Chapter 13
Decision-Making and
Relevant Information
DIFFERENTIAL COSTS AND REVENUES
Bill is currently employed as a lifeguard, but he has been offered a
job in an auto service center in the same town. The differential
revenues and costs between the two jobs are listed below:
Lifeguard
Monthly salary
Auto
Service
Center
Differential
costs and
revenues
$1,200
$1,500
$300
30
90
60
Meals
150
150
0
Apartment rent
450
450
0
0
50
50
10
0
640
740
100
$ 560
$ 760
$200
Monthly expenses:
Commuting
Uniform rental
Union dues
Total monthly expenses
Net monthly income
(10)
Identifying Relevant Costs
Automobile Costs (based on 10,000 miles driven per year)
1
2
3
4
5
6
Annual straight-line depreciation on car
Cost of gasoline
Annual cost of auto insurance and license
Maintenance and repairs
Parking fees at school
Total average cost
7
8
9
10
11
12
13
Annual Cost
of Fixed Items
$
2,800
1,380
360
Cost per
Mile
$
0.280
0.050
0.138
0.065
0.036
$
0.569
Some Additional Information
Reduction in resale value of car per mile of wear
Round-trip train fare
Cost of hotel in New York
Cost of putting dog in kennel while gone
Benefit of having car in New York
Hassle of parking car in New York
Per day cost of parking car in New York
$ 0.026
$
104
$
200
$
40
????
????
$
25
Total and Differential Cost Approaches
The management of a company is considering a new labor saving
machine that rents for $3,000 per year. Data about the company’s
annual sales and costs with and without the new machine are:
Sales (5,000 units @ $40 per unit)
Less variable expenses:
Direct materials (5,000 units @ $14 per unit)
Direct labor (5,000 units @ $8 and $5 per unit)
Variable overhead (5,000 units @ $2 per unit)
Total variable expenses
Contribution margin
Less fixed expense:
Other
Rent on new machine
Total fixed expenses
Net operating income
Current
Situation
$
200,000
Situation
With New
Machine
$
200,000
Differential
Costs and
Benefits
-
70,000
40,000
10,000
120,000
80,000
70,000
25,000
10,000
105,000
95,000
15,000
15,000
62,000
62,000
18,000
62,000
3,000
65,000
30,000
(3,000)
(3,000)
12,000
$
$
Add or Drop a Product Line
Discount Drug Company has three major product lines. What can be done
to improve the company’s overall performance?
Total
250,000
Drug
125,000
Product Line
Cosmetics
75,000
105,000
145,000
50,000
75,000
25,000
50,000
Less: Fixed Expenses
Salaries
Advertising
Utilities
Depreciation – fixtures
Rent
Insurance
Administrative
Total
50,000
15,000
2,000
5,000
20,000
3,000
30,000
125,000
29,500
1,000
500
1,000
10,000
2,000
15,000
59,000
12,500
7,500
500
2,000
6,000
500
9,000
38,000
8,000
6,500
1,000
2,000
4,000
500
6,000
28,000
Net Op Income (Loss)
20,000
16,000
12,000
(8,000)
Sales
Less:
Variable Expenses
Contribution Margin
Housewares
50,000
30,000
20,000
Add or Drop a Product Line
Which fixed expenses in Housewares will Discount Drug be able to
avoid?
Total
Unavoidable
Avoidable
Salaries
8,000
8,000
Advertising
6,500
6,500
Utilities
1,000
1,000
Depreciation - fixtures
2,000
2,000
Rent
4,000
4,000
Insurance
General Administrative
Total Fixed Expenses
500
500
6,000
6,000
28,000
13,000
15,000
Add or Drop a Product Line
• Contribution margin lost if housewares
line is discontinued
$
• Less fixed costs that can be avoided if the
housewares line is discontinued
$
• Inc/(Dec) in overall company net operating inc.
$
DECISION RULE:
• The Housewares Line should be dropped only if the fixed
cost savings exceed the lost contribution margin.
“Make or Buy” Decision
• Essex manufactures part 4A that is
currently used in one of its products.
• The unit cost to make this part is:
Dire
$$ 99
Direct
ct m
maate
teria
rials
ls
Dire
55
Direct
ct la
labor
bor
Va
11
Varia
riable
ble ove
overhe
rheaadd
De
33
Depre
precia
ciation
tion of
of spe
specia
ciall eequip.
quip.
Supe
22
Supervisor's
rvisor'ssa
sala
lary
ry
Ge
10
Gene
nera
rall fa
factory
ctory ove
overhe
rheaadd
10
Tota
$$ 30
Totall cost
cost pe
perr unit
unit
30
“Make or Buy” Decision
• The special equipment used to manufacture
part 4A has no resale value
• General factory overhead is allocated on the
basis of direct labor hours
• The $30 total unit cost is based on 20,000
parts produced each year
• An outside supplier has offered to provide
the 20,000 parts at a cost of $25 per part
• Should we accept the supplier’s offer?
Pop Quiz
Konrade’s Engine Company manufactures part TE456 used in several of its engine
models. Monthly production costs for 1,000 units are as follows:
Direct materials
$ 40,000
Direct labor
10,000
Variable overhead costs
30,000
Fixed overhead costs
20,000
Total costs
$100,000
It is estimated that 10% of the fixed overhead costs assigned to TE456 will no
longer be incurred if the company purchases TE456 from the outside supplier.
Konrade’s Engine Company has the option of purchasing the part from an
outside supplier at $85 per unit.
The maximum price that Konrade’s Engine Company should be willing to pay the
outside supplier is:
a.
$80 per TE456 part.
b.
$82 per TE456 part.
c.
$98 per TE456 part.
d.
$100 per TE456 part.
Accept or Reject a Special Order
Jamestown Candleworks has just received a request from the Williamsburg
Foundation for 800 candles to be used in a special event for major donors. The
candles will be used as the only illumination in the reception room and will be
given out as gifts to the donors as they leave. The candles will be imprinted
with the Williamsburg Foundation logo. This sale will have no effect on the
company’s normal sales to retail outlets. The normal selling price of a candle
of about the size and weight of the special candles is $3.95 and its unit product
cost is $2.30, as shown below:
Direct materials
Direct labor
Manufacturing overhead
Unit product cost
$1.35
0.15
0.80
$2.30
The variable portion of the manufacturing overhead is $0.05 per candle; the
other $0.75 represents fixed manufacturing costs that would not be affected by
this special order.
Accept or Reject a Special Order (continued)
Jamestown Candleworks would have to order a special
candle mold in which the Williamsburg Foundation logo is
inscribed. Such a mold would cost $800. In addition, the
Williamsburg Foundation wants a special wick containing goldlike thread that would add $0.20 to the cost of each candle.
Because of the large size of the order and the charitable
nature of the work, the Williamsburg Foundation has asked to
pay only $2.95 each for this candle.
If accepted, what effect would this order have on the
company’s net operating income?
Accept or Reject a Special Order
Your firm has the capacity to produce 10,000 pencils monthly.
It’s December 15th. To date your firm has orders for 8,000
pencils. You don’t anticipate getting any more orders until
next January.
Your cost and revenue information is as follows:
Sales price per pencil
$
10
Variable cost per pencil
3
Total fixed costs
$28,000
Accept or Reject a Special Order
Jack Frost,Mayor of Burnsville, comes to you and says he
would like to give all his staff pencils as Christmas presents,
but doesn’t want to pay a lot for them. He offers you $4 per
pencil for 2,000 pencils.
Should you take this deal?
Accept or Reject a Special Order
What if, instead, Jack Frost says he will give you $4 per
pencil for 4,000 pencils.
Should you take this deal?
Scarce Resource Constraint
A company has two products: a plain cellular
phone and a fancier cellular phone with many
special features:
Selling price
Variable costs
Contribution margin
Contribution-margin ratio
Plain
Phone
$ 80
64
$ 16
20%
Fancy
Phone
$ 120
84
$ 36
30%
Scarce Resource Constraint
Suppose annual demand for phones of both types is more than
the company can produce in the next year.
Only 10,000 hours of capacity are available
If in one hour plant workers can make either three plain
phones or one fancy phone, which phone is more profitable?
Scarce Resource Constraint
1. Units per hour
2. Contribution margin per unit
Contribution margin per hour
Total contribution for
10,000 hours
Plain
Phone
3
Fancy
Phone
1
$16
$36
Pop Quiz 
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only be
able to supply 2,000 board feet this month. Is this
enough hardwood to satisfy demand?
a. Yes
b. No
Pop Quiz 
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only be able to
supply 2,000 board feet this month. What plan would
maximize profits?
a. 500 chairs and 100 tables
b. 600 chairs and 80 tables
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
Joint Products
Joint
Costs
Joint
Input
Common
Production
Process
Oil
Gasoline
Chemicals
Split-Off
Point
Separate
Processing
Final
Sale
Final
Sale
Separate
Processing
Separate
Product
Costs
Final
Sale
Joint Processing
of Cocoa Bean
Cocoa beans
costing $500
per ton
Joint Production
process costing
$600 per ton
Total joint cost:
$1,100 per ton
Cocoa butter
sales value
$750 for
1,500 pounds
Split-off point
Cocoa powder
sales value
$500 for
500 pounds
Separable
process
costing
$800
Instant cocoa
mix sales value
$2,000 for
500 pounds
Joint Products
Relative Sales Value Method
Joint
Costs
$
Sales Value Relative
Joint Products at Split-Off Proportion
Cocoa Butter $
750
60%
1,100
Cocoa Powder
500
40%
$
1,250
100%
Allocation
of Joint
Costs
$
660
440
$
1,100
Sell or Process Further?
Joint processing leads to cocoa butter and cocoa beans.
Cocoa butter is sold at the end of the joint processing.
Cocoa powder may be sold now or processed into instant
cocoa mix. Further processing costs of $800 will be
incurred if the company elects to make instant cocoa
mix.
Should the cocoa powder be processed into
instant cocoa mix?
Joint Products - Practice
The wood spirits company produces two products, turpentine
and methanol, by a joint process.
Joint costs are $120,000 per batch of output. Each batch
totals 10,000 gallons, 25% methanol and 75% turpentine.
At split-off, methanol sells for $21/gallon and turpentine sells
for $14/ gallon.
Joint Products - Practice (continued)
The company has discovered an new process by which the
methanol can be made into a pleasant-tasting beverage.
The selling price for this beverage would be $40 per gallon.
The additional processing would cost $12 per gallon s and the
company would have to pay excise taxes of 20% on the
selling price.
Should the company undertake further processing?