Weygandt, Kieso, & Kimmel: Managerial Accounting
Weygandt, Kieso, & Kimmel: Managerial Accounting
Weygandt, Kieso, & Kimmel: Managerial Accounting
Prepared by
Karleen Nordquist..
The College of St. Benedict...
and St. John’s University...
with contributions by
Marianne Bradford..
The University of Tennessee...
Gregory K. Lowry….
Macon Technical Institute…..
Incremental Analysis
Chapter 9
Incremental Analysis
After studying this chapter, you should be able to:
1 Identify the steps in management’s decision-making
process.
2 Describe the concept of incremental analysis.
3 Identify the relevant costs in accepting an order at a
special price.
4 Indicate the relevant costs in a make-or-buy decision.
5 Give the decision rule in deciding whether to sell or
process materials further.
Chapter 9
Incremental Analysis
After studying this chapter, you should be able to:
6 Identify the factors to be considered in retaining or
replacing equipment.
7 Explain the factors that are relevant in deciding
whether to eliminate an unprofitable segment.
8 Explain the term “sales mix” and its effects in
determining break-even sales.
9 Determine sales mix when a company has limited
resources.
Preview of Chapter 9
Decision-Making Process
• Incremental Analysis Approach
• How Incremental Analysis
Works
Types of Incremental Analysis
INCREMENTAL • Accept an Order at a Special
ANALYSIS Price
• Make or Buy
• Sell or Process Further
• Retain or Replace Equipment
• Eliminate an Unprofitable
Segment
Preview of Chapter 9
Sales Mix
• Break-even Sales
• Limited Resources
INCREMENTAL
ANALYSIS
Other Considerations
• Qualitative Factors
• Incremental Analysis and ABC
Study Objective 1
Question:
Sunbelt has an offer from Mexico Co.
to purchase an additional 2,000
blenders at $11 per unit. Acceptance
of this offer would not affect normal
sales of the product, and the
additional units can be manufactured
without increasing plant capacity.
Accept an Order at a
Special Price: Incremental Analysis
If management makes its decision on the basis of total cost per unit of
$12 ($8 + $4), the order would be rejected, because costs ($12) would
exceed revenues ($11) by $1 per unit. However, since the units can be
produced within existing plant capacity, the special order will not
increase fixed costs. The relevant data for the decision, therefore, are the
variable manufacturing costs per unit of $8 and the expected revenue of
$11 per unit.
Reject Accept Net Income
Order Order Increase (Decrease)
Revenues $ -0- $22,000 $ 22,000
Costs -0- 16,000 (16,000)
Net income $ -0- $ 6,000 $ 6,000 Illustration 9-4
Decision:
Sunbelt will increase its net income by $6,000 when accepting this
special order.
Study Objective 4
Question:
Should Baron make or buy the
ignition switches?
Make or Buy:
Incremental Analysis
At first glance, it appears that management should buy the switches for
$8 instead of make for $9. However, a review of operations indicates that
if the switches are purchased all of Baron’s variable costs, but only
$10,000 of its fixed manufacturing costs, will be eliminated. Thus,
$50,000 of fixed costs will remain. The incremental costs are:
Net Income
Make Buy Increase (Decrease)
Direct materials $ 50,000 $ - 0 - $ 50,000
Direct labor 75,000 -0- 75,000
Variable manufacturing costs 40,000 -0- 40,000
Fixed manufacturing costs 60,000 50,000 10,000
Purchase price -0- 200,000 (200,000)
Illustration 9-6 Total annual cost $225,000 $250,000 $ (25,000)
Decision:
Barton Company will incur $25,000 of additional costs by buying the
switches. Therefore, Barton should continue to make the switches.
Make or Buy with Opportunity
Cost: Incremental Analysis
Assume that through buying the switches, Baron Co. can use the
released productive capacity to generate additional income of
$28,000. This lost income is an additional cost of continuing to
make the switches in the make-or-buy decision. This opportunity
cost is added to the “Make” column, for comparison.
Net Income
Make Buy Increase (Decrease)
Total annual cost $225,000 $250,000 $(25,000)
Opportunity cost 28,000 -0- 28,000
Illustration 9-7 Total cost $225,000 $250,000 $ 3,000
Decision:
It is now advantageous to buy the switches. Barton will save $3,000
worth of costs with this alternative.
Study Objective 5
Decision:
It would be advantageous for Woodmasters to process the tables
further. In this case, the per unit incremental revenue of $10.00 from
the additional processing is $1.60 higher than the per unit incremental
processing costs of $8.40.
Study Objective 6
Question:
Should Jeffcoat Company
retain or replace the machine?
Retain or Replace:
Incremental Analysis
The incremental analysis for the 4-year period is as follows:
Net Income
Retain Replace Increase (Decrease)
Variable manufacturing costs $640,000a $500,000b $140,000
New machine cost 120,000 (120,000)
Total $640,000 $620,000 $ 20,000
Decision:
In this case, it would be to the company’s advantage to replace the
equipment. The lower variable manufacturing costs due to
replacement more than offset the cost of the new equipment.
Study Objective 7
Question:
Should the Champ segment be eliminated?
Eliminate an Unprofitable
Segment
Although it appears that income would increase if the
Champ line was discontinued, it is possible for income
to decrease if Champ was discontinued. The reason is
that the fixed expense allocated to Champ will have to be
absorbed by the other products. To illustrate, assume
that the $30,000 of fixed costs are allocated 2/3 to Pro
and 1/3 to Master. The revised income statement data is:
Decision:
Once again, total net income has decreased $10,000 ($220,000 –
$210,000). This corresponds to the Champ segment’s contribution
margin. Thus, management should not discontinue the Champ
segment unless other lines can recover some or all of the
sales/contribution margin lost by the discontinued segment.
Study Objective 8
Weighted
Average Unit Break-even Point
Fixed Costs
Contribution = in Units
Margin
$200,000 $250 = 800 units
Break-Even Sales
Note that with a sales mix of 3:1, ¾ of the units sold will be
VCRs and ¼ will be TVs. Therefore, in order to break even,
Vargo Video must sell 600 VCRs (¾ x 800) and 200 TVs (¼
x 800). This can be verified by the following:
Deluxe Standard
Contribution margin per unit $8 $6
Machine hours required per unit .4 .2
Question:
Should Collins Co. shift its sales mix
toward deluxe or standard sets?
Limited Resources
Based on the previous data, it might appear that deluxe
is more profitable since they have a higher contribution
margin. However, standard sets take fewer machine
hours. Therefore, it is necessary to find the contribution
margin per unit of limited resource, as shown below:
Deluxe Standard
Contribution margin per unit (a) $8 $6
Machine hours required per unit (b) .4 .2
Decision:
Once again, it is clear that standard sets produce more contribution
margin. Thus, given adequate demand for standard sets, the sales
mix should shift to that product in order to maximize Collins
Company’s income.
Other Considerations in
Decision Making
In this chapter, the focus was primarily
on the quantitative (those attributes
that can be easily expressed in terms of
numbers) factors that affect a decision.
Many of the decisions involving
incremental analysis have important
qualitative features that, while not
easily measured, should not be
ignored.
Other Considerations in
Decision Making
It was noted in Chapter 4 that many
companies have shifted to activity-
based costing (ABC) to allocate
overhead costs to products.
The concepts presented in this chapter
are completely consistent with the use
of ABC. In fact, ABC will result in
better identification of relevant costs,
and therefore, better incremental
analysis.
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Copyright © 1999 John Wiley & Sons, Inc. All rights reserved.
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or from the use of the information contained herein.
Chapter 9
Incremental Analysis