.
8. (LO-3)
One strategy is to invest less in capacity and rely more on outsourcing.
By doing so, the company would embrace a cost structure with less fixed costs
and more variable costs i.e., a cost structure with lower operating leverage.
Another strategy to find other uses for capacity so that excess capacity can be
put to profitable alternate use during periods of lean demand (such as accepting
special custom jobs, turn key projects and so on).
947.
9. (LO-4)
The idea is to make the most profitable use of critical and most
expensive resources. The opportunity cost of such a resource is by assumption,
high. Any situation in which such a resource has to wait because some other
cheaper resource is in short supply is undesirable. To avoid such situations, it
makes more economic sense to install excess capacity in other resources.
948.
10.(LO-4)
When a resource is in short supply, and it is used in a lumpy manner,
calculating contribution margin per unit of the resource to allocate its use to
various products is at best approximate and can often lead to wrong decisions.
Advanced techniques such as integer programming may have to be employed to
come up with the right way to allocate scarce resources to products in such
settings.
949.
11.(LO-4)
Products requiring minimum production quantities involve committing
requisite amounts of capacity to these products if they are chosen production.
Whenever capacity is in short supply, such products may well necessitate
leaving out products with higher contribution margins per scarce capacity unit in
order to meet their minimum production requirements. The alternative is to not
lock up capacity by scheduling such products, but instead use the capacity to
schedule products that yield lower contribution margins per unit of the scarce
capacity resource. The consequent trade-off will determine whether it is
profitable to make products with minimum production requirements.
950.
12.(LO-5)
Test marketing is a way to minimize risk associated with large
investments. Offering a new product often involves putting in place and
committing to various organizational resources. Once the product is launched it
is often extremely costly to cut back should the product fail. Plants and offices
have to be closed down and people have to be fired and so on. Risk of failure is
an inherent part of business, and products do fail. But one way to reduce this risk
is to do a small scale launch aimed at representative customers. If this test
marketing effort fails, then a larger scale launch is unadvisable. Moreover,
feedback from the test market is often useful in redesigning the product to
reduce the risk of failure subsequently.
951.
13.(LO-5)
Employee morale is an important factor in outsourcing decisions,
especially if outsourcing is a sign of things to come. Loss of morale leads to a
loss in productivity which might make outsourcing even more attractive. The

6-37

Balakrishnan/Managerial Accounting, 2e
company may lose talented and experienced personnel, who may prefer jobs
elsewhere to being fired. Managers therefore have to be clear about the impact
of outsourcing on employee morale so that they can make the appropriate tradeoff between immediate cost savings from outsourcing and longer-term adverse
impact of a loss in morale. Certain critical activities are better done in-house for
strategic reasons, while others can be outsourced. However, decision making
with respect to outsourcing has to be clearly communicated to the employees to
avoid disgruntlement.

6-38

Decision Making in the Short Term


952.

Exercises

1. Ajay Singh offers gift-wrapping services at the local mall. Ajay wraps each
package, regardless of size, in the customers choice of wrapping paper and bow
for a price of $3. Ajays variable costs total $1 per package wrapped, and his
fixed costs amount to $600 per month. Due to the anticipated increase in
demand over the holiday season, Ajay is considering hiring a helper, at a cost of
$8.50 per hour, to help him wrap packages. With the helper, Ajay estimates that
he can wrap 110 packages in a 10-hour day. Without the helper, Ajay estimates
that he can wrap 60 packages in a 10-hour day. Ajay plans on operating his
business for thirty 10-hour days during the holiday season.
953.
954.
Required:
955.
a. Does Ajays decision deal with excess supply or excess demand?
956.
957.
b. Using the gross approach, determine whether Ajay should hire the
helper.
958.
959.
c. Using controllable cost analysis, determine whether Ajay should hire
the helper.
960.
961.
d. Assume Ajays fixed costs were $1,000 rather than $600. Would this
affect Ajays decision
962.
to hire a helper?
963.
964.
965.
966.
967.
968.
2. The Dj Vu Card Company offers greeting cards for every occasion at
unmatched prices. The following information comes from Dj Vus accounting
records for December of the most recent year: Greeting cards sold 100,000 cards
Selling price $1.00 per card Fixed costs:
969. Manufacturing $0.30 per card
970. Marketing & administrative $0.21 per card
971. Variable costs:
972. Manufacturing $0.15 per card
973. Marketing & administrative $0.08 per card
974.
975.
Required:
976.
Dj Vu has an extra stock of 5,000 holiday greeting cards. The
company is considering two options: (1) holding a 50% off sale and (2) holding
an 80% off sale. Dj Vu expects to sell 1,500 cards if it holds a 50% off sale and
4,000 cards if it holds an 80% off sale. The remaining cards would be discarded.
Which option should Dj Vu pursue?
977.

6-39

Balakrishnan/Managerial Accounting, 2e
3. Myers Quarry produces coarse gravel and sand in an 8:2 ratio. Joint costs for a
month (volume 5 9,000 tons of rocks input) amount to $225,000. Values at the
split-off point are $30 per ton for gravel and $40 per ton for sand.
978.
979.
Required:
980.
a. Allocate joint costs to the two products using the relative sales value
at split off as the allocation basis.
981.
982.
b. Suppose Myers can run the sand through a sieve to remove small
rocks and make fine sand used to fill sandboxes. The process will, however,
reduce the yield of sand from 1,800 tons to 900 tons. This superior grade of sand
(sandbox quality) retails for $160 per ton. However, Myers will incur $18,000
to process the sand into sandbox quality. Should Myers sell the coarse sand as
is or process it further into sandbox quality sand?

6-40

Decision Making in the Short Term


983.

Solutions to Exercises

1. (LO1, LO2)
a. Ajays decision deals with excess demand. Due to the holidays, Ajay expects
a surge in gift-wrapping needs. To handle this surge, Ajay is considering hiring
a helper. This is akin to a manufacturing firm outsourcing some production in
periods of high demand.
984.
b. We can construct the entire CVP model for Ajay. We then compare the profit
under each option, selecting the option with the higher profit. With the
information provided, we have:
985.

986.

989.

990.
991.

994.
Dail
y revenue

995.
($3
60; $3
110)

998.
Dail
y variable
costs
1002.
Dail
y pay for
help
1006.
Dail
y
contributio
n
1010.
Total
contributio
n

999.
($1
60; $1
110)
1003.
(0;
$8.50 10)

1011.
30

Row 4

1014.
Total
fixed costs

1015.

Given

1018.
t

1019.

Profi

1007.
Row
1 rows 2 &
3

987.
W
988.
W
ithout
ith
Helper
Helper
992.
60
993. 110
packag
packages
es per
per day
day
996.
997.
$33
$18
0.00
0.0
0
1000. 1001. 110.
60.
00
00
1004. 1005. 85.0
0.0
0
0
1008.
1009. $13
$12
5.00
0.0
0
1012. 1013. $4,0
$3,
50.00
600
.00
1016. 1017. 600.
600
00
.00
1020.
1021. $3,
$3,
450.00
000
.00

1022.
1023. Ajays profit increases by $450 ($3,450 $3,000) for the season, if he
hires the helper. Accordingly, if he wishes to maximize profit then Ajay
should hire the helper.

6-41

Balakrishnan/Managerial Accounting, 2e
1024. In constructing the income statement for each option, we could leave
out the non-controllable fixed costs of $600. While the absolute profit
numbers would change, the difference in profit would be preserved. Thus, the
gross approach provides decision makers some flexibility in terms of what is
included and excluded from the income statement.
c. We compute only the incremental revenues and costs associated with a
particular decision option relative to the status quo. Since operating without
the helper is the status quo, we have:
1025.
1028.
Incremental
revenue

1026.
1029.
50
packages per
day $3
1032.
50
packages per
day $1
1035.
$8.50
10 hours

1027.
1030.
$

1037.
Incremental profit
per day

1038.

1039.
$

1040.
Value of hiring
helper

1041.
$15
30days

1042.
$

1031.
Incremental
variable cost (packages)
1034.
Incremental cost
(helper)

1033.
5
1036.
8

1043. Ajay increases monthly profit by $450 if he hires a helper. The


difference in profit derived with controllable cost analysis exactly equals the
difference in profit under the gross approach.
1044.
d. If Ajay seeks to maximize profit, the change in fixed costs will not alter
his decision to hire the helper. The fixed costs are equal under each
option and are not relevant for this particular problem. Even though the
gross approach uses fixed costs, they wash because they are included in
the total cost for both options.
1045.

6-42

Decision Making in the Short Term


2. (LO2)
Similar to the Superior Cereals problem in the text, the key to this
problem is to realize that the variable costs associated with manufacturing the
greeting cards are sunk thus, they are not relevant to Dj Vus decision.
Additionally, Dj Vus fixed costs are non-controllable for the decision, as they
are not expected to change. Thus, the problem is one of revenue maximization.
1046.
1047. At a 50% off sale, Dj Vus profit increases by $0.50 1,500 = $750.
1048. At an 80% off sale, Dj Vus profit increases by $0.20 4,000 = $800.
1049.
1050. Thus, Dj Vu maximizes its profit by holding the 80% off sale, even
though the resulting price is below the $0.23 (= $0.15+$0.08) in variable
costs associated with producing and selling a card. What we need to
remember is that this is the variable cost of a card yet to be produced, not a
card that has already been produced.
1051.
1052. Note: This problem links to a common business practice. Specifically,
we often observe stores employing a staggered discounting strategy the
store starts with, for example, a 25% discount and increases the discount
rate over time (perhaps by as much as 15-25% a week). In this way, the store
attempts to capture as much consumer surplus (gross revenue) as possible
by grouping customer types according to their willingness to wait and run the
risk of having the item selling out. Such a strategy may work quite well for
Dj Vu i.e., the company could sell the first 1,500 cards at $0.50 and 4,000
1,500 = 2,500 cards at $0.20. By employing such a strategy, Dj Vu could
earn:
1053.
1054. Expected Profit = ($0.50 1,500) + ($0.20 2,500) = $1,250.
1055. This amount represents a $450 (= $1,250 - $800) increase over its
best option.
1056.

6-43

Balakrishnan/Managerial Accounting, 2e
3. (Appendix A)
a. Let us begin by calculating relative sales values.
1057.
Gravel:
$30
$216,000
1058.
Sand:
$40
$72,000
Total
$288,000

9,000 tons 0.8


9,000 tons 0.2

1059. Thus, 75% of the joint cost (=$216,000/$288,000) would be allocated


to gravel and the 25% to sand. We have the cost allocated as 0.75
$225,000 = $168,750 and 0.25 $225,000 = $56,250.
1060.
Alternatively, we can calculate the rate per sales $ at the split off as
$225,000/$288,000 = $0.78125. We then allocate $216,000 $0.78125 =
$168,750 to gravel and $72,000 0.78125 = $56,250 to sand.
b. We know that only incremental revenues and costs are important for this
decision. Let us therefore calculate the net gain from processing the sand
further.
1061.
1062.
Value of sandbox quality
900 tons
$160
$144,000
1063.
Lost value at split off
9,000 tons
0.2 $40
$72,000
1064.
Net gain in revenue
$72,000
1065.
Cost of additional processing
given
($18,000)
1066.
Net value
$54,000
1067. Thus, Myers should process the sand at split off into sandbox
quality sand because it increases profit by $126,0001 - $72,000 =
$54,000.
1068.
1069. Note: The important point to note is that the joint cost, or how it is
allocated, is not relevant for the decision in [b]. That joint cost is sunk for this
decision. These allocations are usually done only for the purpose of valuing
inventory.

1
6-44

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