ACCT 338: Introductory Management Accounting

Module Ten: Chapter Eleven

Relevant Information & Decision Making
In-Class Activities
Question #1

Question 1: Make-or-Buy Decisions

Howard Grills makes high-end barbecues. The company has recently been approached by a supplier who has offere
(the barbecue part that provides a spark to start the flame). The company has offered a price of $5.00 per igniter.
Howard’s internal costs of producing the igniter follow:

30,000 igniters
Per Igniter per year
Direct materials $ 1.25 $37,500 Relevant
Direct labour $ 0.25 7,500 Relevant
Variable manufacturing overhead $ 0.50 15,000 Relevant
Fixed manufacturing overhead – traceable* $ 3.00 90,000 Relevant - 2/3 equipment maint
Fixed manufacturing overhead – allocated $ 1.50 45,000 Irrelevant
Total $ 6.50 $195,000

*2/3 relate to equipment maintenance and 1/3 relate to depreciation of

specialized equipment (no resale value).

Gloria Howard, the owner and CEO of Howard Grills notes: “To make 30,000 igniters costs us $195,000, their starter
only cost us $150,000, I’m no accountant, but it seems obvious we should take this deal.”

Required:
a)      Assuming there is no other use for the space used to make the starters, what is the net dollar advantage
b)      If the offer is accepted, the company could use the space to develop a new product line that would gene
Should the company accept the supplier’s offer?

SOLUTION:

a)      Assuming there is no other use for the space used to make the starters, what is the net dollar advantage or dis

Make Buy
Direct materials $ 1.25
Direct labour $ 0.25
Variable manufacturing overhead $ 0.50
Fixed manufacturing overhead – traceable* $ 2.00
Purchase Price - to buy from supplier - $ 5.00
Total Cost Per Unit $ 4.00 $ 5.00
Number of igniter units 30,000 30,000
Total Cost ($) $ 120,000 $ 150,000
Net Dollar Advantage/(Disadvantage) of Accepting the Offer: $ (30,000) <--- Do not accept the supplier's

b)      If the offer is accepted, the company could use the space to develop a new product line that would generate es
Should the company accept the supplier’s offer?

Additional Cost to Buy Igniters $ (30,000)

Estimated margins on new product line 25,000
Revised net dollar advantage/(disadvantage) $ (5,000)

Should the company accept the supplier's offer?

Based on a purchase price per unit of $5.00, we would not accept the offer. They are still losing money even with th
new product line.
This could be worth considering if they are able to negotiate the purchase price to a lower per unit cost.
 by a supplier who has offered to provide the company igniters
a price of $5.00 per igniter.

evant - 2/3 equipment maintenance; Irrelevant - 1/3 depreciation (non-cash expense)

osts us $195,000, their starters are just as good and buying from them will

at is the net dollar advantage or disadvantage of accepting the supplier’s offer?

product line that would generate estimated margins of $25,000.

e net dollar advantage or disadvantage of accepting the supplier’s offer?

 Do not accept the supplier's offer

ct line that would generate estimated margins of $25,000.

till losing money even with the additional margins on the

wer per unit cost.

ACCT 338: Introductory Management Accounting
Module Ten: Chapter Eleven
Relevant Information & Decision Making
In-Class Activities
Question #2

Question 2: Drop or Retain a Segment

Fresh Juice has three locations in Kamloops: Downtown, North Shore and Dufferin. Management is concerned abou
performance of the downtown location, the rent is high and management is debating closing the store. A company
segmented income statement follows:

Downtown North Shore Dufferin Total

Sales $300,000 $350,000 $250,000 $900,000
Variable expenses 210,000 225,000 175,000 610,000
Contribution margin 90,000 125,000 75,000 290,000
Fixed expenses 150,000 75,000 40,000 265,000
Operating income (loss) ($60,000) $50,000 $35,000 $25,000

An analysis of expenses reveals that $40,000 of the downtown location’s fixed expenses are allocated costs
that would continue even if the store was closed. The North Shore and Dufferin locations could expect a 5%
decrease in revenues due to lost promotional synergies closing the prominent downtown location.

Required:
Compute the net dollar advantage or disadvantage of dropping the downtown location.

SOLUTION:

Option #1: Put together an income statement that shows results if the Downtown location is dropped:

Downtown North Shore Dufferin Total

Sales $ - $ 332,500 $ 237,500 $ 570,000
Variable expenses - (213,750) (166,250) (380,000)
Contribution margin - 118,750 71,250 190,000
Fixed expenses (40,000) (75,000) (40,000) (155,000)
Operating income (loss) (40,000) 43,750 31,250 35,000
Operating income (before) (60,000) 50,000 35,000 25,000
Net dollar advantage/(disadvantage)
$ 20,000 $ (6,250) $ (3,750) $ 10,000

Should they close the downtown location?

Based on the analysis above, they should close the location based on the fact that closing the downtown location
will save the company $10,000.
Option #2: Incremental Analysis:

Lost contribution margin from closing the downtown location $ (90,000)

Reduced fixed expenses from closing the location 110,000
Lost contribution margin - 5% reduction at North Shore (6,250)
Lost contribution margin - 5% reduction at Dufferin (3,750)
Net dollar advantage/(disadvantage) $ 10,000
anagement is concerned about the
losing the store. A company-wide

s are allocated costs

ons could expect a 5%
wn location.

tion is dropped:

ng the downtown location

ACCT 338: Introductory Management Accounting
Module Ten: Chapter Eleven
Relevant Information & Decision Making
In-Class Activities
Question #3

Question 3: Special Order

Eversharp is a knife manufacturer. The company normally sells 5,000 sets of high quality knives each year and,
with its current staff and machinery, has the capacity to produce up to 6,000 sets of knives. At this level of output,
the company estimates its costs of producing and selling one set of knives as follows:

Per unit
Direct materials $ 5.00 Relevant
Direct labour $ 1.50 Relevant
Variable manufacturing overhead $ 1.00 Relevant
Fixed manufacturing overhead $ 2.00 Irrelevant
Sales commissions $ 1.50 Irrelevant
Fixed selling and administrative expenses $ 4.00 Irrelevant
Total costs $ 15.00

The company’s selling price is $20 per unit. An order has been received for 500 units, but because it’s a bulk purcha
the buyer has requested a 40% price discount. If the order were accepted it would not affect the company’s regular
There would be no sales commissions on this deal, and fixed costs would not be affected. The purchasing company
like their logo engraved into the handle of each knife, which would increase labour costs by $0.25 per unit and requ
purchase of a new machine for $2,000.

Required:
a)      Determine the net dollar advantage or disadvantage of accepting the order.
b)      Separate from a.), assume the company finds a box from 1994 containing 1,000 old steak knives, althoug
changed, the knives are still of a reasonably good quality and sharpness. Assuming manufacturing cost data w
what is the minimum selling price that should be accepted?

SOLUTION:

a)      Determine the net dollar advantage or disadvantage of accepting the order.

Special Order
Per Unit Total (500 Units)
Sales Revenue $ 12.00 $ 6,000
Relevant Costs:
Direct materials $ 5.00 $ 2,500
Direct labour 1.75 875
 Variable manufacturing overhead 1.00 500
Special equipment required 4.00 2,000
Total Relevant Costs Related to the Special Order 11.75 5,875
Net Dollar Advantage/(Disadvantage) $ 0.25 $ 125.00

Should they accept the special offer?

Yes, they should accept the special offer because it is profitable.

b)      Separate from a.), assume the company finds a box from 1994 containing 1,000 old steak knives, although styl
changed, the knives are still of a reasonably good quality and sharpness. Assuming manufacturing cost data was sim
what is the minimum selling price that should be accepted?

Per unit
Direct materials $ 5.00 Irrelevant
Direct labour $ 1.50 Irrelevant
Variable manufacturing overhead $ 1.00 Irrelevant
Fixed manufacturing overhead $ 2.00 Irrelevant
Sales commissions $ 1.50 Relevant
Fixed selling and administrative expenses $ 4.00 Irrelevant
Total costs $ 15.00

The minimum selling price should be at least $1.50 to breakeven; any selling price they set above $1.50 is going to b
ty knives each year and,
ives. At this level of output,

but because it’s a bulk purchase,

affect the company’s regular sales.
ed. The purchasing company would
ts by $0.25 per unit and require the

,000 old steak knives, although styles have

ng manufacturing cost data was similar in 1994 to the chart above,
ld steak knives, although styles have
nufacturing cost data was similar in 1994 to the chart above,

set above $1.50 is going to be profitable.

ACCT 338: Introductory Management Accounting
Module Ten: Chapter Eleven
Relevant Information & Decision Making
In-Class Activities
Question #4

Question 4: Sell or Process Further

U-Junk Auto is a car lot that has just received a 1991 Toyota Tercel that is barely in running condition.
The company paid $400 for the car has already received an offer to be sold (as is) for $600.
The shop’s mechanic does not wish to sell the car as is, he believes that the company
should replace the damaged parts at a cost of $200 and have him repair the car. It would take him
30 hours of work at $20 per hour. The company applies variable overhead costs to jobs at a rate of
$10 per direct labour hour. If the upgrades are made, the car could be sold for $1,500.

Required:
Determine the net dollar advantage or disadvantage of selling the car now instead of repairing it.

SOLUTION:

Process
Sell As-Is Further
Sales Revenue $ 600 $ 1,500
Cost of Sales:
Direct Materials (Purchase the car) 400 400
Direct Materials (Replacement Parts) - 200
Direct Labour - 600
Variable Overhead Costs - 300
Total Costs 400 1,500
Gross Margin $ 200 $ -

Net Advantage/(Disadvantage) of Selling As Is $ 200

Should they sell the car as is or repair and then sell?

They should sell the car as is, as this earns them an additional $200 profit vs. repairing and then selling.
ACCT 338: Introductory Management Accounting
Module Ten: Chapter Eleven
Relevant Information & Decision Making
In-Class Activities
Question #5

Question 5: Constrained Resource

Anthony Bertuzzi is a very busy man. He runs an event planning business that organizes weddings, birthday parties,
Anthony’s business is so busy that he has recently started turning away customers. Anthony tried to bring in a partn
wanted Anthony’s magic touch. Anthony enjoys all three types of events - wedding, birthday parties, and corporate
and would like your help in determining which events he should prioritize. Although all events are different, he has
information about “typical” events of each type:

Weddings Birthday Parties Corporate Events

Price $10,000 $2,000 $5,000
Variable expenses 6,000 1,000 2,000
Contribution margin $4,000 $1,000 $3,000

Typically, weddings take 40 planning hours, birthday parties take 15 planning hours and Corporate Events take 20 pl

Required:
Which event requests should Anthony take first? Second? Third? (Explain your answer.)

SOLUTION:

Weddings Birthday Parties Corporate Events

Contribution Margin Per Event $ 4,000 $ 1,000 $ 3,000

Planning Hours Per Event 40 15 20
CM Per Planning Hour $ 100.00 $ 66.67 $ 150.00
Ranking 2nd 3rd 1st

Anthony should accept Corporate Events first, as they have the highest CM per planning hour at $150.00 per hour.
Next, would be Weddings at $100.00 per planning hour.
Last would be Birthday Parties at $66.67 per planning hour.
weddings, birthday parties, and corporate events.
ony tried to bring in a partner, but customers
day parties, and corporate events - equally,
vents are different, he has laid out the following

orporate Events take 20 planning hours.

hour at $150.00 per hour.