Professional Documents
Culture Documents
McGraw-Hill/Irwin
McGraw-Hill/Irwin
1
2
3
4
5
6
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
McGraw-Hill/Irwin
1
2
3
4
5
6
7
8
9
10
11
12
13
McGraw-Hill/Irwin
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
$ 0.026
$
104
????
$
40
????
????
$
25
McGraw-Hill/Irwin
McGraw-Hill/Irwin
$ 23.00
29.90
11.96
50.00
$ 114.86
McGraw-Hill/Irwin
Note
Do not underestimate the importance and
power of the relevant cost idea.
$90,000
$345,000
$300,000
45,000 180,000
200,000
210,000
140,000
Costs
McGraw-Hill/Irwin
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
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
3,000
65,000
30,000
(3,000)
(3,000)
12,000
McGraw-Hill/Irwin
$
$
15,000
(3,000)
12,000
Adding/Dropping Segments
One of the most important decisions
managers make is whether to add or
drop a business segment such as a
product or a store.
Adding/Dropping Segments
Due to the declining popularity of digital
watches, Lovell Companys digital
watch line has not reported a profit for
several years. An income statement for
last year is shown on the next screen.
McGraw-Hill/Irwin
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
Less: variable expenses
Variable manufacturing costs
Variable shipping costs
Commissions
Contribution margin
Less: fixed expenses
General factory overhead
Salary of line manager
Depreciation of equipment
Advertising - direct
Rent - factory space
General admin. expenses
Net operating loss
McGraw-Hill/Irwin
$ 500,000
$ 120,000
5,000
75,000
$ 60,000
90,000
50,000
100,000
70,000
30,000
200,000
$ 300,000
400,000
$ (100,000)
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
$ 500,000
Less: variable expenses
Investigation
has
Investigation
has revealed
revealed
that
total fixed
fixed general
general
Variable manufacuring
coststhat
$ total
120,000
Variablefactory
shippingoverhead
costs
5,000
and
factory
overhead
and general
general
Commissions expenses would not
75,000
200,000
administrative
be
affected
ifif
administrative
expenses
would
not
be
affected
Contribution margin
$ 300,000
the
digital
watch
the
digital
watch line
line is
is dropped.
dropped. The
The fixed
fixed
Less:
fixed
expenses
general
factory
overhead
general
General
factory
overhead
$ and
60,000
general
factory
overhead
and
general
Salary of line manager
90,000
administrative
expenses
to
administrative
expenses assigned
assigned
to this
this product
product
Depreciation of equipment
50,000
would
to
product
would be
be -reallocated
reallocated
to other
other100,000
product lines.
lines.
Advertising
direct
Rent - factory space
70,000
General admin. expenses
30,000
400,000
Net operating loss
$ (100,000)
McGraw-Hill/Irwin
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
$ 500,000
Less: variable expenses
Variable
manufacturing
costs
$ 120,000
The
equipment
used
manufacture
The
equipment
used to
to
manufacture
Variable shipping costs
5,000
digital
digital watches
watches has
has no
no resale
resale
Commissions
75,000
200,000
value
or
Contribution
margin
$ 300,000
value
or alternative
alternative use.
use.
Less: fixed expenses
General factory overhead
$ 60,000
Salary of line manager
90,000
Depreciation of equipment
50,000
Should
retain or drop
Should Lovell
Lovell
Advertising - direct
100,000 retain or drop
the
watch
Rent - factory space
the digital
digital70,000
watch segment?
segment?
General admin. expenses
30,000
400,000
Net operating loss
$ (100,000)
McGraw-Hill/Irwin
McGraw-Hill/Irwin
McGraw-Hill/Irwin
$ (300,000)
260,000
$ (40,000)
Comparative Income
Approach
The Lovell solution can also be obtained
by preparing comparative income
statements showing results with and
without the digital watch segment.
McGraw-Hill/Irwin
McGraw-Hill/Irwin
McGraw-Hill/Irwin
McGraw-Hill/Irwin
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Difference
$ (500,000)
120,000
5,000
75,000
200,000
(300,000)
90,000
100,000
70,000
260,000
$ (40,000)
McGraw-Hill/Irwin
McGraw-Hill/Irwin
McGraw-Hill/Irwin
McGraw-Hill/Irwin
9
5
1
3
2
10
$ 30
McGraw-Hill/Irwin
$ 25
Direct materials
Direct labor
Variable overhead
Depreciation of equip.
Supervisor's salary
General factory overhead
Total cost
9
5
1
3
2
10
$ 30
$ 500,000
The
The special
special equipment
equipment has
has no
no resale
resale
value
value and
and is
is aa sunk
sunk cost.
cost.
McGraw-Hill/Irwin
$ 25
Direct materials
Direct labor
Variable overhead
Depreciation of equip.
Supervisor's salary
General factory overhead
Total cost
9
5
1
3
2
10
$ 30
$ 500,000
Not
Not avoidable;
avoidable; irrelevant.
irrelevant. IfIf the
the product
product is
is dropped,
dropped, itit
will
will be
be reallocated
reallocated to
to other
other products.
products.
McGraw-Hill/Irwin
$ 25
Direct materials
Direct labor
Variable overhead
Depreciation of equip.
Supervisor's salary
General factory overhead
Total cost
9
5
1
3
2
10
$ 30
$ 500,000
McGraw-Hill/Irwin
The
The sunk
sunk costs
costs (depreciation)
(depreciation)
The
The future
future costs
costs that
that will
will not
not differ
differ between
between
making
making or
or buying
buying the
the parts
parts (common
(common costs)
costs)
McGraw-Hill/Irwin
Special Orders
Special Orders
$8 variable cost
McGraw-Hill/Irwin
Special Orders
If Jet accepts the offer, net operating income
will increase by $6,000.
Increase
Increase
Increase
$ 30,000
24,000
$ 6,000
Quick Check
Northern Optical ordinarily sells the X-lens for
$50. The variable production cost is $10, the
fixed production cost is $18 per unit, and the
variable selling cost is $1. A customer has
requested a special order for 10,000 units of the
X-lens to be imprinted with the customers logo.
This special order would not involve any selling
costs, but Northern Optical would have to
purchase an imprinting machine for $50,000.
(see the next page)
McGraw-Hill/Irwin
Quick Check
What is the rock bottom minimum price below
which Northern Optical should not go in its
negotiations with the customer? In other words,
below what price would Northern Optical
actually be losing money on the sale? There is
ample idle capacity to fulfill the order.
a. $50
b. $10
c. $15
d. $29
McGraw-Hill/Irwin
Quick Check
What is the rock bottom minimum price below
Variable production cost
$100,000
which Northern Optical should not go in its
Additional fixed cost
50,000
negotiations with the customer? In other words,
Total relevant cost
$150,000
below what price would Northern Optical
Number of units
10,000
actually be losing money on the sale? There is
Average cost per unit
$15
ample idle capacity to fulfill the order.
a. $50
b. $10
c. $15
d. $29
McGraw-Hill/Irwin
End of Chapter 13
McGraw-Hill/Irwin