Incremental Analysis

CHAPTER 7
INCREMENTAL ANALYSIS
SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY
Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT
True-False Statements
1. 2 K 8. 3 C 15. 6 C 22. 8 K 29. 7 C
2. 1 K 9. 3 C 16. 6 C 23. 2 K 30. 2 K
3. 2 C 10. 4 C 17. 6 C 24. 3 C 31. 4 K
4. 2 K 11. 4 K 18. 7 C 25. 5 K 32. 6 K
5. 1 K 12. 4 C 19. 7 C 26. 7 C
6. 2 C 13. 5 C 20. 8 C 27. 4 K
7. 3 C 14. 5 C 21. 8 C 28. 2 C
Multiple Choice Questions
33. 4 K 50. 1 C 67. 4 C 84. 6 K 101. 5 AN
34. 4 K 51. 2 K 68. 4 C 85. 7 AN 102. 5 AN
35. 3 AP 52. 2 C 69. 4 AP 86. 7 AP 103. 4 K
36. 4 AP 53. 2 C 70. 4 AN 87. 7 AN 104. 3 K
37. 4 K 54. 2 K 71. 4 AN 88. 8 AN 105. 5 AN
38. 7 AP 55. 2 K 72. 3 AN 89. 8 C 106. 6 C
39. 7 AP 56. 2 C 73. 3 AN 90. 8 AP 107. 4 AN
40. 4 AP 57. 2 C 74. 4 AN 91. 3 AP 108. 1 K
41. 5 K 58. 2 C 75. 5 AN 92. 4 C 109. 3 K
42. 8 K 59. 2 C 76. 4 C 93. 7 AN 110. 1 C
43. 5 AP 60. 3 AP 77. 5 AN 94. 8 AP 111. 3 C
44. 3 AP 61. 2 C 78. 5 C 95. 4 K 112. 5 C
45. 1 K 62. 3 C 79. 5 AN 96. 4 AP 113. 2 K
46. 1 K 63. 3 C 80. 6 C 97. 3 C 114. 5 K
47. 1 K 64. 3 C 81. 6 K 98. 4 C 115. 7 C
48. 1 K 65. 3 C 82. 6 C 99. 4 AN 116. 6 K
49. 2 K 66. 4 K 83. 6 C 100. 5 AP 117. 5 K
Brief Exercises
118. 4 AP 122. 7 AP 126. 2 AP 130. 7 AN 134. 4 AN
119. 4 AP 123. 8 AP 127. 8 AN 131. 4 AN 135. 3 AN
120. 4 AP 124. 4 AP 128. 3 AP 132. 5 AN
121. 7 AP 125. 6 AN 129. 4 AP 133. 7 AN
Exercises
136. 7 AN 140. 3 AN 144. 5 AN 148. 7 AN 152. 2 C
137. 7 AP 141. 3 AN 145. 6 AN 149. 8 AN 153. 1 C
138. 3,4 AN 142. 4 AN 146. 6 E 150. 8 AN 154. 6 C
139. 3 AN 143. 4 AN 147. 7 E 151. 3 S 155 4 AN
Completion Statements
156. 2 K 158. 4 K 160. 6 K 162. 1 K
157. 2 K 159. 5 K 161. 8 K
Matching
163. 1-4 K
Short Answer Essay Questions
164. 4 AN 165. 6 E
Multi Part Question
166. 3,8 AN
7-2 Test Bank for Managerial Accounting, Third Canadian Edition
SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type
Study Objective 1
2. TF 45. MC 47. MC 50. MC 110. MC 162. C
5. TF 46. MC 48. MC 108. MC 153. Ex 163. Ma
Study Objective 2
1. TF 23. TF 51. MC 55. MC 59. MC 153. Ex
3. TF 28. TF 52. MC 56. MC 61. MC 156. C
4. TF 30. TF 53. MC 57. MC 113. MC 157. C
6. TF 49. MC 54. MC 58. MC 126. BE 163 Ma
Study Objective 3
7. TF 35. MC 63. MC 73. MC 109. MC 138. Ex 151. Ex
8. TF 44. MC 64. MC 91. MC 111. MC 139. Ex 163. Ma
9. TF 60. MC 65. MC 97. MC 128. BE 140. Ex 166. MP
24. TF 62. MC 72. MC 104. MC 135. BE 141. Ex
Study Objective 4
10. TF 34. MC 68. MC 92. MC 107. MC 131. BE 158 C
11. TF 36. MC 69. MC 95. MC 118. BE 138. BE 163. Ma
12. TF 37. MC 70. MC 96. MC 119. BE 142. Ex 164 SAE
27. TF 40. MC 71. MC 98. MC 120. BE 142. Ex
31. TF 66. MC 74. MC 99. MC 124. BE 143. Ex
33. MC 67. MC 76. MC 103. MC 129. BE 155. Ex
Study Objective 5
13. TF 41. MC 77. MC 100. MC 105. MC 117. MC 159. C
14. TF 43. MC 78. MC 101. MC 112. MC 132. BE
25. TF 75. MC 79. MC 102. MC 114. MC 144. Ex
Study Objective 6
15. TF 32. TF 82. MC 106. MC 145. Ex 160. C
16. TF 80. MC 83. MC 116. MC 146. Ex 165. SAE
17. TF 81. MC 84. MC 125. BE 154. Ex
Study Objective 7
18. TF 29. TF 85. MC 93. MC 122. BE 136. Ex 148. Ex
19. TF 38. MC 86. MC 115. MC 130. BE 137. Ex
26. TF 39. MC 87. MC 121. BE 133. BE 147. Ex
Study Objective 8
20. TF 22. TF 88. MC 90. MC 123. BE 149. Ex 161. C
21. TF 42. MC 89. MC 94. MC 127. BE 150. Ex 166. MP
Note: TF = True-False BE = Brief Exercise C = Completion SAE = Short Answer Essay

MC = Multiple Choice Ex = Exercise Ma = Matching MP = Multipart
Incremental Analysis 7-3
CHAPTER STUDY OBJECTIVES
1. Identify the steps in management's decision-making process. Management's

decision-making process consists of (a) identifying the problem and assigning
responsibility for the decision, (b) determining and evaluating possible courses of action,
(c) making the decision, and (d) reviewing the results of the decision.
2. Describe the concept of incremental analysis. Incremental analysis is the process

companies use to identify financial data that change under alternative courses of action.
These data are relevant to the decision because they will vary in the future among the
possible alternatives.
3. Identify the relevant costs in accepting an order at a special price. The relevant
information in accepting an order at a special price is the difference between the variable
manufacturing costs to produce the special order and expected revenues.
4. Identify the relevant costs in a make-or-buy decision. In a make-or-buy decision, the

relevant costs are (a) the variable manufacturing costs that the company will save, (b) the
purchase price, and (c) opportunity costs.
5. Identify the relevant costs in determining whether to sell or process materials

further. The decision rule for whether to sell or process materials further is as follows:
process further as long as the incremental revenue from processing is more than the
incremental processing costs.
6. Identify the relevant costs in deciding whether to retain or replace equipment. The
relevant costs a company needs to consider in determining whether it should retain or
replace equipment are the effects on variable costs and the cost of the new equipment.
Also, it must consider any disposal value of the existing asset.
7. Identify the relevant costs in deciding whether to eliminate an unprofitable

segment. In deciding whether to eliminate an unprofitable segment, the relevant
information is the contribution margin, if any, produced by the segment and the disposition
of the segment's fixed expenses.
8. Determine sales mix when a company has limited resources. When a company has
limited resources, it is necessary to find the contribution margin per unit of limited
resource. This amount is then multiplied by the units of limited resource to determine
which product maximizes net income.
TRUE-FALSE STATEMENTS
1. Incremental analysis identifies the probable effects of management decisions on future

earnings.
2. In making decisions, management considers only financial information because

accounting is presented in financial context.
3. In incremental analysis, total fixed costs will always remain constant under alternative
courses of action.
4. Incremental analysis is also known as differential analysis.
5. Decision-making involves reviewing the results of a decision once the decision has been
made.
6. Decisions made using incremental analysis focus on the amounts which differ among the
alternatives.
7. A special one-time order is acceptable if the unit sales price is greater than the unit
variable cost.
8. Max Company has excess capacity. A customer proposes to buy 400 widgets at a special
unit price even though the price is less than the unit variable cost to manufacture the item.
Max should accept the special order if demand on other products is unaffected.
9. A company should accept an order for its product at less than its regular sales price if the
incremental revenue exceeds the incremental costs.
10. A decision whether to continue to buy a product instead of producing it externally depends
specifically on the incremental costs and incremental revenues of making the change.
11. An opportunity cost is the potential benefit given up by using resources in an alternative
course of action.
12. An incremental make or buy decision depends solely on which alternative is the lowest
cost alternative.
13. In a sell or process further decision, management should process further as long as the
incremental revenues from additional processing are greater than the incremental costs.
14. It is better to process further rather than sell now if the sales price increases.
15. In a decision concerning replacing old equipment with new equipment, the book value of
the old equipment can be considered an opportunity cost.
16. In a decision to keep or replace old equipment, the salvage value of the old equipment is
a sunk cost in incremental analysis.
17. Equipment which is not fully depreciated should always be replaced.
18. A company should eliminate any segment in which the contribution margin is less than the
fixed costs that are unavoidable.
19. The elimination of an unprofitable product line will always increase the total profits of a
company.
20. When a company has limited resources to manufacture products, it should manufacture
those products which have the highest contribution margin per unit.
21. If a company has limited machine hours available for production, it is generally more
profitable to produce and sell the product with the highest contribution margin per machine
hour.
22. One incremental analysis decision is the allocation of limited resources.
23. The process used to identify the financial data that change under alternative courses of
action is called incremental analysis.
24. If a company is operating at less than capacity, the incremental costs of a special order
will likely include variable manufacturing costs, but not fixed costs.
25. The basic decision rule in a sell or process further decision is: process further if the
incremental revenue from processing exceeds the incremental processing costs.
26. In deciding on the future status of an unprofitable segment, management should

recognize that net income will increase by eliminating the unprofitable segment.
27. Direct materials, direct labour, and allocated fixed and variable manufacturing overhead
are all relevant in a make or buy decision.
28. Sunk costs are considered relevant when choosing among alternatives because they are
differential.
29. If an unprofitable product is eliminated, fixed expenses allocated to the eliminated

segment will likely be eliminated.
30. Incremental costs are always relevant.
31. A disadvantage of using an outside supplier is the associated loss of control over the
production process.
32. The book value of old equipment is an opportunity cost.

ANSWERS TO TRUE-FALSE STATEMENTS

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. T 6. T 11. T 16. F 21. T 26. F 31. T
2. F 7. T 12. F 17. F 22. T 27. F 32. F
3. F 8. F 13. T 18. F 23. T 28. F
4. T 9. T 14. F 19. F 24. T 29. F
5. T 10. F 15. F 20. F 25. T 30. T
MULTIPLE CHOICE QUESTIONS
33. The cost to produce Part A was $5 per unit in 2011. During 2012, it has increased to $8
per unit. In 2012, Supplier Company has offered to supply Part A for $6 per unit. For the
make-or-buy decision,
a. incremental revenues are $1 per unit.
b. incremental costs are $3 per unit.
c. net relevant costs are $3 per unit.
d. differential costs are $2 per unit.
34. Max Company uses 10,000 units of Part A in producing its products. A supplier offers to
make Part A for $7. Max Company has relevant costs of $8 a unit to manufacture Part A.
If there is excess capacity, the opportunity cost of buying Part A from the supplier is
a. $0.
b. $10,000.
c. $70,000.
d. $80,000.
35. Truckel, Inc. currently manufactures a wicket as its main product. The costs per unit are
as follows:
Direct materials and direct labour $11.00
Variable overhead 3.00
Fixed overhead 8.00
Total $22.00
The fixed overhead is an allocated common cost. How much is the relevant cost of the
wicket?
a. $24.00
b. $14.00
c. $11.00
d. $19.00
36. Seran Company has contacted Truckel Inc. with an offer to sell it 5,000 of the wickets for
$18.00 each. If Truckel makes the wickets, variable costs are $11 per unit. Fixed costs are
$12 per unit however $5 per unit is avoidable. Should Truckel make or buy the wickets?
a. Buy; savings = $25,000
b. Buy; savings = $10,000
c. Make; savings = $20,000
d. Make; savings = $10,000
37. Galley Industries can produce 500 units of a necessary component part with the following
costs:
Direct Materials $75,000
Direct Labour 20,000
Variable Overhead 60,000
Fixed Overhead 10,000
If Galley Industries purchases the component externally, $3,000 of the fixed costs can be
avoided. Below what external price for the 500 units would Galley choose to buy instead
of make?
a. $95,000
b. $165,000
c. $155,000
d. $158,000
38. Corn Crunchers has three product lines. Its only unprofitable line is Corn Nuts, the results
of which appear below for 2012:
Sales $350,000
Variable expenses 230,000
Fixed expenses 180,000
Net loss $(60,000)
If this product line is eliminated, 30% of the fixed expenses can be eliminated. How much
are the relevant costs in the decision to eliminate this product line?
a. $54,000
b. $410,000
c. $335,000
d. $284,000
39. North Division has the following information:

Sales $600,000
If this division is eliminated the fixed expenses will be allocated to the company’s other
divisions. What is the incremental effect on net income if the division is dropped?
a. $130,000 increase
b. $410,000 decrease
c. $280,000 decrease
d. $190,000 increase
40. Peters, Inc. produces chocolate chip cookies. Costs for producing one batch appear
below:
Direct materials $ 8.00
Direct labour 3.00
Fixed overhead 4.00
An outside supplier has offered to produce the cookies for $14 per batch. If Peters decides
to buy instead of make the cookies, what is the maximum price it would may?
a. $16.00
b. $12.00
c. $13.60
d. $14.40
41. Walton, Inc. is unsure of whether to sell its product assembled or unassembled. The unit
cost of the unassembled product is $16, while the cost of assembling each unit is
estimated at $17. Unassembled units can be sold for $55, while assembled units could be
sold for $71 per unit. What decision should Walton make?
a. Sell before assembly, the company will save $1 per unit.
b. Sell before assembly, the company will save $15 per unit.
c. Process further, the company will save $1 per unit.

d. Process further, the company will save $16 per unit.
42. Ace Company sells office chairs with a selling price of $45 and a contribution margin per
unit of $20. It takes 5 machine hours to produce one chair. How much is the contribution
margin per unit of limited resource?
a. $4
b. $5
c. $9
d. $20
43. Rosen, Inc. has 10,000 obsolete calculators, which are carried in inventory at a cost of
$20,000. If the calculators are scrapped, they can be sold for $1.10 each (for parts). If they
are repackaged, at a cost of $15,000, they could be sold to toy stores for $2.50 per unit.
What alternative should be chosen, and why?
a. Scrap; profit is $1,000 greater.
b. Repackage; revenue is $5,000 greater than cost.
c. Scrap; incremental loss is $9,000.
d. Repackage; receive profit of $10,000.
44. It costs Lannon Fields $14 of variable costs and $6 of allocated fixed costs to produce an
industrial trash can that sells for $30. A buyer in Mexico offers to purchase 3,000 units at
$18 each. Lannon has excess capacity and can handle the additional production. What
effect will acceptance of the offer have on net income?
a. decrease $4,000
b. increase $4,000
c. increase $54,000
d. increase $12,000
45. Which steps do accountants mostly contribute to in the decision-making process?

a. Identifying the problem and then assigning responsibility.
b. Determining and evaluating possible courses of action and then reviewing the
results of the decision.
c. Determining and evaluating possible courses of action, and then making a
decision.
d. Making a decision and then reviewing the results of that decision.
46. Which one of the following stages of the management decision-making process is properly
sequenced?
a. Evaluate possible courses of action, Make decision
b. Review the actual impact of the decision, Determine possible courses of action
c. Assign responsibility for the decision, Identify the problem
d. Make a decision, Assign responsibility
47. Who prepares relevant revenue and cost data for the decision making process?
a. Department heads
b. The controller
c. Management accountants
d. Factory supervisors
48. Which of the following statements about making decisions is correct?

a. Only relevant financial information should be considered.
b. All information should be considered in the final decision.
c. Management should consider both relevant financial and non-financial
information.
d. Management accountants should provide the information, but they should not
make recommendations. It is up to the managers to make decisions.
49. What is the process of evaluating financial data that changes under alternative courses of
action called?
a. Incremental analysis
b. Decision-making analysis
c. Contribution margin analysis
d. Cost-benefit analysis
50. Which one of the following is nonfinancial information that management might evaluate in
making a decision?
a. Opportunity costs of a decision
b. Contribution margin
c. The effect on profit of a decision
d. The corporate profile in the community
51. Which one of the following is an alternative name for incremental analysis?
a. Managerial analysis
b. Cost analysis
c. Contribution margin analysis
d. Differential analysis
52. Which of the following describes one aspect of incremental analysis?

a. Both costs and revenues that stay the same between alternate courses of action
will be analyzed.
b. Both costs and revenues that differ between alternate courses of action will be
analyzed.
c. All costs and revenues, regardless if they stay the same or differ between
alternate courses of action, will be analyzed.
d. Only costs relating to the decisions at hand are analyzed.
53. Which of the following statements about incremental analysis is true?

a. It cannot be used if more than two alternatives are available.
b. It considers only cost factors, not revenue.
c. Its focus is on the past activities.
d. It only considers factors that are different for each alternative, and only those
factors that will occur in the future.
54. What is a sunk cost?

a. A significant cost that has the potential to “sink” the organization.
b. A cost that has already occurred, but still must be considered in the decision
process.
c. A cost that has already occurred and therefore is not relevant in the decision
process.
d. A cost that cannot be changed.
55. Which one of the following is a true statement about incremental analysis?
a. It is another name for capital budgeting.
b. It is the same as CVP analysis.
c. It is used primarily for long-term planning.
d. It focuses on decisions that involve a choice among alternative courses of action.
56. For which of the following decisions is incremental analysis not appropriate?
a. Elimination of an unprofitable segment
b. Determining cost behaviour
c. A make or buy decision
d. An allocation of limited resource decision
57. For which of the following is incremental analysis appropriate?

a. Acceptance of a special order and a make or buy decision
b. A retain or replace equipment decision and CVP analysis
c. A sell or process further decision and allocation of indirect costs
d. Elimination of an unprofitable segment and allocation of indirect costs
58. Which of the following is a true statement about costs in incremental analysis?
a. Variable costs are always relevant.
b. Fixed costs are never relevant.
c. Fixed costs are always relevant.
d. Both variable and fixed costs can be relevant.
59. Specik, Inc. is considering the following alternatives:

Alternative 1 Alternative 2
Revenues $120,000 $120,000
Variable costs 60,000 65,000
Fixed costs 35,000 39,000
Which of the following are relevant in choosing between the alternatives?
a. Variable costs
b. Revenues
c. Fixed costs
d. Variable costs and fixed costs
60. Seville Company manufactures a product with a unit variable cost of $42 and a unit sales
price of $75. Fixed manufacturing costs were $80,000 when 10,000 units were produced
and sold, equating to $8 per unit. The company has a one-time opportunity to sell an
additional 1,500 units at $55 each in an international market which would not affect its
present sales. The company has sufficient capacity to produce the additional units. How
much is the relevant income effect of accepting the special order?
a. $63,000
b. $7,500
c. $50,000
d. $19,500
61. Which statement is true about relevant costs in incremental analysis?

a. All costs are relevant if they change between alternatives.
b. Only fixed costs are relevant.
c. Only variable costs are relevant.
d. Relevant costs should be ignored.
62. M&H Ltd. has sufficient capacity to fill an order at a special price below its usual price. The
special price exceeds its variable costs. What non-financial factors should also be
considered in the decision?
a. Is there the potential for additional sales to the customer in the future?
b. How existing customers will respond if they find out about the special price.
c. If there is the potential for additional sales to the customer in the future, can a
higher price be charged?
d. All of the above.
63. Canosta, Inc. determined it must expand its capacity to accept a special order. Which
situation is likely?
a. Unit variable costs will increase.
b. Fixed costs will not be relevant.
c. Both variable and fixed costs will be relevant.
d. The company should accept the order.
64. A company is within plant capacity. It is contemplating whether a special order should be
accepted. The order will not impact regular sales. If the company accepts a special order,
what will occur?
a. Incremental costs will not be affected.
b. Net income will increase if the special sales price per unit exceeds the unit
variable costs.
c. There are no incremental revenues.
d. Both fixed and variable costs will increase.
65. Argus Company anticipates that other sales will be affected by the acceptance of a special
order. What should the company do?
a. Reject the order.
b. Consider the opportunity cost of lost sales in the incremental analysis.
c. Accept the order.
d. Accept the order if the plant is below capacity.
66. Which statement is true of an opportunity cost?

a. It is the cost of a special order option.

b. It reduces the possibility of accepting a particular course of action.
c. It is the potential benefit as a result of following an alternative course of action.
d. It is a variable cost.
67. In which situations should opportunity costs be considered?

a. Decision making that involves alternative uses
b. Forecasting sales
c. Financial accounting
d. Breakeven analysis
68. What is the nature of an opportunity cost?

a. It is always variable.
b. It is a potential benefit.
c. It is included as part of cost of goods sold.
d. It is a sunk cost.
69. Wishnell Toys can make 5,000 toy robots with the following costs:
The company can purchase the 5,000 robots externally for $145,000. The avoidable fixed
costs are $15,000 if the units are purchased externally. What is the cost savings if the
company makes the robots?
a. $18,000
b. $15,000
c. $5,000
d. $3,000
Use the following information for questions 70–71.
Hermantic, Inc. can produce 100 units of a component part with the following costs:
70. If Hermantic, Inc. purchases the units externally for $80,000, by what amount will its total
costs change?
a. An increase of $80,000
b. An increase of $5,000
c. An increase of $17,000
d. A decrease of $22,000
71. If Hermantic, Inc. can purchase the component externally for $88,000 and only $8,000 of
the fixed costs can be avoided, what is the correct "make or buy decision"?
a. Make and save $1,000
b. Buy and save $1,000
c. Make and save $5,000
d. Buy and save $13,000
Use the following information for questions 72–73.
Eminen Music produces 60,000 blank CDs on which to record music. The CDs have the following
costs:
72. Eminem could avoid $4,000 in fixed overhead costs if it acquires the CDs externally. If
cost minimization is the major consideration and the company would prefer to buy the
60,000 units externally, what is the maximum external price that Eminem would expect to
pay for the units?
a. $32,000
b. $29,000
c. $36,000
d. $33,000
73. None of Eminem’s fixed overhead costs can be reduced, but another product could be
made that would increase profit contribution by $4,000 if the CDs were acquired
externally. If cost minimization is the major consideration and the company would prefer to
buy the CDs, what is the maximum external price that Eminem would be willing to accept
to acquire the 60,000 units externally?
a. $36,000
b. $32,000
c. $33,000
d. $40,000
74. Harrison Company determines that an opportunity cost of an alternate course of action is
relevant to a make or buy decision. Which statement is true of the opportunity cost?
a. Should be added to the "Buy" costs
b. Should be subtracted from the "Make" costs
c. Should be added to the "Make" costs
d. Should be ignored if it does not involve a cash outlay.
75. A company has a process that results in 1,000 kilograms of Product X that can be sold for
$10 per kilogram. An alternative would be to process Product X further at a cost of $2,000
and then sell it for $13 per kilogram. Should management sell Product X now or should
Product X be processed further and then sold?
a. Process further, the company will be better off by $1,000.
b. Sell now, the company will be better off by $1,000.
c. Process further, the company will be better off by $3,000.
d. Sell now, the company will be better off by $10,000.
76. Which statement is true concerning the decision rule on whether to make or buy?
a. The company should buy if the cost of buying is less than the cost of producing.
b. The company should buy if the incremental revenue exceeds the incremental
costs.
c. The company should buy as long as total revenue exceeds present revenues.
d. The company should buy assuming no additional fixed costs are incurred.
77. PH Toy is unsure of whether to sell its product assembled or unassembled. The unit cost
of the unassembled product is $30 and PH Toy Company would sell it for $65. The cost to
assemble the product is estimated at $21 per unit and PH Toy Company believes the
market would support a price of $85 on the assembled unit. What decision should PH Toy
make?
a. Sell before assembly, the company will be better off by $1 per unit.
b. Sell before assembly, the company will be better off by $20 per unit.
c. Process further, the company will be better off by $29 per unit.
d. Process further, the company will be better off by $14 per unit.
78. What is the nature of a sell or process further decision?

a. It is an incremental revenue decision.
b. It is an incremental cost decision.
c. It is both an incremental revenue and incremental cost decision.
d. It is neither incremental revenue nor incremental cost.
79. Coggin Company gathered the following data about the three products that it produces:
Present Estimated Additional Estimated Sales
Product Sales Value Processing Costs if Processed Further
A $ 9,000 $ 6,000 $ 16,000
B 15,000 5,000 18,000
C 11,000 8,000 16,000
Which of the products should be processed further?
a. Product A
b. Product B
c. Product C
d. All three products
80. Which of the following is relevant information in a decision whether old equipment
presently being used should be replaced by new equipment?
a. The cost of the old equipment
b. The salvage value of the old equipment
c. The book value of the old equipment
d. The accumulated depreciation of the old equipment
81. What is the salvage value of old equipment considered to be?

a. A relevant cost
b. A non-incremental cost
c. An opportunity cost
d. A cost that is not differential
82. A company is deciding whether or not to replace some old equipment with new
equipment. Which of the following is not considered in the incremental analysis?
a. Annual operating cost of the new equipment
b. Annual operating cost of the old equipment
c. Net cost of the new equipment
d. Book value of the old equipment
83. A company is considering replacing old equipment with new equipment. Which of the
following is a relevant cost for incremental analysis?
a. Total accumulated depreciation of the old equipment
b. Cost of the old equipment
c. Annual operating cost of the new equipment
d. Book value of the old equipment
84. What role does a trade-in allowance on old equipment play in a decision to retain or
replace equipment?
a. It relevant since it increases the cost of the new equipment.
b. It is not relevant since it reduces the cost of the old equipment.
c. It is not relevant to the decision since it does not impact the cost of the new
equipment.
d. It is relevant since it reduces the cost of the new equipment.
85. Diversified Machines has four product lines, one of which reflects the following results:
Sales $220,000
Contribution margin 100,000
Net loss $(20,000)
If this product line is eliminated, 40% of the fixed expenses can be eliminated and the
other 60% will be allocated to other product lines. If management decides to eliminate this
product line, what will happen to the company's net income?
a. It will increase by $20,000.
b. It will decrease by $52,000.
c. It will decrease by $32,000.
d. It will increase by $48,000.
86. Halliburton Division has the following data:

Sales $500,000
The fixed costs are not avoidable and must be allocated to profitable divisions if the
segment is eliminated. What will be the incremental effect on net income if Halliburton
Division is eliminated?
a. $60,000 increase
b. $260,000 decrease
c. $280,000 decrease
d. Cannot be determined from the data provided
87. SmartCard is considering eliminating one of its product lines. The fixed costs currently
allocated to the product line will be allocated to other product lines upon discontinuance.
What financial effects occur if the product line is discontinued?
a. Net income will decrease by the amount of the contribution margin of the product
line being discontinued.
b. The company's total fixed costs will increase.
c. Total fixed costs will decrease by the amount of the product line's fixed costs.
d. Net income will decrease by the amount of the product line's fixed costs.
88. Shorebuck’s Coffee can sell all the units it can produce of either latte or cappuccino but not
both. Latte has a unit contribution margin of $45 and takes three machine hours to make
and cappuccino has a unit contribution margin of $32 and takes two machine hours to
make. There are 1,300 machine hours available to manufacture a product. What should
Shorebuck’s do?
a. Make latte which creates $13 more profit per unit than cappuccino does.
b. Make cappuccino which creates $1 more profit per constraint than latte does.
c. Make cappuccino because more units can be made and sold than latte.
d. The same total profits exists regardless of which product is made.
89. What is the key factor in performing incremental analysis if a company has limited
resources?
a. Contribution margin per unit of limited resource
b. The amount of fixed costs per unit
c. Total contribution margin
d. The cost of limited resources
90. Hari’s Fish House can produce and sell only one of the following two products:
Fryer Contribution
Hours Required Margin Per Unit
Fried catfish 3 $15
Fried grouper 4 $16
The company has fryer capacity of 12,000 hours. How much will the contribution margin
be if it produces only the most profitable product?
a. $48,000
b. $36,000
c. $60,000
d. $12,000
91. It costs Fortune Company $12 of variable and $5 of fixed costs to produce one bathroom
scale which normally sells for $35. A foreign wholesaler offers to purchase 1,000 scales at
$16 each. Fortune would incur special shipping costs of $2 per scale if the order were
accepted. Fortune has sufficient unused capacity to produce the 1,000 scales. If the
special order is accepted, what will be the effect on net income?
a. $2,000 increase
b. $2,000 decrease
c. $3,000 decrease
d. $15,000 increase
92. Which one of the following does not affect a make or buy decision?
a. Variable manufacturing costs
b. Opportunity cost
c. Incremental revenue
d. Direct labour
93. How should that portion of fixed costs that are unavoidable be handled when making a
decision on whether to eliminate an unprofitable segment?
a. They should be subtracted from the contribution margin and if that results in a net
loss, the segment should be eliminated.
b. They should not be considered as they are not relevant.
c. They should be allocated to other segments. If that causes a loss in another
segment, that segment should be eliminated as well.
d. Fixed costs are never relevant.
94. Diaz Company’s contribution margin is $4 per unit for Product A and $5 for Product B.
Product A requires 2 machine hours and Product B requires 4 machine hours. How much
is the contribution margin per unit of limited resource for each product?
A B
a. $4.00 $5.00
b. $2.00 $1.25
c. $1.25 $2.00
d. $2.50 $1.00
95. What non-financial factors should be considered when making a decision about buying
rather than making a component of a company’s product?
a. Is the quality of the purchased component acceptable?
b. Will the outside supplier increase prices significantly in the future?
c. Will the supplier deliver on time?
d. All of the above.
96. Litto Fray’s produces corn chips. The cost of one batch is below:
Direct labour 13.00
Fixed overhead 14.00
An outside supplier has offered to produce the corn chips for $26 per batch. How much
will Hungry Bites save if it accepts the offer?
a. $2.00 per batch
b. $17.00 per batch
c. $31.00 per batch
d. $6.00 per batch
97. When a company does not have sufficient capacity to fill an order for less than the current
selling price, what additional factor must be taken into consideration?

a. The decision process is the same whether there is sufficient capacity or not.
b. How will the lack of capacity affect the quality of the product.
c. Can resources be transferred from producing product to sell at the current price
to producing product at the special price?
d. Opportunity costs
98. Meow Cat Toys utilizes Lincoln Fabrics by purchasing the fabric to cover toy mice for its
mouse toy division. As it pertains to Lincoln Fabrics, what decision situation does this
create?
a. Make or buy
b. Sell or process further
c. Relevant costing
d. Budgeting
99. During 2011, it cost Westa, Inc. $12 per unit to produce Part T5. During 2012, it has
increased to $14 per unit. In 2011, Southside Company has offered to provide Part T5 for
$9 per unit to Westa. As it pertains to the make-or-buy decision, which statement is true?
a. Differential costs are $5 per unit.
b. Incremental costs are $3 per unit.
c. Net relevant costs are $3 per unit.
d. Incremental revenues are $2 per unit.
100. Serene Dairy has 4 product lines: sour cream, ice cream, yogurt, and butter. The total
costs of producing the milk base for the products is $53,000 which has been allocated
based on litres of milk base used by each product. Results of July follow:
Sour
Ice Cream Yogurt Butter Total
Cream
Units sold 1,700 750 500 5,000 7,950
Revenue $7,000 $15,000 $12,000 $25,000 $59,000
Variable departmental costs 4,000 10,000 7,000 12,000 33,0000
Fixed costs 4,500 1,000 2,000 6,000 13,500
Net income (loss) ($1,500) $4,000 $3,000 $7,000 $12,500
How much are total joint costs of the products?

a. $33,000
b. $13,500
c. $53,000
d. $12,500
101. EKP purchased a raw material in bulk for $10,000. It then spent an additional $500 to
package the product into smaller quantities which it can sell for $12,000. Recently, a
situation has arisen in which EKP can add an additional ingredient to the individual
packages and sell them for $14,000. The cost of adding the additional ingredient is
$1,700. Which amounts are relevant to the decision?
a. $10,000+$500, $12,000 and $14,000
b. $$10,000+$500, $1,700 and $14,000
c. $12,000, $1,700 and $14,000

d. $$10,000, $500, $12,000, $14,000 and $1,700
102. Namov Company has old inventory on hand that cost $12,000. Its scrap value is $16,000.
The inventory could be sold for $38,000 if manufactured further at an additional cost of
$12,000. What should Narst do?
a. Sell the inventory for $16,000 scrap value.
b. Dispose of the inventory to avoid any further decline in value.
c. Hold the inventory at its $12,000 cost.
d. Manufacture further and sell it for $38,000.
103. Which decision will involve no incremental revenues?

a. Make or buy decision
b. Drop a product line
c. Accept a special order
d. Additional processing decision
104. A factory is operating at less than 100% capacity. Potential additional business will not
use up the remainder of the plant capacity. Given the following list of costs, which one
should be ignored in a decision to produce additional units of product?
a. Variable selling expenses
b. Fixed factory overhead
c. Direct labour
d. Contribution margin of additional units
105 Market Makeup produces face cream. Each bottle of face cream costs $10 to produce and
can be sold for $13. The bottles can be sold as is, or processed further into sunscreen at a
cost of $14 each. Market Makeup could sell the sunscreen bottles for $23 each.
a. Face cream must be further processed because its profit is $9 each.
b. Face cream must not be further processed because costs increase more than
revenue.
c. Face cream must not be further processed because it decreases profit by $1
each.
d Face cream must be further processed because it increases profit by $3 each.
106. A company decided to replace an old machine with a new machine. Which of the following
is considered a relevant cost?
a. The book value of the old equipment
b. Depreciation expense on the old equipment
c. The loss on the disposal of the old equipment
d. The current disposal price of the old equipment
107. Chapman Company manufactures widgets. Embree Company has approached Chapman
with a proposal to sell the company widgets at a price of $60,000 for 100,000 units.
Chapman is currently making these components in its own factory. The following costs are
associated with this part of the process when 100,000 units are produced:
Direct material $23,000
Direct labour 22,000

Manufacturing overhead 30,000
Total $75,000
The manufacturing overhead consists of $12,000 of costs that will be eliminated if the
components are no longer produced by Chapman. From Chapman’s point of view, how
much is the incremental cost or savings if the widgets are bought instead of made?
a. $15,000 incremental savings
b. $3,000 incremental cost
c. $3,000 incremental savings
d. $15,000 incremental cost
108. Costs that are relevant for future decision making in a manufacturing environment include:
a. Only variable manufacturing costs.
b. Only fixed manufacturing costs.
c. All manufacturing costs.
d. Only future costs that impact on the alternatives presented.
109. When making a decision to accept a special order management must consider:
a. The impact that additional manufacturing time will have on unit costs of its current
products.
b. If the purchaser will accept additional high costs of a special order.
c. If a lower price will convince the purchaser to become a regular customer.
d. If capacity exists to meet the demand of the order.
110. Which of the following statements is true?

a. All variable costs are relevant costs.
b. Only those variable costs that differ between alternatives are relevant costs.
c. Fixed costs are never relevant costs.
d. All fixed costs are relevant costs as they impact on overall unit costs.
111. Excess capacity decisions for management involve:

a. Decreasing sales prices to stimulate demand.
b. Accepting special orders.
c. Outsourcing some products to specialist manufacturers.
d. Mixing production to reduce variable costs.
112. The main purpose of allocating joint costs to products is to:

a. Assist management in setting prices for its products.
b. Assist in the annual budgetary processes.
c. Assist in determining the cost of the products involved.
d. Assist in determining which products should be added or dropped.
113. When management has excess capacity available to it in the short run, which of the
following would be the best path to follow?
a. Consider ways to reduce its fixed costs
b. Consider accepting special orders
c. Consider outsourcing certain products
d. Consider mixing its product offerings in a new way
114. Costs that are common to two or more products are considered to be:
a. Joint costs.
b. Split-off costs.
c. Allocated costs.
d. Shared fixed costs.
115. Which of the following statements is true?

a. Common costs should be considered when deciding to drop a product line.
b. If a segment of a company has been losing money for several years, that
segment should be dropped.
c. If an unprofitable segment is dropped, the company’s net income will increase.
d. If an unprofitable segment is dropped, fixed costs will decrease.
116. The most important thing to consider when deciding to replace or keep equipment is:
a. Salvage value of the current equipment.
b. The estimated number of years remaining on the books.
c. The expected variable costs of the new equipment.
d. If book value is higher than replacement value.
117. Costs that are common to one or more products are called:
a. Split-off costs.
b. Sunk costs.
c. Joint costs.
d. Incremental costs.
ANSWERS TO MULTIPLE CHOICE QUESTIONS
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
33. d 46. a 59. d 72. a 85. b 98. a 111. b
34. b 47. c 60. d 73. b 86. b 99. a 112. c
35. b 48. c 61. a 74. c 87. a 100. c 113. b
36. c 49. a 62. d 75. a 88. b 101. c 114. a
37. d 50. d 63. c 76. a 89. a 102. d 115. a
38. d 51. d 64. b 77. a 90. c 103. a 116. c
39. c 52. b 65. b 78. c 91. a 104. b 117. c
40. b 53. d 66. c 79. a 92. c 105. b
41. a 54. c 67. a 80. b 93. b 106. d
42. a 55. d 68. b 81. a 94. b 107. b
43. a 56. b 69. d 82. d 95. d 108. d
44. d 57. a 70. b 83. c 96. b 109. d
45. b 58. d 71. c 84. d 97. d 110. b
BRIEF EXERCISES
Brief Exercise 118
Temple, Inc. produces several models of clocks. An outside supplier has offered to produce the
commercial clocks for Temple for $350 each. Temple needs 500 clocks annually. Temple has
provided the following unit costs for its commercial clocks:
Direct materials $ 70
Direct labour 80
Variable overhead 75
Fixed overhead (30% avoidable) 120
Prepare an incremental analysis which shows the effect of the make or buy decision.
Solution Brief Exercise 118

Incremental Analysis Incremental Effect
Cost to buy (500 x $350) ($175,000)
Cost savings:
Savings of DM $70 x 500 = $35,000
Savings of DL $80 x 500 = 40,000
Savings of VOH $75 x 500 = 37,500
Savings of FOH 30% x $120 x 500 = 18,000
Total cost savings +130,500
Net cost savings if commercial clock are bought $ 44,500
Brief Exercise 119

Calc, Inc. owns a machine that produces baskets for the gift packages the company sells. The
company uses 1,000 baskets in production each month. The costs of making one basket is $7 for
direct materials, $5 for variable manufacturing overhead, $4 for direct labour and $8 for fixed
manufacturing overhead. The unit cost is based on the monthly production of 1,000 baskets. The
company determined that 25% of the fixed manufacturing overhead is avoidable. An outside
supplier has offered to sell Calc the baskets for $15 each, and can supply all the units it needs.
Prepare an incremental analysis to determine if Calc should buy the component from the supplier.

Incremental cost to buy (1,000 x $15) ($15,000)
Incremental cost savings:
DM ($7 x 1,000) +7,000
VOH ($5 x 1,000) +5,000
DL ($4 x 1,000) +4,000
FOH ($8 x 25% x 1,000) +2,000
Total savings to buy ($3,000)
OR
Make Buy
Incremental cost to buy (1,000 x $15) $15,000
Incremental costs to make: DM ($7 x 1,000) $7,000
VOH ($5 x 1,000) 5,000
DL ($4 x 1,000) 4,000
FOH 8,000 6,000
Incremental cost to buy $24,000 $21,000
Brief Exercise 120

Signa Corporation currently manufactures 17,000 staplers annually for its main product. The
costs per stapler are as follows:
Direct labour 7.50
Fixed overhead 8.00
Total $21.00
Darsel Company has contacted Signa with an offer to sell it 17,000 staplers for $19.00 each. $6
of the fixed overhead per unit is unavoidable. Prepare an incremental analysis for the make or
buy decision.

Incremental cost to buy ($19.00 x 17,000 staplers) ($323,000)
Incremental savings on direct materials ($2.50 x 17,000) +42,500
Incremental savings on direct labour ($7.50 x 17,000) +127,500
Incremental savings on variable MOH ($3.00 x 17,000) +51,000
Incremental savings on fixed MOH ([$8.00 - $6.00] x 17,000) +34,000
Incremental net cost to buy ($68,000)
Brief Exercise 121

Parrino has three product lines in its retail stores: books, DVDs, and music. The allocated fixed
costs are based on revenue and are unavoidable. Results of the fourth quarter are presented
below:
Books Music DVDs Total
Units sold 750 1,000 1,200 2,950
Revenue $22,500 $15,000 $9,600 $47,100
Variable departmental costs 12,000 8,000 5,000 25,000
Direct fixed costs 4,000 3,000 4,500 11,500
Allocated fixed costs 4,777 3,185 2,038 10,000
Net income (loss) $ 1,723 $815 ($1,938) $600
Demand of individual products is not affected by changes in other product lines. Prepare an
incremental analysis of the effect of dropping the DVDs product line.

Incremental revenue ($9,600)
Incremental savings on variable costs +5,000
Incremental savings on direct fixed costs +4,500
Incremental cost/decrease in profit to drop video line ($100)
Brief Exercise 122

Crisp has 4 product lines: sour cream, ice cream, yogurt, and butter. The allocated fixed costs are
based on units sold and are unavoidable. Demand of individual products is not affected by
changes in other product lines. 40% of the fixed costs are direct, and the other 60% are allocated.
Results of June follow:
Sour Ice
Yogurt Butter Total
Cream Cream
Units sold 2,000 500 400 200 3,100
Revenue $10,000 $20,000 $10,000 $20,000 $60,000
Variable departmental costs 6,000 13,000 4,200 4,800 28,000
Fixed costs 5,000 2,000 3,000 7,000 17,000
Net income (loss) ($1,000) $5,000 $2,800 $8,200 $15,000
Prepare an incremental analysis of the effect of dropping the sour cream product line.

Incremental variable cost savings +6,000
Incremental fixed cost savings ($5,000 x .40) +2,000
Incremental decrease in profits if dropped ($2,000)
Brief Exercise 123

Sam Company makes 2 products, footballs and baseballs. Additional information follows:
Footballs Baseballs
Units 2,000 3,000
Sales $60,000 $25,000
Variable costs 24,000 13,750
Fixed costs 10,000 5,250
Net income $26,000 $6,000
Metres of leather per unit 1.25 0.25
Profit per unit $13.00 $2.00
Contribution margin per unit $18.00 $3.75
Assume that Sam is able to order an additional 2,000 metres of leather and wishes to maximize
its income. Of the additional units it produces, at least 300 of each product are necessary for
sales. How many units of each must be produced?

Footballs Baseballs
Contribution margin per metre $18/1.25 = $14.40 $3.75/.25 = $15
Produce more baseballs since CM per constraint is more.
Footballs Baseballs
Minimum: 300 x 1.25 metre. = 375 metre. 300 footballs
Yards remaining for baseballs:
2,000 - 375 = 1,625 metres .
# of baseballs: 1,625/.25 metre = 6,500 baseballs
Brief Exercise 124

Hernandez, Inc. manufactures 5 models of picture frames, for a total of 12,000 frames per year.
The unit cost to produce a metal frame follows:
Direct Materials $4
Direct Labour 5
Variable Overhead 1
Fixed Overhead (60% unavoidable) 6
Total $16
A local company has offered to supply Hernandez the 12,000 metal frames it needs for $12 each.
Create an incremental analysis for the make or buy decision.

Incremental cost to buy ($144,000)
Incremental savings:
Direct materials savings +$48,000
Direct labour savings +60,000
Variable overhead savings +12,000
Fixed overhead savings - avoidable portion +28,800
Incremental savings if 'buy' decision is made $4,800
Brief Exercise 125

Myrna’s Mowing Ltd. cuts lawns. It has a riding lawnmower with a book value of $5,000, and a
remaining useful life of 5 years. A new, more efficient lawnmower is available with a cost of
$15,000. The useful life of the new machine is also expected to be 5 years. Myrna estimates that
the new machine will allow her to cut more lawns, and therefore increase revenue from $20,000
per year to $22,000, and reduce variable costs from $12,000 per year to $10,500. Prepare an
analysis showing whether Myrna should retain the old mower, or buy new.

Retain Replace Net Income
Equipment Equipment Change
Revenue $100,000 $110,000 $10,000*
Variable manufacturing costs (60,000) (52,500) 7,500
New machine cost (15,000)
Net savings over 5 years $ 2,500
*For 5 years
Brief Exercise 126

Jamie has been accepted to a university in a city far from her home. She will need to rent an
apartment, and has two choices. The first choice cost $1,000 per month, and is within walking
distance of the university. The second apartment costs $925 per month, but Jamie will have to
buy a bus pass in order to get to the university. The pass costs $100 per month. Jamie has been
hired to work part time at a job that is a bus ride away from both apartments.
Identify which costs are relevant in the incremental analysis. What other factors should be
considered?

Since Jamie will have to buy a bus pass in both cases in order to get to her job, the $100 cost of
the pass is not relevant. Accordingly, the only relevant costs given are the rent. The second
apartment is $75 cheaper than the first, and therefore strictly from a cost perspective is the better
choice. Other factors that need to be considered are the amount of time spent commuting, and
how Jamie could use that time, and Jamie’s preference of which apartment she likes better.
Brief Exercise 127

Gladiator Company provided the following information concerning two products:
Contribution margin per unit – Product 12 $22
Contribution margin per unit – Product 43 $15
Machine hours required for one unit – Product 12 2.5 hours
Machine hours required for one unit – Product 43 1.5 hours
Calculate the contribution margin per unit of limited resource for each product. Which product
should Gladiator tell its sales personnel to ‘push’ to customers?

Product 12: $22/2.5 hours = $8.80
Product 43: $15/1.5 hours = $10
Sales personnel should push product 43.
Brief Exercise 128

McIntosh Enterprises produces giant stuffed bears. Each bear consists of $12 of variable costs
and $9 of fixed costs and sells for $45. A wholesaler offers to buy 8,000 units at $14 each, of
which McIntosh has the capacity to produce. McIntosh will incur extra shipping costs of $1.25 per
bear. Determine the incremental income or loss that McIntosh Enterprises would realize by
accepting the special order.

Incremental revenue (8,000 x $14) $112,000
Incremental variable costs ($12 x 8,000) (96,000)
Incremental shipping costs ($1.25 x 8,000) (10,000)
Incremental profit if special order accepted $6,000
Brief Exercise 129

Chuckie’s Chunks produces fudge candy. It costs $.0.20 to make each box in which the fudge is
packaged. Of this cost, $0.12 is variable and $0.08 is fixed. A supplier offers to make the boxes
for the fudge for $0.15 each. If the offer is accepted, Chuckie’s will save all variable costs but no
fixed costs. Chuckie’s uses 2,000 boxes per year. Prepare an incremental analysis showing the
total effect on costs if the boxes are bought instead of manufactured.

Incremental cost to buy (2,000 x $0.15) ($300)
Incremental variable costs (2,000 x $0.12) 240
Incremental cost of buying ($ 60)
Brief Exercise 130

Harmark has three product lines in its retail stores: kites, wind socks, and flags. Results of the
fourth quarter are presented below:
Kites Wind Socks Flags Total

Units sold 1,000 2,000 2,000 5,000
Revenue $22,000 $40,000 $23,000 $85,000

Net income (loss) ($2,000) $ 7,000 $ 1,000 $ 6,000
The allocated fixed costs are unavoidable. Demand of individual products is not affected by
changes in other product lines. What will happen to profits if Harmark discontinues the ‘Kites’
product line?

Incremental costs:
Variable costs savings +15,000
Direct fixed costs savings +1,000
Drop in profits if discontinued ($6,000)
Brief Exercise 131

Wood Chuck Furniture currently manufactures rocking chairs as its main product. Each chair
uses one seat cushion and one back cushion with the following costs per set of cushions (one
seat and one back):

Direct labour 10.00
Fixed overhead 8.00
Total $24.00
Sherpert Company has contacted Wood Chuck with an offer to sell it 5,000 of sets of cushions for
$18.00 each. If Wood Chuck makes the cushions, $5 of the fixed overhead per unit will be
allocated to other products. Should Wood Chuck make or buy the cushions?
Solution Exercise 131

Cost to make − costs to buy = incremental cost
($24 − $3) − $18 = $3 = incremental cost per set
Incremental cost to make = $3 x 5,000 units = $15,000
Wood Chuck should buy to save $3 per set.
Brief Exercise 132

Cluck Farms, Inc. produces a crop of chickens at a total cost of $66,000. The production
generates 60,000 chickens which can be sold for $1 each to a slaughtering company, or the
chickens can be slaughtered in house and then sold for $2.25 each. It costs $55,000 more to turn
the annual chicken crop into chicken meat. If Cluck Farms slaughters the chickens, how much is
incremental profit or loss? What should Cluck Farms do?

Incremental revenues: ($2.25 - $1.00) x 60,000 chickens = $75,000
Incremental costs: given as $55,000
Incremental profits: $75,000 - $55,000 = $20,000 profit
Cluck Farms should slaughter.

Brief Exercise 133

Dolls R Us sells three products in its retail stores: baby dolls, teenage dolls, and plush dolls.
Results of the 4th quarter are below:
Baby Dolls Teenage Plush Total

Units sold 1,000 2,000 2,000 5,000
Revenue $31,000 $43,000 $26,000 $100,000
Net income ($2,000) $ 8,000 $ 3,000 $ 9,000
Demand of individual products is not affected by changes in other product lines. Prepare an
incremental analysis to determine if baby dolls should be discontinued.

Incremental costs:
Variable costs savings +22,000
Direct fixed costs savings +5,000
Drop in profits if discontinued ($4,000)
Brief Exercise 134

The Compressed Air Company makes scuba tanks. The tanks have a regulator that requires the
company to make a special valve. The cost to make this valve is as follows:
Direct labour 3.25
Variable manufacturing overhead 2.10
Fixed manufacturing overhead 1.10
Unit product cost $13.95
The company makes 10,000 tanks every year. An outside supplier has offered to sell the
company the same valve at a cost of $12.50 per unit. By purchasing the valve the company will
eliminate half of its fixed manufacturing overhead.
Calculate the relevant costs the company should consider before making the decision to
purchase the valve from the outside supplier

$13.95 x ($1.10 x ½) = $13.40
(Only half of the fixed manufacturing overhead is avoided. Therefore all other costs are relevant)
Brief Exercise 135
Winslow Industries makes large waste storage bins and sells them for $150 each. The
manufacturing cost of each bin is as follows:
Direct material $50
Direct labour $40
Manufacturing overhead $20
The manufacturing overhead is 80% variable and 20% fixed. The company receives an order for
1,000 bins which will cost an additional $10 in shipping costs per bin. The company has sufficient
excess capacity to produce the order.
Required:
Calculate the minimum price that Winslow should charge for each bin.

Direct material $50
Direct labour 40
Manufacturing overhead ($20 x .8) 16
Shipping costs 10
Minimum selling price 116
EXERCISES
Exercise 136
Anheiser has three divisions: Bud, Wise, and Er. The results of May, 2012 are presented below:
Bud Wise Er Total

Units sold 5,000 7,000 4,000 16,000
Revenue $80,000 $60,000 $30,000 $170,000
Less variable costs 37,000 42,000 14,000 93,000
Less direct fixed costs 15,000 25,000 13,000 53,000
Less allocated fixed costs 3,125 4,375 2,500 10,000
Net income $24,875 ($11,375) $ 500 $14,000
All of the allocated costs will continue even if a division is discontinued. Anheiser allocates
indirect fixed costs based on the number of units to be sold. Since the Wise division has a net
loss, Anheiser feels that it should be discontinued. Anheiser feels if the division is closed, that
sales at the Bud division will increase by 30%, and that sales at the Er division will stay the
same.
Instructions
a. Prepare an analysis showing the effect of discontinuing the Wise division.
b. Should Anheiser close the Wise division? Briefly indicate why or why not.
Solution Exercise 136 (10–12 min.)

a.
Bud Er Total
Revenue $104,000 $30,000 $134,000
Less variable costs 48,100 14,000 62,100
Less direct fixed costs 15,000 13,000 28,000
Less allocated fixed costs 15,400 9,500 25,000
Net income $25,400 $ (6,500) $18,900
Calculations:
Units = 5,000 x 130% = 6,500
Revenue = $80,000 x 130% = $104,000
Variable costs = $37,000 x 130% = $48,100
Allocation of total allocated fixed costs of $25,000:
To Bud: 6,500/(6,500 + 4,000) x $25,000 = $15,500
To Er: 4,000/(6,500 + 4,000) x $25,000 = $9,500
b. Yes. The profit increases by $4,900 ($18,900 - $14,000) when the division is eliminated.
Direct fixed costs and variable costs for the Wise division were relatively high compared to
those for the Bud and Er divisions. The increase in sales by 30% of the Bud division was
enough to offset the loss of the Wise division.
Exercise 137
Beyonce Company sells two items, peanuts and soybeans. The company is considering dropping
soybeans. It is expected that sales of peanuts will increase by 30% as a result. Dropping
soybeans will allow the company to cancel its monthly rental of its bean shucker costing $50 a
month. The other existing equipment will be used for additional production of peanuts. One
employee earning $2,000 per month can be terminated if soybean production is dropped.
Beyonce’s other fixed costs are allocated and will continue regardless of the decision made. A
condensed, budgeted monthly income statement with both products is below:
Total Soybeans Peanuts

Sales $40,000 $10,000 $30,000
Food materials 14,000 4,000 10,000
Direct labour 12,000 3,000 9,000
Equipment rental 1,600 700 900
Other allocated overhead 2,950 2,000 950
Operating income $9,450 $ 300 $9,150
Instructions
Prepare an incremental analysis to determine the financial effect of dropping soybean production.

Beyonce Company
Incremental Analysis
Incremental change in revenue:
Increase in peanut sales: $30,000 x 30% +$9,000
Decrease in soybean sales (10,000)
Incremental decrease in revenue ($1,000)
Incremental change in variable costs:

Food materials: Increase in peanut costs: $10,000 x 30% (3,000)
Decrease in soybean costs +4,000
Direct labour: Increase in peanut labour: $9,000 x 30% (2,700)
Decrease in soybean labour +3,000
Incremental decrease in variable costs +1,300
Equipment rental reduction - soybean shucker +50
Incremental increase in profits if soybean production is dropped
($350)
Exercise 138
Turner, Inc. budgeted 10,000 widgets for production during 2012. Turner has capacity to produce
15,000 units. Fixed factory overhead is allocated using ABC. The following estimated costs were
provided:
Direct material ($8/unit) $ 80,000
Direct labour ($20/hr. x 3 hrs./unit) 600,000
Variable manufacturing overhead ($5/unit) 50,000
Fixed factory overhead costs ($2/unit) 20,000
Total $750,000
Cost per unit = $75.00
Instructions
Answer each of the following independent questions:
a. Turner received an order for 3,000 units from a new customer in a country in which Turner
has never done business. This customer has offered $73.50 per widget. Should Turner
accept the order?
b. Turner received an offer from another company to manufacture the same quality widgets for
$72.50. Should Turner let someone else manufacture all 10,000 widgets and focus only on
distribution?

a. Yes, it can make $1,500.
Incremental revenue per widget $73.50

Incremental cost per widget:
$8 + ($20 x 3) + $5 = 73.00
Incremental profit per unit $ 0.50
Total incremental profit = $0.50 x 3,000 = $1,500
b. Yes, Turner will save $5,000 if they are bought instead of made.
Cost to buy per widget $72.50

Cost to make per widget:
$8 + ($20 x 3) + $5 = 73.00
Incremental savings per widget if purchased $ 0.50
Total incremental savings if purchased = $0.50 x 10,000 = $5,000
Exercise 139
Paulsen Company produced and sold 7,000 units of product and is operating at 70% of plant
capacity. Unit information about its product is as follows:
Sales Price $40

Variable manufacturing cost $25
Fixed manufacturing cost ($35,000 ÷ 7,000) 5 30
Profit per unit $10
The company received a proposal from a foreign company to buy 500 units of Paulsen
Company's product for $28 per unit. This is a one-time only order and acceptance of this proposal
will not affect the company's regular sales. The president of Paulsen Company is reluctant to
accept the proposal because he is concerned that the company will lose money on the special
order. All fixed costs are allocated to individual products.
Instructions
Prepare a schedule reflecting an incremental analysis of this proposal. Indicate the effect the
acceptance of this order might have on the company's income.

Paulsen Company
Incremental Analysis
Proposal to buy 500 units at $28
Net Income
Reject Order Accept Order Increase (Decrease)
Revenues (500 × $28) $ -0- $ 14,000 $14,000
Variable costs (500 × $25) -0- (12,500) (12,500)
Net Income $ 1,500
Paulsen Company would increase its income by $1,500 in accepting the special order.
Exercise 140
Smooth Brew manufactures cappuccino makers. For the first eight months of 2012, the company
reported the following operating results while operating at 80% of plant capacity:
Sales (120,000 units) $6,000,000

Cost of goods sold 3,600,000
Gross profit 2,400,000
Operating expenses 1,800,000
Net income $ 600,000
An analysis of costs and expenses reveals that variable cost of goods sold is $25 per unit and
variable operating expenses are $10 per unit.
In September, Smooth Brew received a special order for 5,000 machines at $40 each from a
major coffee shop franchise. Acceptance of the order would result in $2,000 of shipping costs but
no increase in fixed expenses.
Instructions
a. Prepare an incremental analysis for the special order.
b. Should Smooth Brew accept the special order? Justify your answer.

a. Net Income
Revenues $ -0- $200,000 $200,000
Cost of Goods Sold -0- 125,000* (125,000)
Operating Expense -0- 52,000** (52,000)
Net Income $ -0- $ 23,000 $ 23,000
*Variable cost of goods sold = 5,000 × $25 = $125,000

**Variable operating expenses = 5,000 × $10 = $50,000 + $2,000 = $52,000
b. The incremental analysis shows that Smooth Brew should accept the special order because
incremental revenues exceed incremental costs. This recommendation assumes that
acceptance of the special order will not affect relations with existing customers.
Exercise 141
Vincent Company supplies schools with floor mattresses to use in physical education classes.
Vincent has received a special order from a large school district to buy 500 mats at $40 each.
Acceptance of the special order will not affect fixed costs but will result in $800 of shipping costs.
For the first 6 months of 2012, the company reported the following operating results while
operating at 80% capacity:
Sales (25,000 units) $1,250,000
Cost of goods sold 980,000
Gross profit 270,000
Operating expenses 170,000
Net income $ 100,000
Cost of goods sold was 80% variable and 20% fixed; operating expenses were 70% variable and
30% fixed.
Instructions
a. Prepare an incremental analysis for the special order.
b. Should Vincent Company accept the special order? Justify your answer.

a. Net Income
Revenues $ -0- $20,000 $20,000
Cost of Goods Sold -0- 15,680 (15,680)
Operating Expense -0- 3,180 (3,180)
Net Income $ -0- $ 1,140 $1,140
Variable cost of goods sold = $980,000 × 80% = $784,000

Variable cost of goods sold per unit = $784,000 ÷ 25,000 = $31.36
Variable cost of goods sold for the special order = 500 × $31.36 = $15,680
Variable operating expenses = $170,000 × 70% = $119,000

Variable operating expenses per unit = $119,000 ÷ 25,000 = $4.76
Variable operating expenses for the special order = 500 × $4.76 = $2,380 + $800 = $3,180
b. The incremental analysis shows Vincent Company should accept the special order because
incremental revenues exceed incremental costs.
Exercise 142
Johnson Motors manufactured 500 gears that are used in its motors and incurred the following
costs:
Direct materials $50,000

Direct labour 19,000
Variable manufacturing overhead 30,000
Fixed manufacturing overhead 20,000
$119,000
A supplier has offered to sell the gears to Johnson for $200 each. The fixed manufacturing
overhead consists mainly of depreciation on the equipment used to manufacture the part and
would not be reduced if the gears were purchased from the outside firm. If the gears are
purchased from the supplier, Johnson has the opportunity to use the factory equipment to
produce another product which is estimated to have a contribution margin of $3,000.
Instructions
Prepare an incremental analysis report for Johnson Motors which can serve as informational
input into this make or buy decision.

Make Buy Increase (Decrease)
Direct materials $ 50,000 $ -0- $ 50,000
Direct labour 19,000 -0- 19,000
Variable manufacturing overhead 30,000 -0- 30,000
Fixed manufacturing overhead 20,000 20,000 -0-

Purchase price (500 × $200) -0- 100,000 (100,000)
Total annual cost 119,000 120,000 (1,000)
Opportunity cost 3,000 -0- 3,000
Total cost $122,000 $120,000 $ 2,000
Income is expected to increase by $2,000 if the component part is purchased from the outside
supplier if the company also manufactured its new product.
Exercise 143
Escher Skateboards has been manufacturing its own wheels for its skateboards. The company is
currently operating at 100% capacity, and variable manufacturing overhead is charged to
production at the rate of 30% of direct labour cost. The direct materials and direct labour cost per
unit to make the wheels are $1.50 and $1.80, respectively. Normal production is 200,000 wheels
per year.
A supplier offers to make the wheels at a price of $4 each. If the skateboard company accepts
this offer, all variable manufacturing costs will be eliminated, but the $42,000 of fixed
manufacturing overhead currently being charged to the skateboard wheels will have to be
absorbed by other products.
Instructions
a. Prepare the incremental analysis for the decision to make or buy the wheels.
b. Should Escher Skateboard buy the wheels from the outside supplier? Justify your answer.

a. Net Income
Make Buy Increase (Decrease)
Direct Materials (200,000 × $1.50) $300,000 $ -0- $300,000
Direct Labour (200,000 × $1.80) 360,000 -0- 360,000
Variable Manufacturing Costs
($360,000 × 30%) 108,000 -0- 108,000
Purchase Price (200,000 × $4) -0- 800,000 (800,000)
Total annual cost $768,000 $800,000 ($ 32,000)
b. The wheels should continue to be manufactured by Escher Skateboard. As indicated, the

company's net income would decrease $32,000 by purchasing the wheels.
Exercise 144
Jackson Chemical Corporation produces a water-based pest control chemical which it sells to
pest control companies to manufacture as a pesticide. In 2012, the company incurred $140,000
of costs to produce 14,000 kilograms of the chemical. The selling price of the chemical is $21.00
per kilogram. The costs per unit to manufacture a kilogram of the chemical are presented below:

Direct labour 3.00
Variable manufacturing overhead 2.00
Fixed manufacturing overhead 1.50
Total manufacturing costs $10.00
The company is considering manufacturing the pesticide itself. If the company processes the
chemical further and manufactures the pesticide itself, the following additional costs per kilogram
will be incurred: Direct materials $1.00, Direct labour $.25, Variable manufacturing overhead,
$1.00. No increase in fixed manufacturing overhead is expected. The company can sell the
pesticide at $25.00 per kilogram.
Instructions
Determine the incremental per kilogram increase in net income and the total increase in net
income if the company manufactures the pesticide.

Net Income
Sell Chemical Process Further Increase (Decrease)
Sales price per unit $21.00 $25.00 $4.00
Cost per unit:
Direct materials a. 3.50 4.50 (1.00)
Direct labour b. 3.00 3.25 (.25)
Variable manufacturing overhead c. 2.00 3.00 (1.00)
Fixed manufacturing overhead 1.50 1.50 —
Total 10.00 12.25 (2.25)
Net income per unit $11.00 $12.75 $ 1.75
a. $3.50 + $1.00
b. $3.00 + $0.25
c. $2.00 + $1.00
Assuming the company sells all 14,000 kilograms that it produces, the incremental net income
would be $24,500 (14,000 kilograms × $1.75).
Exercise 145
Evett Corporation uses a machine that winds twine onto spools. The machine is unreliable and
results in a significant amount of downtime and excessive labour costs. The management is
considering replacing the machine with a more efficient one which will minimize downtime and
excessive labour costs. Data are presented below for the two machines:
Old Machine New Machine

Original purchase cost $160,000 $240,000
Accumulated depreciation 120,000 —
Estimated life 4 years 4 years
It is estimated that the new machine will produce annual cost savings of $55,000. The old
machine can be sold to a scrap dealer for $24,000. Both machines will have a salvage value of
zero if operated for the remainder of their useful lives.
Instructions
Determine whether the company should purchase the new machine.

Keep Replace Net Income
Equipment Equipment Increase/(Decrease)
Cost savings $ -0- $220,000 1. $220,000
New machine cost -0- (240,000) (240,000)
Proceeds from sale of old machine $ -0- 24,000 24,000
Net incremental net income $ -0- $ 4,000 $ 4,000

1. $55,000 × 4 = $220,000
The company should purchase the new machine because there will be an increase in net income
of $4,000 over the 4 year life of the new machine.
Exercise 146
Doey, Cheatem and Howe, Attorneys, rely heavily on a colour laser printer to process the
paperwork. Recently the printer has not functioned well and print jobs were not being processed.
Management is considering updating the printer with a faster model.
Current Printer New Model

Original purchase cost $30,000 $24,000
Accumulated depreciation 17,000 —
Estimated operating costs (annual) 3,000 2,000
Useful life 4 years 4 years
If sold now, the current printer would have a salvage value of $4,000. If operated for the
remainder of its useful life, the current printer would have zero salvage value. The new printer is
expected to have zero salvage value after four years.
Instructions
Prepare an analysis to show whether the company should retain or replace the printer.

Net Income
Retain Machine Replace Machine Increase (Decrease)
Operating costs $12,000 $ 8,000 $4,000
New machine cost -0- 24,000 (24,000)
Salvage value -0- (4,000) 4,000
Totals $12,000 $28,000 ($16,000)
The current printer should not be replaced. The incremental analysis shows that net income for
the four-year period will be $16,000 higher by replacing.
Exercise 147
Herman Corporation operates two divisions, the A Division and the B Division. Both divisions
manufacture and sell logs to paper manufacturers. The company is considering disposing of the
B Division since it has been consistently unprofitable for a number of years. The income
statements for the two divisions for the year ended December 31, 2012 are presented below:
A Division B Division Total

Sales $400,000 $300,000 $700,000
Cost of goods sold 150,000 200,000 350,000
Gross profit 250,000 100,000 350,000
Selling & administrative expenses 200,000 120,000 320,000
Net income $ 50,000 $(20,000) $ 30,000
In the B Division, 80% of cost of goods sold is variable costs and 20% of selling and
administrative expenses are variable costs. The management of the company feels it can save
$30,000 of fixed cost of goods sold and $30,000 of fixed selling expenses if it discontinues
operation of the B Division.
Instructions
a. Determine whether the company should discontinue operating the B Division.
b. If the company had discontinued the division for 2012, determine what net income would
have been reported.

a. Net Income
Continue Eliminate Increase (Decrease)
Sales $300,000 $ -0- $(300,000)
Variable expenses:
Cost of goods sold 160,000 (A) -0- 160,000
Selling and admin. exp. 24,000 (B) -0- 24,000
Contribution margin 116,000 -0- (116,000)
Fixed expenses:
Cost of goods sold 40,000 (C) 10,000 30,000
Selling and admin. exp. 96,000 (D) 66,000 30,000
Net income $ (20,000) $(76,000) $ (56,000)
(A) $200,000 × 80% = $160,000 (C) $200,000 – $160,000 = $40,000

(B) $120,000 × 20% = $24,000 (D) $120,000 – $24,000 = $96,000
The company should continue the B Division because its contribution margin, $116,000, is
greater than the avoidable fixed costs, $60,000.
b. A Division + Decrease in Net Income

$50,000 + $(56,000) = ($6,000)
Exercise 148
A recent accounting graduate from Lethbridge University evaluated the operating performance of
Fane Company's three divisions. The following presentation was made to Fane’s Board of
Directors. During the presentation, the accountant made the recommendation to eliminate the
Southern Division stating that total net income would increase by $20,000, as shown in the
analysis below.
Other Two Divisions Southern Division Total

Sales $1,000,000 $300,000 $1,300,000
Cost of Goods Sold 650,000 200,000 850,000
Gross Profit 350,000 100,000 450,000
Operating Expenses 100,000 120,000 220,000
Net Income $ 250,000 $ (20,000) $ 230,000
Cost of goods sold is 80% variable and operating expenses are 70% variable. If the division is
eliminated, 40% of the fixed costs will be eliminated.
Instructions
Do you concur with the new accountant's recommendation? Present a schedule to support your
answer.

Net Income
Continue Eliminate Increase (Decrease)
Sales $300,000 $ -0- $(300,000)
Variable Expenses
Cost of goods sold 160,000 -0- 160,000
Operating expenses 84,000 -0- 84,000
Total Variable 244,000 -0- 244,000
Contribution Margin 56,000 -0- (56,000)
Fixed Expenses
Cost of goods sold 40,000 24,000 16,000
Operating expenses 36,000 21,600 14,400
Net Income (Loss) $(20,000) $(45,600) $(25,600)
The accountant is not correct. If the Southern Division is eliminated, the net income will be
$25,600 less, not $20,000 greater.
Exercise 149
Movie House has 4,000 machine hours available to use to produce either Product 22 or Product
44. The cost accounting department developed the following unit information for each of the
products:
Product 22 Product 44
Sales price $20.00 $40.00
Direct materials 5.00 8.00
Direct labour 3.00 2.00
Variable manufacturing overhead 4.50 5.00
Fixed manufacturing overhead 3.00 5.00
Machine time required 15 minutes 75 minutes
Instructions
Management wants to know which product to produce in order to maximize the company's
income. Taking into consideration the constraint under which the company operates, prepare a
report to show which product should be produced and sold.

Contribution Margin per Unit Limited Resource
Contribution margin per unit: Product 22 Product 44
Sales price $20.00 $40.00
Variable costs
Direct material $5.00 $8.00
Direct labour 3.00 2.00
Variable overhead 4.50 12.50 5.00 15.00
Contribution margin $ 7.50 $25.00
Machine hours required: 1/4 hr 1 1/4 hrs
Contribution margin per unit of limited resource

($7.50 ÷ .25) $ 30.00
($25 ÷ 1.25) $ 20.00
Machine hours available 4,000 4,000
Contribution margin $120,000 $80,000
The company should produce and sell Product 22.

Exercise 150
PHR Company manufactures and sells two products. Relevant per unit data concerning each
product are given below:
Product
Standard Deluxe
Selling price $50 $75
Variable costs $30 $30
Machine hours 1.6 3
Instructions
a. Calculate the contribution margin per unit of the limited resource for each product.
b. If 1,200 additional machine hours are available, which product should be manufactured?

a. Product
Standard Deluxe
Contribution margin per unit $20 $45
Machine hours required 1.6 3
Contribution margin per unit of limited resource $12.50 $15.00
b. The Deluxe product should be manufactured because it results in the highest contribution
margin per machine hour: $15.00 x 1,200 = $18,000
Exercise 151
What are some qualitative considerations with accepting a special order with a new supplier?

a. Managers need to consider whether it would be likely to generate repeat orders from this
special order customer.
b. Is it possible to increase the selling price on repeat orders, or subsequent special orders
from different customers?
c. Is it possible to reduce variable costs by increasing volume by taking on special orders?
d. Would the repeat business from this special order customer be reliable, and worth doing this
special order right now?
e. What would be the reaction of regular customers if they found out the cost structure for this
special order?
Exercise 152
Explain how, and why, depreciation should be handled in incremental analysis. Hint – use the
term, “sunk cost” in your answer.

Depreciation is a systematic method of matching the cost of a long-lived asset with the revenue it
generates. Though the depreciation expense will be recorded in future periods, the actual cost of
the asset occurred in the past. Accordingly, it is a sunk cost and therefore not relevant. Another
way to look at it, if the equipment is retained, the book value of the equipment will be reduced to
zero via depreciation cost incurred over the remaining life of the asset. If the equipment is
eliminated, the book value will be written off immediately. Accordingly, both options will expense
the book value of the asset. If the cost is the same between two options, the cost is not relevant.
Exercise 153
A group of your friends have invited you to join them on a mini road trip. They are planning to rent
a van and drive to Toronto where they will stay at a hotel for the weekend. Another friend who
moved to Montreal recently has invited you to visit at his home for the weekend.
What financial and non-financial factors should you consider in your decision to choose between
the two options.

Financial:
a. Transportation costs to Toronto vs. Montreal
b. Cost of the hotel in Toronto
c. Cost of meals in Toronto vs. Montreal
d. Cost of entertainment in Toronto vs. Montreal
e. Cost of a “thank-you gift” for your host in Montreal
Non-financial:
a. Which option are you apt to enjoy more?
b. Would you offend someone if you do not accept their offer?
Exercise 154
Barnstorming Company flies vintage aircraft at air shows and has a fleet of three airplanes. One
of the airplanes cost $250,000 to purchase ten years ago and now has a book value of $75,000.
The company is considering replacing this airplane with a different type which will cost $350,000.
The current airplane could be sold for $50,000.
If the company buys the new airplane, it is expected that fuel costs will decrease from $80,000
annually to $45,000 annually and maintenance costs will decrease from $70,000 to $30,000.
Both the current airplane and the new airplane will have a service life of ten years. At that time,
both airplanes would have to be scrapped with no recovery value.
Instructions:
Calculate whether the company should purchase the new airplane or not.
Keep Buy New Net Income

Airplane Airplane Increase (Decrease)
Variable operating costs (1) $1,500,000 $750,000 $750,000
New airplane cost (2) 300,000 (300,000)
Net impact $450,000
(1) Keep: 10 years x $150,000 New 10 years x $75,000

(2) $350,000 - $50,000 = $300,000
All other things being equal, the company should purchase the new airplane as it will result in
$450,000 additional income over the life of the airplane.
Note that the book value of the current airplane is irrelevant in this decision.
Exercise 155 (6–8 min.)

Bonzai Company grows and sells Bonzai trees. It also makes the pot that holds the trees at a
cost of $10 per pot. This cost includes $3 of fixed overhead. The company makes 10,000 trees
each year.
Potsdam Industries approaches Bonzai and offers to sell it pots for only $9.
Instructions:
Calculate the impact that purchasing the pots from Potsdam would have on Bonzai’s Net Income.

Cost from Potsdam $9
Costs avoided at Bonzai ($10 - $3) $7
Unit savings (additional cost) ($2)
Impact on Net Income 10,000 x $2 = $20,000 decrease

COMPLETION STATEMENTS
156. The process used to identify the financial data that change under alternative courses of
action is called __________________ analysis.
157. In a decision on whether an order should be accepted at a special price when there is
plant capacity available, a major consideration is whether the special price exceeds
__________________.
158. The potential benefit that may be obtained by following an alternative course of action is
called an _________________ cost.
159. A decision whether to sell a product now or to process it further, depends on whether the
incremental _____________ from processing further are greater than the incremental
processing ______________.
160. The ______________ value of old equipment is irrelevant in a decision to replace that
equipment and is often referred to as a _____________ cost.
161. In an environment where there are limited resources, the products with the highest
contribution per unit of ______________ should identify the products to be produced.
162. An important purpose of management accounting is to provide _____________________

for decision making.
ANSWERS TO COMPLETION STATEMENTS

156. incremental (differential)
157. variable costs (incremental costs)
158. opportunity
159. revenues, costs
160. book, sunk
161. limited resource
162. relevant information

MATCHING
163. Match the items below by entering the appropriate code letter in the space provided.
A. Incremental analysis
B. Opportunity cost
C. Sunk cost
____ a. A cost that cannot be changed by any present or future decision.
____ b. The process of identifying the financial data that change under alternative courses of
action.
____ c. The potential benefit that may be lost from following an alternative course of action.
ANSWERS TO MATCHING
a. C
b. A
c. B
SHORT-ANSWER ESSAY QUESTIONS
Short Answer Essay 164

Management is often faced with the alternative of continuing to make a product or component
internally, or going to an external source and purchasing the product or component. In gathering
relevant information for these two alternatives, briefly identify the quantitative factors that should
be considered. Are there any qualitative factors that should also be considered?
Solution Short Answer Essay 164

The quantitative factors to be considered in a make or buy decision include the incremental costs
to make the product, the incremental costs of buying the product, and the opportunity cost
(potential benefit foregone) if the product is made. Generally, all variable production costs are
relevant in a make or buy decision, but only some fixed costs, or no fixed costs, are relevant
because many fixed costs will be incurred regardless of whether the decision is to make or buy.
Qualitative factors include the possible adverse effect on employees and the stability of the
supplier's price and quality.
Short Answer Essay 165 (Communication)

You are the general accountant for Word Systems, Inc., a typing service based in Winnipeg,
Manitoba. The company has decided to upgrade its equipment. It currently has a widely used
version of a word processing program. The company wishes to invest in more up-to-date software
and to improve its printing capabilities.
Two options have emerged. Option D is for the company to keep its existing computer system,
and upgrade its word processing program. The memory of each individual work station would be
enhanced, and a larger, more efficient printer would be used. Better telecommunications
equipment would allow for the electronic transmission of some documents as well.
Option Z would be for the company to invest in an entirely different computer system. The
software for this system is extremely impressive, and it comes with individual laser printers.
However, the company is not well known, and the software does not connect well with well-known
software. The net present value information for these options follows:
Option Z Option D
Initial Investment $95,000 $270,000
Cost savings of labour over 4 years 89,000 284,000
Instructions:
Prepare a brief report for management in which you make a recommendation for one system or
the other, using the information given.
Solution Short Answer Essay 165

I recommend that the company accept Option D, to purchase upgrades to our present system
and to buy a more efficient printer. In the first place, the changes will be easier to implement
because the equipment is similar to that which we already use. Second, the costs savings exceed
those of Option Z.
MULTI PART QUESTION
Multi-Part Question 166

Chocolate Delight Company (CDC) makes specialty chocolates and can produce 40 pieces per
hour. The firm estimates that the variable cost of producing chocolate is $0.35 per piece and
each piece sells for $0.60.
Smiles For All (SFA) is a large greeting card company and it has asked CDC to produce a special
flat chocolate greeting card for them and will pay $2.50 for each chocolate card. The cost to
manufacture the new card will be $1.80 each. If this order is accepted, CDC will have to buy a
new machine at a cost of $12,000. The new machine will be able to produce 20 cards per hour.
SFA offers to buy 70,000 cards. CDC has a capacity of 10,000 machine hours available and
fixed costs of $400,000 for its regular production activity.
Instructions:
a. Assume the demand for its own chocolates is 250,000 pieces. SFA says that the chocolate
card order has to be produced in total or not at all. Should CDC accept the special order?
b. Assume the demand for its own chocolates is 300,000 pieces. SFA says that the chocolate
card order has to be produced in total or not at all. Should CDC accept the special order?
Are there any other considerations that CDC should keep in mind?
c. Assume the demand for its own chocolates is 275,000 pieces and CDC can decide to accept
any quantity of the chocolate card order. Determine the mix of chocolates and cards that it
should produce.
Solution Multi Part Question 166

a. Hours required by special order: 70,000 ÷ 20 = 3,500
Hours required by regular sales: 250,000 ÷40 = 6,250
There is sufficient capacity to produce both regular chocolates and the special order
Incremental operating income of special order

CM: 70,000 x ($2.50 – $1.80) = $49,000
Cost of new machine (12,000)
Incremental income $37,000
The company should accept this new order
b. Hours required by special order = 70,000 ÷ 20 = 3,500

Hours required by regular sales = 300,000 ÷ 40 = 7,500
Regular sales lost are 1,000 x 40 = 40,000 chocolate pieces (10,000 hrs – (3,500 + 7,500) )

Incremental operating income of special order $37,000
Less CM lost on regular sales (40,000 x $0.60 - $0.35) (10,000)
Incremental income of accepting the special order $27,000
The company should accept this new order only if it can recover its lost sales of 40,000 chocolate
pieces in the future.
c. Attempt to maximize production of the products that generates the highest CM per machine
hour:
Pieces Cards
CM per unit $0.25 $0.70
Machine hours per unit 0.004 0.016

CM per machine hour $62.50 $43.75
Maximize sales of both products: make 300,000 pieces + 20,000 cards (1,000 x 20 cards per
hour)

CM: 20,000 x ($2.50 – $1.80) = $14,000
Cost of new machine (12,000)
Incremental income $2,000
Legal Notice
Copyright © 2011 by John Wiley & Sons Canada, Ltd. or related companies. All rights
reserved.
The data contained in these files are protected by copyright. This manual is furnished
under licence and may be used only in accordance with the terms of such licence.
The material provided herein may not be downloaded, reproduced, stored in a retrieval
system, modified, made available on a network, used to create derivative works, or
transmitted in any form or by any means, electronic, mechanical, photocopying,
recording, scanning, or otherwise without the prior written permission of John Wiley &
Sons Canada, Ltd.

Incremental Analysis

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Incremental Analysis

Uploaded by

Copyright:

Available Formats

CHAPTER 7

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Note: TF = True-False BE = Brief Exercise C = Completion SAE = Short Answer Essay

CHAPTER STUDY OBJECTIVES

1. Identify the steps in management's decision-making process. Management's

2. Describe the concept of incremental analysis. Incremental analysis is the process

4. Identify the relevant costs in a make-or-buy decision. In a make-or-buy decision, the

5. Identify the relevant costs in determining whether to sell or process materials

7. Identify the relevant costs in deciding whether to eliminate an unprofitable

1. Incremental analysis identifies the probable effects of management decisions on future

2. In making decisions, management considers only financial information because

4. Incremental analysis is also known as differential analysis.

17. Equipment which is not fully depreciated should always be replaced.

22. One incremental analysis decision is the allocation of limited resources.

26. In deciding on the future status of an unprofitable segment, management should

29. If an unprofitable product is eliminated, fixed expenses allocated to the eliminated

30. Incremental costs are always relevant.

32. The book value of old equipment is an opportunity cost.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

39. North Division has the following information:

c. Process further, the company will save $1 per unit.

45. Which steps do accountants mostly contribute to in the decision-making process?

48. Which of the following statements about making decisions is correct?

52. Which of the following describes one aspect of incremental analysis?

53. Which of the following statements about incremental analysis is true?

54. What is a sunk cost?

57. For which of the following is incremental analysis appropriate?

59. Specik, Inc. is considering the following alternatives:

61. Which statement is true about relevant costs in incremental analysis?

66. Which statement is true of an opportunity cost?

a. It is the cost of a special order option.

67. In which situations should opportunity costs be considered?

68. What is the nature of an opportunity cost?

Use the following information for questions 70–71.

Use the following information for questions 72–73.

d. Sell now, the company will be better off by $10,000.

78. What is the nature of a sell or process further decision?

81. What is the salvage value of old equipment considered to be?

86. Halliburton Division has the following data:

selling price, what additional factor must be taken into consideration?

How much are total joint costs of the products?

c. $12,000, $1,700 and $14,000

103. Which decision will involve no incremental revenues?

Direct labour 22,000

110. Which of the following statements is true?

111. Excess capacity decisions for management involve:

112. The main purpose of allocating joint costs to products is to:

d. Consider mixing its product offerings in a new way

115. Which of the following statements is true?

ANSWERS TO MULTIPLE CHOICE QUESTIONS

Solution Brief Exercise 118

Brief Exercise 119

Solution Brief Exercise 119

Brief Exercise 120

Solution Brief Exercise 120

Brief Exercise 121

Solution Brief Exercise 121

Brief Exercise 122

Solution Brief Exercise 122

Brief Exercise 123

Solution Brief Exercise 123

Produce more baseballs since CM per constraint is more.

Brief Exercise 124