ACCT 130 – Principles of Management Accounting

Fall 2023, S5 & S6

Practice Sheet 11 – Chapter 13 Differential Analysis

MCQs:
1. Marley Company makes three products (X, Y, & Z) with the following characteristics:
Product
X Y Z
Selling price per unit ..................... $10 $15 $20
Variable cost per unit .................... $6 $10 $10
Machine hours per unit .................. 2 4 10
The company has a capacity of 2,000 machine hours, but there is virtually unlimited demand for
each product. In order to maximize total contribution margin, how many units of each product
should the company produce?
A) 2,000 units of X, 500 units of Y, and 200 units of Z
B) 0 units of X, 0 units of Y, and 200 units of Z
C) 0 units of X, 500 units of Y, and 0 units of Z
D) 1,000 units of X, 0 units of Y, and 0 units of Z

2. Moyer Corporation is a specialty component manufacturer with idle capacity.

Management would like to use its extra capacity to generate additional profits. A
potential customer has offered to buy 2,300 units of component TIB. Each unit of TIB
requires 9 units of material F58 and 7 units of material D66. Data concerning these
two materials follow:
Material Units in Original Cost Per Current Market Disposal Value Per
Stock Unit Price Per Unit Unit
F58 18,940 $4.40 $4.65 $4.35
D66 15,700 $6.10 $6.50 $4.80

Material F58 is in use in many of the company's products and is routinely replenished.
Material D66 is no longer used by the company in any of its normal products and existing
stocks would not be replenished once they are used up.

What would be the relevant cost of the materials, in total, for purposes of determining
a minimum acceptable price for the order for product TIB?
A) $189,890
B) $174,215
C) $168,533
D) $200,905

Material F58:
Quantity needed = 2,300*9 = 20,700
Cost = 20,700 * $4.65 = $96,255

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Material D66:
Quantity needed = 2,300*7 = 16,100
Cost = 15,700 * $4.8 + (16,100 – 15,700) * $6.5 = $77,960

3. Teich Inc. is considering whether to continue to make a component or to buy it from an

outside supplier. The company uses 15,000 of the components each year. The unit
product cost of the component according to the company's absorption cost accounting
system is given as follows:

Direct materials ......................................... $ 7.90

Direct labor ................................................ 2.10
Variable manufacturing overhead ............. 1.10
Fixed manufacturing overhead .................. 4.00
Unit product cost ....................................... $15.10

Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 10% is
avoidable if the component were bought from the outside supplier; the remainder is not
avoidable. In addition, making the component uses 3 minutes on the machine that is the
company's current constraint. If the component were bought, this machine time would be
freed up for use on another product that requires 6 minutes on the constraining machine
and that has a contribution margin of $8.10 per unit.

When deciding whether to make or buy the component, what cost of making the
component should be compared to the price of buying the component?
A) $15.55
B) $11.50
C) $19.15
D) $15.10

4. Itehad Corporation has 2,000 obsolete units of a product that are carried in inventory at
a manufacturing cost of $40,000. If the units are re-machined for $10,000, they could be
sold for $18,000. Alternatively, the units could be sold for scrap for $2,000. Which
alternative is more desirable and what are the total relevant costs for that alternative?
A) remachine; $10,000.
B) remachine; $50,000.
C) scrap; $40,000.
D) scrap; $40,000.

5. BlackCo produces 2,000 parts per year, which are used in the assembly of one of its
products. The unit product cost of these parts is:
Variable manufacturing cost $24
Fixed manufacturing cost 18
Unit product cost $42

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The part can be purchased from an outside supplier at $40 per unit. If the part is
purchased from the outside supplier, two thirds of the fixed manufacturing costs can be
eliminated. The annual impact on BlackCo’s net operating income as a result of buying
the part from the outside supplier would be:
A) $4,000 increase.
B) $4,000 decrease.
C) $8,000 increase.
D) $8,000 decrease.

6. A study has been conducted to determine if one of the departments of Kelly Company
should be discontinued. The contribution margin in the department is $100,000 per year.
Fixed expenses charged to the department are $130,000 per year. It is estimated that
$80,000 of these fixed expenses could be eliminated if the department is discontinued.
These data indicate that if the department is discontinued, Kelly's overall net operating
income would:
A) decrease by $20,000 per year.
B) increase by $20,000 per year.
C) decrease by $50,000 per year.
D) increase by $50,000 per year.

Short Computational:
1. Harari Corporation sells component FN87 at a selling price of $28 per unit. The company’s
cost per unit, based on full capacity of 160,000 units, is as follows:

Direct materials $6.00

Direct labor $4.00
Overhead (2⁄3 of which is variable) $9.00

Harari has been approached by a distributor in another city offering to buy a special order
consisting of 30,000 component FN87. Harari has the capacity to fill the order. However, it will
incur an additional shipping cost of $2 for each component it sells to the distributor.

Required:
a. Assume that Harari is currently operating at a level of 100,000 units. What unit price should it
charge the distributor if it wishes to increase operating income by $2 for each unit included
in the special order?

b. Assume that Harari is currently operating at full capacity. To fill the special order, regular
customers will have to be turned away. Now what unit price should it charge the distributor if
it wishes to increase total operating income by $60,000 more than it would be without accepting
the special order?

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Solution:
a. Variable Costs
Direct materials $6.00
Direct labor $4.00
Overhead $6.00
Shipping costs $2.00
$18.00 per unit
Add: Profit per unit $2.00 per unit
Min. Selling Price $20.00 per unit

b. Variable Costs
Direct materials $6.00
Direct labor $4.00
Overhead $6.00
Shipping costs $2.00
$18.00 per unit
Add: Lost CM $12.00 per unit ($28-$6-$4-$9x2/3)
Add: Profit per unit $2.00 per unit ($60,000/30,000)
Min. Selling Price $32.00 per unit

2. The Talbot Company makes wheels that it uses in the production of bicycles. Talbot's costs to
produce 100,000 wheels annually are:
Direct materials ............................. $30,000
Direct labor .................................... $50,000
Variable overhead ......................... $20,000
Fixed overhead .............................. $70,000

An outside supplier has offered to sell Talbot similar wheels for $1.25 per wheel. If the wheels
are purchased from the outside supplier, $15,000 of annual fixed overhead could be avoided and
the facilities now being used could be rented to another company for $45,000 per year.

Required:
a. If Talbot chooses to buy the wheel from the outside supplier, then what would be the change in
annual net operating income due to accepting the offer?

b. What is the highest price that Talbot could pay the outside supplier for the wheel and still be
economically indifferent between making or buying the wheels?

Solution:
a. Incremental benefit = Avoidable FC + Potential rental income
= $15,000 + $45,000 = $60,000

Incremental cost = Cost to buy – Avoidable VC

= $1.25 * 100,000 – ($30,000 + $50,000 + $20,000) = $25,000

Net advantage = Incremental benefit – Incremental cost

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= $60,000 - $25,000 = $35,000 increase

b. Highest price would be where, the cost to buy results in $0 net advantage/increase in income
SP = $1.25 + $35,000/100,000 = $1.60 per unit

3. Veronica Mars, a recent graduate of Bell’s accounting program, evaluated the operating
performance of Dunn Company’s six divisions. Veronica made the following presentation to
Dunn’s board of directors and suggested the Percy Division be eliminated. “If the Percy Division
is eliminated,” she said, “our total profits would increase by $26,000.”

The Other Percy

Five Divisions Division Total
Sales $1,664,200 $100,000 $1,764,200
Cost of goods sold 978,520 76,000 1,054,520
Gross profit 685,680 24,000 709,680
Operating expenses 527,940 50,000 577,940
Net income $ 157,740 $ (26,000) $ 131,740

In the Percy Division, cost of goods sold is $61,000 variable and $15,000 fixed, and operating
expenses are $30,000 variable and $20,000 fixed. None of the Percy Division’s fixed costs will
be eliminated if the division is discontinued.

Required:
a. Is Veronica right about eliminating the Percy Division?

Solution:
a. Total Approach
Net Income
Increase
Continue Eliminate (Decrease)
Sales $100,000) $( 0) $(100,000)
Variable costs
Cost of goods sold ( 61,000) ( 0) (61,000)
Operating expenses (30,000) ( 0) (30,000)
Total variable (91,000) ( 0) (91,000)
Contribution margin ( 9,000) ( 0) (9,000)
Fixed costs
Cost of goods sold (15,000) (15,000) ( 0)
Operating expenses (20,000) (20,000) ( 0)
Total fixed (35,000) (35,000) ( 0)
Net income (loss) $(26,000) $(35,000) $ (9,000)

Contribution Margin Approach:

Contribution Margin lost ($100K-61K-30K) = ($9,000)

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Less: Avoidable fixed costs = $0
Net disadvantage = ($9,000)

Veronica is incorrect. The incremental analysis shows that net income is expected to be $9,000
less if the Percy Division is eliminated. As there are no avoidable fixed costs, this amount equals
the contribution margin that would be lost through discontinuing the division.

4. Wexpro, Inc., produces several products from processing 1 ton of clypton, a rare mineral.
Material and processing costs total $60,000 per ton, one-fourth of which is allocated to product
X15. Seven thousand units of product X15 are produced from each ton of clypton. The units can
either be sold at the split-off point for $9 each, or processed further at a total cost of $9,500 and
then sold for $12 each.

Required:
a. What is the financial advantage (disadvantage) of further processing product X15?
b. Should product X15 be processed further or sold at the split-off point?
c. What is the minimum amount the company should accept for product X15 if it is to be sold at
the split-off point?

Solution:
a. Additional Revenue – Additional cost
= ($12 - $9) * 7,000 - $9,500
= $11,500 net advantage.

b. X15 should be processed further as the incremental revenue exceeds the additional cost of
processing.
Note: The $60,000 cost incurred up to the split-off point is not relevant in a sell or process
further analysis.

c. Min SP = $9 + $11,500/7,000 = $10.64 per unit.

If Wexpro Inc., can sell X15 at $10.64 right after split off point, then the company would be
indifferent between selling at split off or processing further.

Long form Problems:

Question 1:
Svahn, AB, is a Swedish manufacturer of sailing yachts. The company has assembled the
information shown below that pertains to two independent decision-making contexts called Case
A and Case B:
Case A:
The company chronically has no idle capacity and the old Model B100 machine is the
company’s constraint. Management is considering purchasing a Model B300 machine to use in
addition to the company’s present Model B100 machine. The old Model B100 machine will
continue to be used to capacity as before, with the new Model B300 machine being used to
expand production. This will increase the company’s production and sales. The increase in
volume will be large enough to require increases in fixed selling expenses and in general
administrative overhead, but not in the fixed manufacturing overhead.

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Case B:
The old Model B100 machine is not the company’s constraint, but management is considering
replacing it with a new Model B300 machine because of the potential savings in direct materials
with the new machine. The Model B100 machine would be sold. This change will have no effect
on production or sales, other than some savings in direct materials costs due to less waste.

Required:
Place an X in the appropriate column to indicate whether each item is relevant or irrelevant to the
decision context described in Case A and Case B.

Solution:
Case A Case B
Item Relevant Irrelevant Relevant Irrelevant
a. Sales revenue X X
b. Direct materials X X
c. Direct labor X X
d. Variable manufacturing overhead X X
e. Depreciation— Model B100
machine X X
f. Book value— Model B100
machine X X
g. Disposal value— Model B100
machine X X
h. Market value—Model B300
machine (cost) X X
i. Fixed manufacturing overhead
(general) X X
j. Variable selling expense X X
k. Fixed selling expense X X
l. General administrative overhead X X

Question 2:
Holt Company makes three products in a single facility. Data concerning these products follow:
A B C
Selling price per unit $ 67.90 $ 57.70 $ 43.90
Direct materials $ 12.10 $ 10.30 $ 8.60
Direct labor $ 14.10 $ 8.00 $ 6.80
Variable MOH $ 2.60 $ 2.20 $ 1.80
Variable selling cost per unit $ 2.50 $ 2.20 $ 2.50
Mixing minutes per unit 2.70 3.30 4.70
Monthly demand in units 1,000 3,000 3,000

The mixing machines are potentially the constraint in the production facility. A total of 25,800
minutes are available per month on these machines. Direct labor is a variable cost in this
company.

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Required:
a. How many minutes of mixing machine time would be required to satisfy demand for all three
products?
b. Given the constraint, how much of each product should be produced to maximize net
operating income? (Round off to the nearest whole unit.)
c. Up to how much should the company be willing to pay for one additional hour of mixing
machine time if the company has made the best use of the existing mixing machine capacity?

Solution:
a.
A B C
Mixing minutes per unit 2.70 3.30 4.70
Monthly demand in units 1,000 3,000 3,000
Total minutes required 2,700 9,900 14,100

Total = 2,700 + 9,900 + 14,100

= 26,700 minutes

b.
A B C
Selling price per unit $ 67.90 $ 57.70 $ 43.90
Variable costs per unit $ 31.30 $ 22.70 $ 19.70
CM per unit $ 36.60 $ 35.00 $ 24.20
Mixing minutes per unit 2.70 3.30 4.70
CM per unit of constraint $ 13.56 $ 10.61 $ 5.15
Ranking 1 2 3
Monthly demand in units 1,000 3,000 3,000
Units that can be produced 2,700 9,900 2,809*

* Minutes remaining = 25,800 – 2,700 – 9,900 = 13,200

Units for C = 13,200 mins / 4.7 min per unit = 2,809 units (rounded)

Units of C foregone = 3,000 – 2,809 = 191.

c. Value of 1 hour = 60 minutes x CM per unit of constraint of C (product units foregone)

= 60 minutes x $5.15 per minute = $308.94

Question 3:
Your company is considering whether to engage in a one-off overseas contract, the costs for
which are given below. Assume the regularly business will not be affected:
____________________(£)
Material App 4,000
Material Bet 8,000
Direct labour 6,000
Supervision 2,000
Overheads 12,000

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 32,000
You ascertain the following:
(i) Material App is already in stock. It was originally purchased at £4,000. It has no other use in the
company’s regular business and it would cost £1,750 to dispose of. Material Bet is not in stock and
the above is its replacement price.

(ii) The £6,000 direct labour costs are in respect of workers that will be transferred to this
project from some other work. Additional labour will need to be recruited to complete the other
work at a cost of £7000.

(iii) The allocation rate for supervision costs is 33 1/3 % of labour costs. This will be carried out
by existing staff within normal working hours.

(iv) Overheads have been charged to the one-off order at 200% of direct labour.

(v) An item of machinery will need to be used on this project which has no other use to the
company upon completion of the project. The purchase price of the machinery is £10,000 and
scrap value after the end of the project will be £5,250.

The customer is willing to pay a maximum of £30,000 for the project and a competitor is willing
to accept the order at this price.

Required:
Cost the project, clearly stating how you have arrived at your figures and giving reasons for the
exclusion of other figures. Should the company accept this order?

Solution:
Cost Amount Reason
Material App (£1,750) Disposal cost if material remains un-used
Material Bet 8,000 Replacement cost
Direct Labour 7,000 Cost incurred to replace labour for regular
work
Net cost of Machinery 4,750 Machinery has no other use
Relevant Cost £18,000

Supervision can be completed within existing hours so there is no incremental cost.

Overheads are allocated, which would likely be re-allocated to other work, even if this project is
not taken.
Since the customer is willing to pay £30,000, and the relevant cost is only £18,000, it would
result in a positive contribution margin of £12,000, so the company should accept the order.

Decision Decision Rule

Add/drop segment or product line Lost CM – avoidable costs if segment is dropped;
Drop if profit would increase
Keep if profit would decrease
Make or Buy (product and service) Total avoidable costs > Cost to buy, then buy

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 Total avoidable costs < Cost to buy, then make

Special orders Incremental revenue > incremental cost (variable +

opportunity cost on lost sales), accept

Incremental revenue < incremental cost (variable +

opportunity cost on lost sales), reject

Min. Selling price per unit = VC per unit + (CM on

outside sales * units sacrificed / special order units) +
Target profit per unit

What is relevant cost for materials?

Regularly used (readily available) – regular
market price or replacement value
Idle material – scrap or disposal value
Historical cost – sunk cost
Constrained resource Rank and produce products based on highest
contribution margin per unit of the constrained
resource
Value assigned to an additional units of constrained
resource = CM per unit of the constrained resource
for the product which could not be fully produced
Sell or Process Further Incremental revenue from further processing > the
incremental processing costs after the split-off point,
process
Incremental revenue from further processing < the
incremental processing costs after the split-off point,
sell
Joint costs are irrelevant here as sunk cost in nature.

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