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### Practice As You Learn

#### Medium Practice Test

Do the following when making a short-term decision:

1) Identify irrelevant costs and ignore them
2) Identify relevant costs and use them in the analysis
3) Memorize and use the format that is common for the type of analysis required

Answer – Practice as You Learn – Problem 1. Special Order

A manufacturing company produces a single product. They have the capacity to produce 100,000 units and are currently producing 70,000 units. A special order has been received for 5,000 units at a price of \$8. Units are normally sold to customers for \$10 per unit. When producing at 70,000 units, per unit costs are as follows:

 Per unit Direct materials \$2 Direct labor \$1 Variable manufacturing overhead \$0.50 Fixed manufacturing overhead \$2.50 Variable selling expenses \$0.40 Fixed administrative and selling \$1.50

For the special order, variable selling costs will not be incurred and an additional part for the machine that costs \$15,000 must be purchased. The order will be shipped separately at a cost of \$800.

A. Should the company accept the special order

B. Should the company accept the special order if the company had a capacity of 70,000 and are currently selling 70,000 units without the order?

A. Use the common format for special orders:

 Sales \$ per unit \$8.00 – Variable cost per unit \$3.50 (2+1+.50) = CM per unit \$4.50 x Total units 5,000 = Total contribution margin \$22,500 – Additional total fixed costs \$15,800 = Impact on profits \$ 6,700 Accept the order

Current fixed costs are ignored because they are not relevant and won’t change if the special order is accepted.

Variable selling costs are not included in variable costs because they will not be incurred for the special order

B. If the company is currently at capacity, the contribution margin lost from normal orders that will not occur must be considered.

 Sales \$ per unit \$10 – Variable cost per unit \$3.90 (2+1+.40+.50)) = CM per unit \$6.10 x Total units 5,000 = Total contribution margin \$30,500 lost if accept the special order
 Additional profits from special order \$ 6,700 – Contribution margin lost if accept special order (\$30,500) =Net impact of accepting the special order if at capacity (\$23,800)

Do not accept the order if currently producing at capacity

Answer – Practice as You Learn – Problem 2. Make or Buy?

A manufacturing company currently makes a part that is part of one of its products. The costs of making the part at their factory is as follows:

 Per unit Direct materials \$2.25 Direct labor \$1.10 Variable manufacturing overhead \$0.50 Fixed manufacturing overhead -allocated \$2.00 Fixed manufacturing overhead – related to machines that make the part \$4.25 Fixed manufacturing overhead – related to the supervisor making the part \$1.75

A supplier has proposed to supply the part for \$10 per unit. The supervisor salary and the machine related overhead can be avoided if the part is purchased rather than made. The space that is currently used to manufacture the part can be used for warehousing and would save \$10,000 paid currently for additional outside warehouse space. Currently, 15,000 parts are manufactured annually.

A. Should the company continue to make the part or purchase it from the supplier?
B. What is the maximum amount the company should be willing to pay the supplier?

A. Use the common format for analysis:

Make

\$2.25
\$1.10
\$0.50
\$3.85 per unit

x 15,000 units
\$57,750

+ \$10,000 opportunity costs
= \$67,750

\$10.00
(\$4.25)
(\$1.75)
= \$4.00

x 15,000
= \$60,000

The company is \$7,750 more profitable if they buy the part from the supplier

Allocated fixed costs are ignored; they are irrelevant since they will not change

B. To answer this question, determine what it costs the company to make each unit.

\$67,750 / 15,000 units = \$4.52 per unit

This is the maximum amount the company can pay someone else to make it and keep profits the same

Answer – Practice as You Learn – Problem 3. Process Further?

A manufacturing company produces two products from a joint process. Information relative to each product follows:

 Product X Product Y Sales value at split-off \$50,000 \$75,000 Joint process costs – allocated \$30,000 \$60,000 Sales value after further processing \$60,000 \$80,000 Further processing costs \$ 6,000 \$ 7,000

Should each product be sold at the split off point or processed further?

 Use the common format: Product X Product Y Final Sales \$ after further processing \$60,000 \$80,000 – Sales \$ at the split-off point (\$50,000) (\$75,000) = Incremental Revenue from further processing \$10,000 \$ 5,000 – Cost of further processing (\$6,000) (\$7,000) = Profit or Loss from further processing \$4,000 (\$2,000)

The company should process further Product X because it will bring the company more profit. Product Y should not be processed further

Joint process costs are ignored because they are irrelevant, sunk costs

Answer – Practice as You Learn – Problem 4. Constrained Resources

A manufacturing company manufactures 2 products. The company has available 10,000 labor hours per month of trained labor. Information related to the two products follows:

 Product A Product B Sales price per unit \$10 \$14 Variable manufacturing cost per unit \$ 5 \$ 8 Variable sales cost per unit \$ 1 \$ 1 Fixed cost per unit \$ 2 \$ 2 Direct labor hours required per unit 0.5 0.6 Units that can be sold each month 15,000 15,000

A. Is direct labor hours a constrained resource?
B. What is the mix of products the company should make to maximize profits?
C. What is the maximum contribution margin the company can earn given the amount of direct labor hours available?

A. To determine this, you must first determine how many direct labor hours it will take to produce the products that can be sold each month and compare this to how many direct labor hours are available.

 Product A Product B Units 15,000 15,000 x Direct labor hours/unit 0.5 0.6 =Total hours required 7,500 9,000

Total of 16,500 needed and only 10,000 available — constrained

B. To determine the most profitable mix, first determine the contribution margin per unit and then determine the contribution margin per constrained resource – direct labor hours.

 Product A Product B Sales \$10 \$14 – Variable costs \$ 6 \$ 9 CM per unit \$ 4 \$ 5 / hours required 0.5 0.6 = CM per hour \$8 \$8.33

Product B will give more contribution margin per each unit of restrained resource. The company should use 9,000 of the hours to produce 15,000 units of Product B. The other 1,000 hours should be used for Product A which will produce 2,000 units (1,000 hours / .5 hours per unit = 2,000 units)

C. The maximum contribution margin the company can achieve is calculated as follows

 Product A Product B Units to be sold 2,000 15,000 x CM per unit \$ 4 \$ 5 = Total CM \$8,000 + \$75,000 Total CM = \$83,000

Answer – Practice as You Learn – Problem 5. Dropping a Product Line

A manufacturing company currently produces the following 2 product lines. The company is considering dropping Product Line B. The following information has been gathered:

 Product Line A Product Line B Sales \$1,000,000 \$1,500,000 Variable expenses 600,000 900,000 Fixed expenses – direct 100,000 400,000 Fixed expenses – allocated 200,000 200,000 Operating Income 100,000 0

The company is considering dropping product line B. If product line B is dropped, the direct costs would not be incurred and the allocated costs would still be incurred by the company. Sales of product line A are expected to increase by 20% if product line B is dropped.

Should the company drop product line B?

Fixed expenses allocated are ignored because they will not change and are irrelevant

 Use the common format: Product Line B Contribution Margin lost if discontinued (\$600,000) (S – VC) – Fixed costs avoided if discontinued \$400,000 Direct only Lost operating income if dropped (\$200,000)

Also consider:
Sales will increase 20% for product line A.
If sales increase 20%, contribution margin will increase 20% also

 Product Line A Sales \$1,000,000 – Variable Costs 600,000 = Contribution Margin 400,000 x 20% .20 Increase in CM \$80,000

The company will increase CM \$80,000 from product line A The company will lose operating income of \$200,000 from product line B The net to the company is a loss of \$120,000 operating profit

The company should not drop product line B

Answer – Practice as You Learn – Problem 6. Adding a Product Line

A manufacturing company currently manufactures only product line X. The company is considering adding product line Y. Information related to the two product lines follows:

 Line X Line Y Sales price per unit \$10 \$14 Variable manufacturing cost per unit \$ 5 \$ 6 Variable sales cost per unit \$ 1 \$ 1 Annual direct fixed costs \$40,000 \$50,000 Annual shared administrative costs \$60,000 \$25,000 Units sold each year 30,000 10,000

Should the company add product line Y?