incremental analysis 2

8/9/2019 Incremental Analysis 2

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Incremental Analysis

Making decisions is an important management function.

Does not always follow a set pattern.

Decisions vary in scope, urgency, and importance.

In making business decisions,

Considers both nancial and non-nancial information:

Financial information

Revenues and costs, and

Eect on overall protability.

Incremental Analysis Approach

Decisions involve a choice among alternative actions.

!rocess used to identify the nancial data that change under

alternative courses of action.

"oth costs and revenues may vary or

#nly revenues may vary or

#nly costs may vary

How Incremental Analysis Works

Non!nancial information

Eect on employee

turnover$he nvironment


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%ncremental revenue is &'(,))) lessunder *lternative ".

%ncremental cost sa"ingsof &+),))) is realied.

*lternative " produces #$,%%% more net income.

Important concepts used in incremental analysis&

'- Relevant cost. +- #pportunity cost. - un/ cost.

How Incremental Analysis Works

ometimes involves changes that seem contrary to

intuition.

0ariable costs sometimes do not change under alternatives.

1i2ed costs sometimes change between alternatives.

%ncremental analysis not the same as C0! analysis.

'ypes of Incremental Analysis &

'. *ccept an order at a special price.

+. 3a/e or buy component parts or nished products.

. ell or process further them further

4. Repair, retain, or replace e5uipment.

(. Eliminate an unprotable business segment or product.

Accept an (rder at a )pecial *rice- #btain additional business by ma/ing a ma6or price concession to a

specic customer.- *ssumes that sales of products in other mar/ets are not aected by

special order.- *ssumes that company is not operating at full capacity


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+Accept an (rder at a )pecial *rice

'- unbelt Company produces ')),))) moothie blenders per month,

which is 7)8 of plant capacity. 0ariable manufacturing costs are &7 per unit.

1i2ed manufacturing costs are &4)),))), or &4 per unit. $he blenders are

normally sold directly to retailers at &+) each. unbelt has an oer from

9ensington Co. a foreign wholesaler; to purchase an additional +,)))

blenders at &'' per unit. *cceptance of the oer would not aect normal

sales of the product, and the additional units can be manufactured without

increasing plant capacity. What should management do

Fi-ed costsdo not change since within e2isting capacity < thus 2ed

costs are not rele"ant.

ariable manufacturing costsand e2pected revenues change < thus

both are rele"antto the decision.

+- Cobb Company incurs costs of &+7 per unit &'7 variable and &')

2ed; to ma/e a product that normally sells for &4+. * foreign

wholesaler oers to buy (,))) units at &+( each. Cobb will incur

additional shipping costs of &' per unit. Compute the increase or

decrease in net income Cobb will realie by accepting the special

order, assuming Cobb has e2cess operating capacity. hould Cobb

Company accept the special order=


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/Make or buy component parts or !nished products.

'- "aron Company incurs the following annual costs in producing +(,)))

ignition switches for motor scooters.

%nstead of ma/ing its own switches, "aron Company might purchase theignition switches at a price of &7 per unit. 1i2ed costs will reduced by &

'),))). 0What should management do1

$otal manufacturing cost is &' higher per unit than purchase price.

3ust absorb at least &(),))) of 2ed costs under either option

(pportunity 2ost$he potential bene!tthat may be obtained from following an

alternative course of action.

+- *ssume that through buying the switches, "aron Company can use the

released productive capacity to generate additional income of &7,)))

from producing a dierent product. $his lost income is an additional

cost of continuing to ma/e the switches in the ma/e-or-buy decision.


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- >uanita Company must decide whether to ma/e or buy some of its

components for the appliances it produces. $he costs of producing

'??,))) electrical cords for its appliances are as follows:

Direct materials &@),))) 0ariable overhead &+,)))

Direct labor +),))) 1i2ed overhead +4,)))

%nstead of ma/ing the electrical cords at an average cost per unit of &'.))

&'??,))) A '??,)));, the company has an opportunity to buy the cords at

&).@) per unit. %f the company purchases the cords, all variable costs and

one-fourth of the 2ed costs will be eliminated.

a; !repare an incremental analysis showing whether the company

should ma/e or buy the electrical cords.b; Bill your answer be dierent if the released productive capacity

will generate additional income of &(,)))=

3a4 *repare an incremental analysis showing whether the company

should make or buy the electrical cords.

>uanita Company will incur &',4)) of additional costs if it buys the electrical

cords rather than ma/ing them.

3b4 Will your answer be di5erent if the released producti"e capacity

will generate additional income of #$,%%%


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es, net income will be increased by &,?)) if >uanita Company purchasesthe electrical cords rather than ma/ing them.

6)ell or process them further

3ay have option to sell product at a given point in production or to

process further and sell at a higher price.

7ecision 8ule:

!rocess further as long as the incremental revenue from suchprocessing e2ceeds the incremental processing costs.

+ ell or !rocess 1urther - ingle-!roduct Case

Boodmasters %nc. ma/es tables. $he cost to manufacture an unnished

table is &(. $he selling price per unnished unit is &(). Boodmasters has

unused capacity that can be used to nish the tables and sell them at &?)

per unit. 1or a nished table, direct materials will increase &+ and direct

labor costs will increase &4. 0ariable manufacturing overhead costs willincrease by &+.4) ?)8 of direct labor;. o increase is anticipated in 2ed

manufacturing overhead.

'he incremental analysis on a per unit basis is as follows.


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hould Boodmasters sell or process further=

+-ell or !rocess 1urther - 3ultiple-!roduct Case>oint product situation for 3arais Creamery. Cream and s/im mil/ are

products that result from the processing of raw mil/.

>oint product costs are sunk costsand thus not relevant to the sell-or-

process further decision.

2ost and re"enue data per day for cream.


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Determine whether the company should simply sell the cream or

process it further into cottage cheese. *nalysis of whether to sell cream or process into cottage cheese.

3arais should or should not process the cream further=

2ost and re"enue data per day for skim milk.

Determine whether the company should sell the s/im mil/ or process it

further into condensed mil/.

*nalysis of whether to sell s/im mil/ or process into condensed mil/.

3arais should or should not process the mil/ further=


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+/$,%%% , and the old unit could be


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11/12

imon 1orest Corporation operates two divisions, the $imber Division and the Consumer Division.

$he $imber Division manufactures and sells logs to paper manufacturers. $he Consumer Division

operates retail lumber mills which sell a variety of products in the do-it-yourself homeowner

mar/et. $he company is considering disposing of the Consumer Division since it has been

consistently unprotable for a number of years. $he income statements for the two divisions for

the year ended December ', +))+ are presented below:

$imber Division Consumer Division $otal

ales &',()),))) &()),))) &+,))),)))

Cost of goods sold @)),))) (),))) ',+(),)))

ross prot ?)),))) '(),))) F(),)))

elling G administrative e2penses +(),))) '7),))) 4),)))

et income & (),))) &),))); & +),)))

%n the Consumer Division, F)8 of the cost of goods sold are variable costs and )8 of selling and

administrative e2penses are variable costs. $he management of the company feels it can save

&?),))) of 2ed cost of goods sold and &(),))) of 2ed selling e2penses if it discontinues

operation of the Consumer Division.

Instructionsa; Determine whether the company should discontinue operating the Consumer Division.

b; %f the company had discontinued the division for +))+, determine what net income would

have been.

a; C#H3ER D%0%%#

et %ncome

Continue Eliminate %ncrease

Decrease;

ales &()),))) &-)-

&()),)));

0ariable e2penses:

Cost of goods sold +4(,))) *; -)- +4(,)))

elling and admin. e2p. (4,))) "; -)- (4,)))

Contribution margin +)',))) -)- +)',)));

1i2ed e2penses:

Cost of goods sold ')(,))) C; 4(,))) ?),)))

elling and admin. e2p. '+?,))) D; F?,))) (),)))

et income & ),))); &'+',))); & @',)));

*; &(),))) I F)8 J &+4(,))) C; &(),))) < &+4(,))) J &')(,)))

"; &'7),))) I )8 J &(4,))) D; &'7),))) < &(4,))) J &'+?,)))

$he company should continue the Consumer Division because contribution margin, &+)',))), is

greater than the avoidable 2ed costs, &''),))).


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b; et income for the total company would have been &+(@,)))

$imber Division K Decrease in et %ncome&(),))) K &@',))); J &+(@,)))

incremental analysis 2

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