CHAPTER Chapter 8 – Using Accounting Information to Make Managerial Decisions

8 Using Accounting Information to

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Make Managerial Decisions

Learning Objectives

1. Identify relevant information for decision making. (Unit 8.1)

2. Determine the qualitative and quantitative impacts of special-order pricing. (Unit 8.2)
3. Determine the qualitative and quantitative impacts of outsourcing decisions. (Unit 8.3)
4. Determine how to allocate constrained resources to maximize income. (Unit 8.4)
5. Calculate the effects on operating income of keeping or eliminating operations. (Unit 8.5)

Summary of End of Chapter Material

Difficulty: E = Easy, M = Moderate, D = Difficult
Bloom: K = Knowledge, C = Comprehension, AP = Application, AN = Analysis, S = Synthesis, E = Evaluation
AACSB: A = Analytic, C = Communication, E = Ethics
AICPA FN: DM = Decision modeling, RA = Risk Analysis, M = Measurement, R = Reporting, RS = Research, T = Technology
AICPA PC: C = Communication, I = Interaction, L = Leadership, P = Professional demeanor, PM = Project Management,
PS = Problem Solving and Decision Making, T = Technology
IMA: BA = Business applications, BP = Budget Preparation, CM = Cost Management, DA = Decision Analysis,
PM = Performance Measurement, R = Reporting, SP = Strategic Planning

Item L. O. Difficulty Minutes to Bloom’s AACSB AICPA AICPA IMA Ethics

Level Complete Taxonomy FN PC Coverage
GUIDED UNIT PREPARATION
Unit 8.1
1 1 E 2 K A DM PS DA
2 1 M 4 K, C A DM PS DA
3 1 M 3 K A DM PS DA
Unit 8.2
1 2 M 4 C A DM PS DA
2 2 D 2 C A DM PS DA
3 2 D 4 C A DM PS DA
4 2 E 2 C A DM PS DA
Unit 8.3
1 3 M 2 K A DM PS DA
2 3 D 4 K A DM PS DA
3 3 E 3 K A DM PS DA
Unit 8.4
1 4 M 2 C A DM PS DA
2 4 M 2 C A DM PS DA
3 4 D 3 C A DM PS DA
4 4 E 1 K A DM PS DA
5 4 M 3 C A DM PS DA
Unit 8.5
1 5 M 2 C A DM PS DA
2 5 E 1 K A M PS DA
3 5 M 4 K, C A M PS DA
4 5 M 2 C A DM PS DA

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Item L. O. Difficulty Minutes to Bloom’s AACSB AICPA AICPA IMA Ethics

Level Complete Taxonomy FN PC Coverage
EXERCISES
8-1 1 M 12 AP A M PS DA
8-2 1 D 12 AP, AN A M, DM PS DA
8-3 1 D 15 AP, AN A DM PS DA
8-4 2 M 10 AP A M, DM PS DA
8-5 2 D 10-15 AP A M, DM PS DA
8-6 2 M 10-15 AP, AN A M PS DA
8-7 2 D 15 AP A M, DM PS DA
8-8 3 E 10-15 AP, AN A M, DM PS DA
8-9 3 M 10-15 AP, AN A M, DM PS DA
8-10 3 M 10 AP, AN A M, DM PS DA
8-11 3 D 15-20 AP, AN A M, DM PS DA
8-12 4 E 10-15 AP A M, DM PS DA
8-13 4 M 15 AP A M, DM PS DA
8-14 4 M 15 AP A M, DM PS DA
8-15 4 M 15-20 AP, AN A M, DM PS DA
8-16 5 E 10- AN A DM PS DA
8-17 5 E 10-15 AP, AN A M, DM PS DA
8-18 5 E 10 AP, AN A M, DM PS DA
8-19 5 M 15-20 AP, AN A M, DM PS DA
PROBLEMS
8-20 2 M 25-30 AP, AN A M, DM PS DA
8-21 2 D 40-45 AP, AN A M, DM PS DA
8-22 1, 3 M 20-25 AP, AN, C A M, DM PS DA
8-23 3 E 10 AP, AN A M, DM PS DA
8-24 3 M 15-20 AP, AN A M, DM PS DA
8-25 2, 3 D 20 AP, AN A M, DM PS DA
8-26 4 D 30-35 AP, AN A M, DM PS DA
8-27 4 D 35-40 AP, AN A M, DM PS DA
8-28 3, 4 M 30 AP A M, DM PS DA
8-29 5 M 20-25 AP, AN A M, DM PS DA
8-30 5 E 30-35 AP, AN, E A M, DM PS DA
C&C CONTINUING CASE
8-31 4 D 45-50 AP, AN, E A M, DM PS DA
CASES
8-32 1 D 50-55 AP, AN, E A M, DM PS DA
8-33 2, 3, D 55-60 AP, AN, E A M, DM PS DA
5
8-34 3 D 25-30 AP, AN, E E R C BA 

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SOLUTIONS TO GUIDED UNIT PREPARATION

Unit 8.1

1. To be relevant, information must pertain to the future and differ

between the alternatives under consideration.

2. Avoidable costs are those that occur only when a particular decision
is made. Unavoidable costs are those that are unaffected by a
decision. For example, when deciding whether to continue to live in
your current apartment or to rent one closer to work, the additional
gas costs are avoidable but your car insurance is unavoidable.

3. A sunk cost is a cost that has occurred in the past; there is nothing
that can be done to affect the cost. So sunk costs are never relevant
to a future decision. However, sunk costs can be informative as they
illustrate the results of prior decisions.

Unit 8.2

1. A company may be willing to sell its products at a price lower than

normal for several reasons. Perhaps there is excess production
capacity that would otherwise be unused, or the customer may be
placing a one-time order. The order may be for a product of lower
quality, or it may be for a large quantity.

2. If a business always has excess capacity to accept special orders,

managers might consider selling the unused assets to reduce
capacity, and thus fixed costs.

3. The company should compare the contribution margin earned on the

special order to the contribution margin that will be lost from the
regular orders that cannot be filled if the special order is accepted.
Even if the financial result of the special order is positive, managers
must consider the impact of not providing products to its existing
customers and whether that will impact future business.

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4. The minimum price that a business can charge for a special order
without losing money on the order is the total relevant cost of the
special order.

Unit 8.3

1. While any process or input can be outsourced, companies generally

concentrate on outsourcing those that are not core competencies or
strategic advantages for the firm.

2. Information about the avoidable relevant cost to make the product or

deliver the service must be compared to the cost to outsource the
product or service. In addition, information about alternative uses of
the freed-up capacity must be considered. Finally, various qualitative
issues, such as the transfer of technological risk and the sharing of
confidential information must be considered.

3. An opportunity cost is the cost of the next best alternative. In an

outsourcing decision, the alternative use of freed-up capacity is an
opportunity cost of not outsourcing and continuing to produce the
product or deliver the service internally.

Unit 8.4

1. Any resource can be a constraint. Among the more common

constraints are machine hours, labor hours, and direct materials.

2. The best way to allocate a constrained resource is on the basis of the

contribution margin per unit of constrained resource.

3. Production is planned to meet customer demand. Therefore, even if

a product has the highest contribution margin per unit of constrained
resource, production should not be greater than the number of units
customers will purchase.

4. A bottleneck is a production process that limits total output.

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5. A bottleneck can be alleviated by purchasing additional machinery,

hiring additional workers, decreasing the amount of time the process
requires, or reducing the number of defects.

Unit 8.5

1. Managers are often motivated to consider eliminating an operation or

product line when it shows a net loss, particularly if the net loss
occurs for several periods.

2. Segment margin is contribution margin minus direct fixed costs.

3. An allocated cost is a cost that is incurred to benefit the entire

organization and thus is not directly traceable to specific segments of
the business. These costs are also referred to as common costs. If a
cost object, such as a product line, is eliminated, total allocated costs
do not change, and they are reallocated to the remaining segments.

4. Managers should continue to produce the product until a better use of

resources is found.

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SOLUTIONS TO EXERCISES

Exercise 8-1

Operating cost of old machine $10,000 Relevant

Production of old machine 50,000 units Relevant
Purchase price of old machine $200,000 Irrelevant
Loan balance $125,000 Irrelevant
Market value of old machine $70,000 Relevant
Cost of new machine $220,000 Relevant
Production of new machine 85,000 units Relevant
Operating cost of new machine $12,000 Relevant

Exercise 8-2

a. Scrap (throw away) the defective units

Rework and sell for $100 per unit
Sell to liquidation company as is for $80 per unit

b. The $100,000 book value of the defective units

c. Scrap = $0
Rework = ($100 - $10) per unit  500 units = $45,000
Sell to liquidation company = $80 per unit  500 units = $40,000

Rework and sell generates the best financial result.

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Exercise 8-3

a.
Stat-Max Buy Tracker
Purchase price $912,000 $500,000
Programmer hours 80 hours 125 hours
Annual License fee $0 $10,000
Technical support 24-hour 8 a.m. – 5 p.m. CST

not relevant: disk storage space and hours of user training

b. Other information you would want to know includes ease of report

customization, customer satisfaction/testimonies, frequency of
upgrades, and other potential future costs.

c. The out-of-pocket cost will be more than the relevant cost due to the
cost of purchasing the disk storage space.

Exercise 8-4

Avoidable costs of the special order:

Variable costs $15,000
Machine rent 21,000
$36,000

They should charge $36,000 at a minimum. Any amount over that

will increase the company’s operating income.

Exercise 8-5

Since Byways only has capacity to produce 2,000 units, it will have to
give up 3,000 units of its regular sales to complete the special order.

Special order contribution margin ($75 – $65)  5,000 units $50,000

Lost contribution margin ($100 – $65)  3,000 units (105,000)
($55,000)

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Byways’ net income will decrease by $55,000 if it accepts the special

order.
Exercise 8-6

Sales price $35

Variable costs per unit:
Direct materials 6
Direct labor 4
Variable overhead ($15  .4) 6
Total variable costs 16
Contribution margin $19  15,000 pairs = $285,000

Lybrand’s income will increase by $285,000

Exercise 8-7

Relevant cost to produce:

Variable manufacturing costs $880,000
Variable selling and administrative costs 128,000
Total relevant costs to produce $1,008,000
Units produced  16,000
Cost per unit $63

Contribution margin per unit = $60 – $63 = ($3)

If the company produces and sells 1,500 helmets to the American

Motorcycle Club at $60 per helmet, operating income will decrease by
$4,500 (1,500 helmets  $3).

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Exercise 8-8

a. Direct Materials $2
Direct Labor 3
Variable Overhead 4
Relevant cost to make $9

Outland should continue to make as the relevant cost to make ($9) is

less than the cost to buy ($12).

b.
Make Buy
Total relevant cost to make $9  1,000 = $9,000
Total cost to buy $12  1,000 = $12,000
Contribution margin from released facilities (5,000)
Net cost to buy $7,000

Now it makes financial sense to buy the parts and use the facilities to
earn an additional $5,000 in contribution margin.

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Exercise 8-9

a.
Make Buy
Direct materials $3
Direct labor 4
Variable overhead 1
Relevant cost per unit to make $8
Cost to buy $12
Units needed  5,000  5,000
Total variable cost $40,000 $60,000
Additional fixed costs to make 28,000 -
Total cost $68,000 $60,000

The company should continue to purchase the tires.

b. Qualitative factors to consider include:

 the quality of the purchased tires as compared to those it could
make
 the relationship with the supplier of the tires – consistent, timely
delivery of tires and future price increases
 the strain on the manufacturing facility by adding additional
production

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Exercise 8-10

Make Buy
Direct materials $5
Direct labor 12
Variable overhead 8
Avoidable fixed costs ($10  .4) 4
Relevant cost per unit to make $29
Cost to buy $32
Units needed  5,000  5,000
Total cost $145,000 $160,000
Contribution margin from released facilities (10,000)
Net cost $150,000

Do not accept offer. Financially, Kansas is $5,000 better off making the
part.

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Exercise 8-11

a.
Operate cafeteria
Meal revenue ($5/meal  5,000 meals  12 months) $300,000
Relevant cost to operate ($180,000 + $90,000 + $12,000) (282,000)
Relevant contribution from cafeteria operations $ 18,000

Outsourced cafeteria
Meal revenue ($.50/meal  5,000 meals  12 months) $30,000

Merit Bay should accept Best Ever’s offer since the net result is
higher under the outsourcing option.

b. Assuming the same relative costs, the food cost per meal is $3.00
($180,000 / 60,000 meals). Each worker costs $18,000 per year
($90,000 / 5 workers).

Operate cafeteria
Meal revenue ($5/meal  1,000 meals  12 months) $60,000
Food costs ($3/meal  1,000 meals  12 months) (36,000)
Worker salaries ($18,000  3) (54,000)
Fixed operating costs (12,000)
Net loss ($42,000)

Outsourced cafeteria
Meal revenue ($.50/meal  1,000 meals  12 months) $6,000

The company should not resume the operation of the cafeteria.

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Exercise 8-12

Small Mediu Large

m
Contribution margin per unit $ 2.00 $ 3.00 $ 4.00
Machine hours per unit  1.00  2.40  3.00
Contribution margin/machine hour $ 2.00 $ 1.25 $ 1.33
Preference ranking #1 #3 #2

Produce Hours per unit Hours used Hours available

2,000
Small 500 1 500 1,500
Large 500a 3 1,500 0
Medium 0
a
Since only 1,500 hours remain to make large balloons, and it takes 3 hours to make a large balloon,
only 500 larges can be made (1,500  3).

Exercise 8-13

A B C
Sales price per unit $ 3.00 $ 5.00 $16.00
Variable costs per unit 1.20 3.40 10.00
Contribution margin per unit 1.80 1.60 6.00
Labor hours per unit  1.20  .50  5.00
Contribution margin/labor hour $ 1.50 $ 3.20 $ 1.20
Preference ranking #2 #1 #3

Produce Hours per unit Hours used Hours available

1,800
B 600 .50 300 1,500
A 500 1.20 600 900
C 180a 5.00 900 0
a
Since only 900 hours remain to make product C, and it takes 5 hours to make one C, only 180 Cs
can be made (900  5).

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Exercise 8-14

a.
Banner Kites
s
Sales price per unit $12.00 $15.00
Variable costs per unit 9.00 14.00
Contribution margin per unit 3.00 1.00
Machine hours per unit  1.00  .25
Contribution margin/machine hour $ 3.00 $ 4.00
Preference #2 #1

Produce Hours per unit Hours used Hours available

1,000
Kites 1,200 .25 300 700
Banners 700a 1.00 700 0
a
Since only 700 hours remain to make Banners, and it takes 1 hour to make one banner, only 700
banners can be made (700  1).

b. Managers need to rent machines so that 2,300 additional machine

hours are available.

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Exercise 8-15

a.
Chocolate Chip Sugar Oatmeal Raisin
Sales price $130 $110 $130
Variable cost 81 62 88
Contribution margin $ 49 $ 48 $ 42

Make and sell chocolate chip cookies since they have the highest
contribution margin per batch.

b. (12,000 × $49) + (8,000 × $48) + (10,000 × $42) = $1,392,000

c.
Chocolate Chip Sugar Oatmeal Raisin
Contribution margin $ 49 $ 48 $ 42
÷ lbs. flour per batch ÷2 ÷2 ÷ 1.5
Contribution margin/lb. $24.50 $24.00 $28.00
Production order 2 3 1

Flour Remaining
50,000 lbs.
Oatmeal Raisin 10,000 batches × 1.5 lbs. = 15,000 lbs. used 35,000 lbs.
Chocolate Chip 12,000 batches × 2 lbs. = 24,000 lbs. used 11,000 lbs.
Sugar 5,500a batches × 2 lbs. = 11,000 lbs. used 0 lbs.
a
11,000 lbs. available ÷ 2 lbs. flour per batch

CM = (12,000 × $49) + (5,500 × $48) + (10,000 × $42) = $1,272,000

d. Yes, all products using gluten-free flour must be considered.

Allocation of the flour will depend on the contribution margin per
pound of flour generated by the other products.

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Exercise 8-16

There is not a single correct list of desired information; however, the

desired information might include items such as:

 Store segment margin for several years

 Comparable store segment margins for several years
 Projected population growth patterns
 Demographics for the surrounding area of the new stores
 Concentration of other fast food restaurants in the areas of interest

Exercise 8-17

Segment margin of Round:

Sales $6,600
Variable costs 3,000
Contribution margin 3,600
Avoidable fixed costs 1,680 ($4,200  40%)
Segment margin $1,920

Since the Round Game’s segment margin is positive, dropping the

Round Game before the last quarter would have resulted in a lower
operating income:

Operating income with Round $3,250

Lost segment margin without Round (1,920)
Operating income without Round $1,330

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Exercise 8-18

a.
Weak Average Strong Total
Sales $125,00 $350,000 $500,00 $975,000
0 0
Variable expenses 50,00 200,000 300,00 550,000
0 0
Contribution margin 75,000 150,000 200,000 425,000
Direct expenses 30,00 80,000 110,00 220,000
0 0
Segment margin $45,00 $70,000 $90,00 205,000
0 0
Allocated expenses 150,000
Operating income $55,000

b. $45,000 decrease—the segment margin from the Weak Division.

c. It appears that the total allocated expense is split evenly among the
divisions. If Weak is dropped, then $75,000 ($150,000  2) will be
allocated to Average, resulting in a $5,000 loss for the division as
currently reported.

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Exercise 8-19

a.
Sales revenue $200,000
Cost of goods sold
Variable $130,000
Fixed 32,000 162,000
Gross margin 38,000
Operating expenses
Commissions 10,000
Advertising 10,000
Corporate support 25,000 45,000
Operating income ($7,000)

b.
Sales revenue $200,000
Variable expenses
Cost of goods sold $130,000
Commissions 10,000 140,000
Contribution margin 60,000
Traceable fixed expenses
Cost of goods sold 16,000
Advertising 10,000 26,000
Segment margin $ 34,000

c. Luis should use the segment margin income statement. If the

company truly has capacity to absorb this new product line, then the
company’s operating income will increase by the segment margin.

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SOLUTIONS TO PROBLEMS

Problem 8-20

a. The variable cost of Andrea’s special order is $0.28 per box.

Paper $0.15
Direct labor 0.05
Variable overhead 0.08
Total variable cost per box $0.28

Since the variable cost of $0.28 per box exceeds the sales price of
$0.25 per box that Andrea is willing to pay, Guilford should not accept
the order.

b. With the lighter, cheaper paper, the variable cost per box is $0.23.

Paper $0.10
Direct labor 0.05
Variable overhead 0.08
Total variable cost per box $0.23

Since the sales price of $0.25 per box that Andrea is willing to pay is
greater than the variable cost per box, Guilford should accept the
special order.

c. Sales price on special order = $0.50 × 110% = $0.55

Contribution margin = $0.55 - $0.32 = $0.23 per box

Contribution margin on special order $2,300

Less shipping expenses (800)
Profit on special order $1,500

Guilford should accept the special order since it generates a positive

profit.

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d. Given that the company has excess capacity, Guilford should

consider options to increase sales volume. Andrea is a potential new
customer that Guilford could develop a long-term relationship with, if
she can get to a financial position where she can be a profitable
customer. The company may want to continue to explore cheaper
materials to use in producing a box that Andrea will find acceptable.
Guilford will need to be careful, though, because producing lower
quality boxes may affect the company’s reputation.

The London bakery is unlikely to be a regular customer, but if it does

decide to switch to Guilford, a different arrangement needs to be
made for the excess shipping costs that are incurred, as it is unlikely
that the bakery will pay a premium price for a regular order.

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Problem 8-21

a. The variable costs are the only relevant costs of the special order, so
those amounts need to be calculated first.

Total manufacturing overhead ($23/unit  400,000 units) $9,200,000

Fixed overhead (5,000,000)
Variable overhead $4,200,000
Number of units in budget  400,000
Variable overhead per unit $10.50

Selling and administrative costs ($14/unit  400,000 units) $5,600,000

Fixed selling and administrative costs (3,100,000)
Variable selling and administrative costs $2,500,000
Number of units in budget  400,000
Variable selling and administrative costs $6.25
Distributor’s commission ($140  2%) (2.80)
Remaining variable selling and administrative costs $3.45

Contribution from special order:

Sales ($140  60%) $84.00
Direct materials (37.00)
Direct labor (16.00)
Variable overhead (10.50)
Distributor’s commission ($84  2%) (1.68)
Variable selling and administrative costs (3.45)
Contribution margin $15.37
Number of units  75,000
Total contribution from special order $1,152,750

The financial results suggest that Wayne should grant Nordic’s

request.

b.
 Possibility that Nordic will become a regular customer – supports
request
 Possibility that Nordic will expect a permanent price reduction –
does not support request

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Problem 8-21, continued

 Potential violation of the Robinson-Patman Act – does not support

request
 Current customer dissatisfaction with Nordic paying a lower price –
does not support request

c.
Contribution from special order:
Sales $95.00
Direct materials (37.00)
Direct labor (16.00)
Variable overhead (10.50)
Variable selling and administrative costsa (1.45)
Contribution margin $30.05
Number of units  125,000
Contribution from special order $3,756,250
a
Total S&A costs 400,000 windows × $14 $5,600,000
Less fixed S&A costs 3,100,000
Total variable S&A costs 2,500,000
÷ 400,000 windows
$6.25 per window
Less costs not incurred on special order:
Commission $140 × .02 2.80
Shipping 2.00
Variable S&A cost per unit $1.45 per window

Contribution lost from regular sales:

Sales $140.00
Direct materials (37.00)
Direct labor (16.00)
Variable overhead (10.50)
Distributor’s commission (2.80)
Variable selling and administrative costs (3.45)
Contribution margin $70.25
Number of units  25,000
Contribution lost from regular sales ($1,756,250)
Net contribution from special order $2,000,000

The special order will generate $3,756,250 in additional contribution

margin; however, $1,756,250 in contribution margin will be lost from

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the regular sales that cannot be made if the special order is filled.
The net result of $2,000,000 in additional contribution margin
suggests that Wayne should accept Ryster’s offer.

d.
Contribution from outsourcing windows
Sales $140.00
Purchase price (105.00)
Distribution ($140 × 0.02) (2.80)
Variable selling and administrative costs (3.45)
Contribution margin $28.75
Number of units  25,000
Contribution from outsourcing $718,750

Outsourcing the production of the 25,000 windows needed to fill both

regular orders and the special order generates $718,750 in
contribution margin. Therefore, the financial results suggest that
outsourcing the window production is a good idea.

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Problem 8-22

a.
Appropriate/ Correct/ Explanation
Inappropriate Incorrect
1. Appropriate Correct
2. Inappropriate Since the supervisor is
being transferred, the
salary amount will be
incurred regardless of
the decision. Therefore,
it is non-differential and
not relevant to the
decision.
3. Appropriatea Correct
4. Appropriate Incorrect
5. Appropriate Correct
6. Appropriate Incorrect
7. Appropriate Correct
8. Appropriate Correct
9. Appropriate Incorrect
a
If the company chooses not to outsource, there are two purchasing clerk salaries to pay – the one in the
assembly department and the one in the sales department. If the company chooses to outsource, there is
only one purchasing clerk salary to pay (in the sales department). Therefore, even though the assembly
purchasing clerk is being paid under both scenarios, the cost of the assembly position is relevant since
the net effect of ousourcing is a reduction in total purchasing clerk salaries from the elimination of the
assembly department position.

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b.
Reduction in assembly technicians $1,170,000
$32,500  36
Purchasing clerk transferred 19,000
Storage rental savings 18,000
1,500 sq. ft.  $12/sq. ft
Reduced purchase orders 1,680
1,200 P.O.s  $1.40/P.O.
Increased component cost (5,050,000)
125,000 units ($88 – $36 – $11.60)
Hire junior engineer (28,000)
Hire quality control inspector (26,000)
Storage costs for safety stock (16,250)
125,000 units  $3.25/unit  4% increase
Net annual cost ($3,911,570)

c. Financial stability of vendor

Quality of workmanship
Timeliness of deliveries
Long-term financial evaluation – can’t start production back up easily
Morale of remaining employees

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Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

Problem 8-23

a. The engineers’ time is an unavoidable fixed cost—it won’t be saved if

Benson outsources the design to Longan.

Therefore, the relevant cost to make the module is $50 per unit.
Compared to Longan’s proposed cost of $60, it is better for Benson to
make the unit.

b. Total cost to buy = $60  1,000 = $60,000

Total relevant cost to make = $50  1,000 = 50,000
Savings/return from Benson projects $10,000

The projects that the Benson engineers work on instead of designing

the module would have to save the company $10,000 to make it
worthwhile to outsource the module.

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Problem 8-24

a.
Make Buy
Direct materials $12.00
Direct labor 6.00
Variable overhead 3.00
Salaries ($8 × 30%) 2.40
Relevant cost per unit to make $23.40
Cost to buy $32
Units needed  40,000  40,000
Total cost $936,000 1,280,000

Do not accept Talbert’s offer. It is cheaper for Henry to make the

units.

b.
Make Buy
Direct materials $12
Direct labor 6
Variable overhead 3
Relevant cost per unit to make $21
Cost to buy $32
Units needed  40,000  40,000
Total cost $840,000 $1,280,000
Contribution margin from alternative use of
facilities (($11 - $7)  100,000 units) (400,000)
Net cost $880,000

Do not accept Talbert’s offer. It is still cheaper for Henry to make

the units.

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Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

Problem 8-25

a.
Per unit Ratio
Revenues $18,000 $15.00 100.0%
Variable Costs
Cartons (6,000) (5.00) (33.3%)
Cushioning (600) (.50) (3.3%)
Tape, labels (1,500) (1.25) (8.4%)
Total variable costs (8,100) (6.75) (45.0%)
Contribution margin 9,900 $8.25 55.0
Fixed Costs
Salaried Labor (4,000)
Overhead (4,100)
Total fixed costs (8,100)
Income $1,800

On average, variable costs are $6.75 per unit and the selling price is
$15 per unit. A 20% discount results in an average price of $12,
which is high enough to cover variable costs. Labor is not included
as a variable cost because the workers are paid a fixed salary.

Unless the proportions of the other material costs to sales price vary
widely, it is unlikely that Roger will lose money.

b. If Elizabeth’s work increases the burden on the existing employees by

a sufficient amount, Roger may need to hire additional workers, and
that will reduce his profits. Also, if Elizabeth tells her friends about
the discount, they will likely want one too. Finally, if Elizabeth’s work
creates a backlog for other customers who are used to speedy
service, those customers may decide to use another service provider.

c. Any problems with packing and shipping are still Elizabeth’s

responsibility. She seems to be satisfied with the quality of the work,
as it is, but she needs to articulate her expectations so that she
doesn’t lose money on her side of the business.

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Problem 8-26

a. (4,000 units × .5 MH/unit) + (7,000 units × .8 MH/unit) = 7,600 MH

b.
Dumbbell Rack Weight Bench
Sales price $50 $61
Variable cost 27 29
Contribution margin $23 $32
÷ MH/unit .5 .8
Contribution margin/MH $46 $40
Production order 1 2

MH Remaining
6,000 MH
Dumbbell Rack 4,000 racks × .5 MH = 2,000 MH used 4,000 MH
Weight Bench 5,000a benches × .8 MH = 4,000 MH used 0 MH
a
4,000 MH available ÷ .8 MH per bench

c. CM = (4,000 racks × $23) + (5,000 benches × $32) = $252,000

d. new contribution margin for weight bench = $69 - $29 = $40

new contribution margin per MH = $40 ÷ .8 MH/bench = $50/MH

MH Remaining
6,000 MH
Weight Bench 5,800 benches × .8 MH = 4,640 MH used 1,360 MH
Dumbbell rack 2,720 a racks ×.5 MH = 1,360 MH used 0 MH
a
1,360 MH available ÷ .5 MH per bench

CM = (5,800 benches × $40) + (2,720 racks × $23) = $294,560

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 Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

Problem 8-26, continued

e. new contribution margin for dumbbell rack = $56 - $27 = $29

new contribution margin per MH = $29 ÷ .5 MH/rack = $58/MH

MH Remaining
6,000 MH
Dumbbell Rack 2,000 racks ×.5 MH = 1,000 MH used 5,000 MH
Weight Bench 6,250a benches × .8 MH = 5,000 MH used 0 MH
a
5,000 MH available ÷ .8 MH per bench
CM = (2,000 racks × $29) + (6,250 benches × $32) = $258,000

f. Raising the price of the weight bench results in the greatest total
contribution margin. Because the company is unable to meet so
much demand, Sarah should consider purchasing another machine to
increase capacity.

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Problem 8-27

a.
Hours per Hours
Demand session needed
Math 120 .75 90
Writing 210 1.50 315
Science 100 .50 50
Total 455

Carie cannot satisfy current demand. She only has 350 hours
available to meet total demand of 455 hours.

b.
Math Writing Science
Sales price per session $25.00 $30.00 $15.00
Variable costs per session 13.00 24.00 8.00
Contribution margin per session 12.00 6.00 7.00
Labor hours per session  .75   .50
1.50
Contribution margin/labor hour $16.00 $4.00 $14.00
Preference ranking #1 #3 #2

Sessions Hours per Hours

offered session Hours used available
350
Math 120 .75 90 260
Science 100 .50 50 210
Writing 140a 1.50 210 0
a Since only 210 hours remain to teach the Writing sessions, and it takes 1.5 hours per session, only
140 sessions can be offered (210  1.5).

c.
Sessions Contributio
offered n per Total
session
Math 120 $12 $1,440
Science 100 $7 700
Writing 140 $6 840
$2,980

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Problem 8-27, continued

d.
Students Sessions Hours per Hours
Demand per session needed session needed
Math 120 2 60 .75 45.0
Writing 210 1 210 1.50 315.0
Science 100 4 25 .50 12.5
Total 372.5

Carie still does not have enough capacity to cover all sessions.

Math Writing Science

(2) (1) (4)
Revenue per session $50.00 $30.00 $60.00
Less
Labor costs per session 12.00 22.00 7.00
Supplies cost per session 2.00 2.00 4.00
Contribution margin per session $36.00 $6.00 $49.00
Labor hours per session  .75   .50
1.50
Contribution margin/labor hour $48.00 $4.00 $98.00
Preference ranking #2 #3 #1

Writing still generates the lowest contribution margin per labor hour,
so hours will be allocated first to Science and then Math.

Sessions Hours per Hours

offered session Hours used available
350.00
Science 25 .50 12.50 337.50
Math 60 .75 45.00 292.50
Writing 195a 1.50 292.50 0
a
Since only 292.5 hours remain to teach the Writing sessions, and it takes 1.5 hours per session,
only 195 sessions can be offered (292.5  1.5).

e. Space is now the constrained resource. Carie can lease another

building to get the space she needs. She will need to ensure that the
additional contribution margin generated by the 250 hours (600 –
350) is more than adequate to cover the new lease payments.
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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Problem 8-28

First calculate fixed expenses in total:

Manufacturing overhead ($6.25  8,000) $50,000
Selling and administrative ($7.00  8,000) 56,000
Total fixed expenses $106,000

Option 1:
Per unit
Sales revenue $688,000 $86.00
Variable expenses
Direct materials $136,000 17.00
Direct labor 150,000 18.75
Manufacturing overhead 56,000 7.00
Selling & administrative 80,000 10.00
Total variable expenses 422,000 52.75
Contribution margin 266,000 $33.25
Fixed expenses 106,000
Operating income $160,000

Option 2:
Regular Outsourced Total
Sales revenue $86.00 $86.00
Purchase price $68.00
Direct materials 17.00
Direct labor 18.75
Manufacturing overhead 7.00
Selling & administrative 10.00 10.00
Total variable cost 52.75 78.00
Contribution margin 33.25 8.00
Units sold  8,000  4,000
Total contribution margin $266,000 $32,000 $298,000
Fixed expenses 106,000
Operating income $192,000

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Problem 8-28, continued

Option 3:
Tackle boxes Skateboards Total
Sales revenue $86.00 $45.00
Variable production costs
Purchase price $68.00 22.50
Selling & administrative 10.00 10.00
Total variable cost 78.00 32.50
Contribution margin $8.00 12.50
Units sold  9,000  17,500
Total contribution margin $72,000 $218,750 $290,750
Fixed expenses 106,000
Operating income $184,750

Recap:
Option 1 $160,000
Option 2 $192,000
Option 3 $184,750

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Problem 8-29
a.
A B C Total
Sales revenue $2,20 $1,400 $1,800 $5,400
0
Variable expenses 1,40 800 1,080 3,280
0
Contribution margin 800 600 720 2,120
Less direct fixed expenses
Advertising 630 525 520 1,675
Depreciation 15 10 20 45
Segment margin $ 155 $ 65 $ 180 400
Less common fixed expenses 275
Operating profit $ 125

b. Net income would decrease by $75,000. The $10 depreciation won’t

go away or be saved as a result of eliminating product B.

c. New product contribution margin = $10 - $4 = $6/unit. To be as well

off with the new product as the current product B, the new product
must generate $600,000 in total contribution margin. At a $6/unit
contribution margin, the company would have to sell 100,000
units of the new product.
 $600,000 
 
 $6/unit 

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Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

Problem 8-30

a. If Fenner Road is closed:

Sales revenue ($80,000 × .9) $72,000

Variable expenses ($32,000 × .9) 28,800
Contribution margin 43,200
Less:
Maple Avenue direct fixed expenses 20,000
Remaining Fenner Road direct fixed expenses 10,000
Total common fixed expenses 10,000
Operating income $ 3,200

No, the Fenner Road store should not be closed. Closing the store
will result in monthly operating income of $3,200, which is lower than
the current monthly operating income. The reduced sales at Maple
Avenue and the Fenner Road direct fixed expenses that remain after
closing the store are greater than the current loss reported by the
Fenner Road store.

b. The Maple Avenue store should not be closed since it generates a

$28,000 segment margin each month.

Sales revenue $80,000

Variable expenses 32,000
Contribution margin 48,000
Less direct fixed expenses 20,000
Segment margin $28,000

c. 10% increase in Fenner contribution margin $3,600

($36,000 × 0.10)
Cost of advertising (6,000)
Decrease in operating income with advertising ($2,400)

The advertising campaign should not be implemented as the

contribution margin generated is not sufficient to cover the cost.

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Problem 8-30, continued

d.
Sales at Remaining Total Fenner
Variable Cost Sales Road Sales
Sales $60,000 $60,000 $120,000
Variable expenses 60,000 24,000 84,000
Contribution margin $0 $36,000 $ 36,000

Contribution margin lost on remaining sales ($7,200)

($36,000  20%)
Direct expenses saved ($40,000  15%) 6,000
Decrease in operating income ($1,200)

Management should not implement the changes as operating income

will decrease.

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Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

SOLUTIONS TO C&C CONTINUING CASE

Case 8-31

a.
Pants Jerseys Jackets
Sales price $12.00 $14.80 $125.00
Direct materials $ 4.47 $ 6.85 $ 44.72
Direct labor 2.40 1.92 14.40
Variable overhead 1.32 1.05 7.92
Commission .60 .74 6.25
Shipping .40 .40 .40
Total variable cost $ 9.19 $10.96 $ 73.69
Contribution margin $ 2.81 $ 3.84 $ 51.31

b.
Pants Jerseys Jackets
Contribution margin $ 2.81 $ 3.84 $51.31
÷ Direct labor hours per unit ÷ .25 ÷ .20 ÷ 1.50
Contribution margin per DLH $11.24 $19.20 $34.21

c. Jackets, jerseys, pants

d.
Pants 200,000 pants × 0.25 DLH/pant = 50,000 DLH
Jerseys 70,000 jerseys × 0.20 DLH/jersey = 14,000 DLH
Jackets 18,000 jackets × 1.5 DLH/jacket = 27,000 DLH
91,000 DLH

91,000 DLH ÷ 52 weeks = 1,750 DLH per week

e. 1,750 DLH ÷ (2 shifts × 8 DLH × 5 days) = 22 workers

11 sewing machines would be needed each shift

f. 3,500 additional jerseys would require 700 additional DLH (3,500

jerseys × 0.20 DLH/jersey) and would generate an additional
contribution margin of $13,440 (3,500 jerseys × $3.84/jersey).

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

If jerseys are made instead of pants, C&C will make 2,800 fewer
pants (700 DLH ÷ 0.25 DLH/pant). This will result in a loss of $7,868
in contribution margin (2,800 pants × $2.81 CM/pant), for a net
increase in contribution margin of $5,572 ($13,440 - $7,868).

If jerseys are made instead of jackets, C&C will make 467 fewer
jackets (700 DLH ÷ 1.5 DLH/jacket). This will result in a loss of
$23,962 in contribution margin (467 jackets × $51.31 CM/jacket), for
a net decrease in contribution margin of $10,522 ($13,440 - $23,962).

If C&C Sports wants to produce the additional 3.500 jerseys without

reducing production of pants or jackets, the company must find a way
to supply the additional 700 DLH required for the jerseys’ production.
While C&C Sports could hire an additional worker to provide these
hours, there would not be enough hours to hire this person full-time
for the year. Another option would be to ask two or three of the most
productive workers to work overtime to produce the extra jerseys.
C&C will also need to ensure that there is enough sewing machine
time available for those additional direct labor hours.

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Solutions for Davis & Davis, Managerial Accounting, 2nd ed.

SOLUTIONS TO CASES

Case 8-32

a. Option 1: Hold conference as planned with 15 attendees

Option 2: Cancel the conference and return conference fees
Option 3: Reschedule conference for Dec. 8th and 9th

b.
Option 1 Option 2 Option 3
a
Registration fee revenue $ 8,925 $ 0 $ 76,440
Expenses
Meals 1,875 16,250
Conference materials 675 5,850
Direct mail advertising 4,500 4,500 6,000
Meeting room rental 3,500 3,500
Cancellation fee 10,000
Guest room guarantee fee 5,000
Equipment rental 500 500
Speaker fees:
Newton 600 600
Smith 2,000 2,000
Townsley 4,000 1,000 4,000
Speaker travel:
Newton 200 200
Smith 1,200 800 1,300
Townsley 1,000
Compton 200 200
Total expenses 25,250 16,300 40,400
Operating income ($16,325) ($16,300) $36,040
a
Registration fee income for option 3
(6,500 mailings  2%  90%  $595) + (6,500 mailings  2%  10%  $525)

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Case 8-32, continued

c.
Option 1 Option 2 Option 3
Net Income ($16,325) ($16,300) $36,040
Add back unavoidable costs
Direct mail advertising 4,500 4,500 4,500
Townsley speaker fees 1,000 1,000 1,000
Relevant income (loss) ($10,825) ($10,800) $41,540

The $5,500 has already been spent or committed. The relevant

income (loss) represents the additional amount that Flagstone will
make or lose with each option.

d. Holding the conference as scheduled will maintain Flagstone's

reputation with the speakers, hotel, and registrants. This will also
allow for the possibility of more registrants before the actual
conference date. Existing registration fees will not have to be
returned. The conference should result in enhanced relationships
with the registrants and may present the opportunity to sell additional
consulting services to the registrants. Flagstone also is able to meet
its internal goal of creating a new national conference. On the
downside, the meeting room that is designed to hold up to 300 people
will look bad with only 15 people in the audience. Additional fees
must be paid to University Parks Inn for not meeting the minimum
number of guest rooms. The speakers may resent coming to speak
to such a small crowd and may not be willing to speak at future
Flagstone conferences.

e. The obvious benefit to canceling the conference is that this action

cuts the losses of the conference. Holding the conference with only
15 registrants will cost Flagstone more than canceling the conference
and paying the cancellation fee to University Parks Inn. Canceling
the conference at this time may result in ill will on the part of existing
registrants. As a consulting firm, Flagstone is heavily dependent on
its reputation in the marketplace. Canceling the conference may
result in some damage to that reputation. There may also be some
reputation damage in the eyes of the speakers that had been retained
for the conference. While University Parks Inn is compensated for

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Case 8-32, continued

the cancellation, Flagstone may not be in a good bargaining position

with the hotel for future conferences. With the difference between
holding the conference as scheduled and canceling the conference
being only $25, Flagstone managers need to focus more on the
qualitative issues surrounding these options rather than the dollar
amount.

f. In addition to the benefits of holding the conference as scheduled,

rescheduling the conference will allow Flagstone more time to market
the conference and increase attendance. This would generate
additional exposure and revenue. However, there is no guarantee
that the rescheduled conference will be better attended. Flagstone
could spend additional funds for no additional benefit. Flagstone also
runs the risk of alienating some of the existing registrants in changing
the date, particularly if they cannot attend at that time. The potential
for inclement weather in Boston in December may deter some
professionals from registering and attending.

g. In looking at the conference, Flagstone needs to ensure that the

conference supports the mission, vision, and values of the firm.
While the initial reaction may be to look at the conference in the short
term, particularly from a financial perspective, the conference may
have much more benefit in the long term. It is difficult to measure at
the current time what future consulting revenues may be generated
from the conference registrants, but also from non-registrants who
later hear about the conference. Flagstone is also learning valuable
lessons for planning future conferences.

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Case 8-33

a. Pick the selling price that maximizes total contribution margin:

Household
Varia Total
ble Contribu contribu
Sal costs tion Units tion
a
es margin sold margin
$18 120,0 $240,00
$16 $2 00 0
$20 100,0 $400,00
$16 $4 00 0
$21 90,00 $450,00
$16 $5 0 0
$22 80,00 $480,00
$16 $6 0 0
$23 50,00 $350,00
$16 $7 0 0
a
Raw materials + Direct labor + Variable overhead + Variable selling and administrative = $7 + 4 +
1 + 4= $16

Commercial
Total
Sale Variable Contributio Units contribution
s costsa n margin sold margin
$25 $21 $4 175,000 $700,000
$27 $21 $6 140,000 $840,000
$30 $21 $9 100,000 $900,000
$32 $21 $11 55,000 $605,000
$35 $21 $14 35,000 $490,000
a
Raw materials + Direct labor + Variable overhead + Variable selling and administrative = $8 + 4 +
2 + 7= $21

The selling prices/quantities that maximize net income are:

Household: $22/80,000
Commercial: $30/100,000

b.
Household Commercial Total
Contribution margin $480,000 $900,000 $1,380,000
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Direct fixed expenses (400,000) (500,000) (900,000)

Segment margin $80,000 $400,000 $480,000
Selling and admin fixed (600,000)
Operating income ($120,000)

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 Chapter 8 – Using Accounting Information to Make Managerial Decisions

Case 8-33, continued

c. The Household product should not be dropped because it has a

positive segment margin.

d. The plant has capacity to make 175,000 cases of the Commercial

product in the second half of the year. If it accepts the special order,
it will only be able to sell 95,000 cases to regular customers:

Regular Special order Total

Sales price $30 $20.00
Variable costs 21 17.80a
Contribution margin/unit $9 2.20
Units sold  95,000  80,000
Total contribution margin $855,000 $176,000 $1,031,000
a
($21 - $3.20)

Compare this $1,031,000 contribution margin to the $900,000

contribution margin without the special order. The difference of
$131,000 would go straight to the bottom line and increase operating
income to $11,000 (($120,000) + $131,000). The special order
allows the company to make better use of the facilities. While this is
good in the short run, management needs to consider several things:
 Is the relationship with CleanMe on-going? If so, will they expect
this kind of price break indefinitely?
 If CleanMe becomes a regular customer, will commissions need
to be paid? If so, the price does not cover variable costs in that
case. If CleanMe continues as a customer but commissions are
not ever paid on this account, the sales representatives have lost
the opportunity to earn commissions on the 5,000 units lost from
regular sales, and there is no capacity for them to bring in new
customers to increase commissions. That could result in a
morale problem for the sales representatives.
 What will current customers think of this price break for
CleanMe? Is it a violation of the Robinson-Patman act?

This special order is a good one-time opportunity for Karpet Kleen to

achieve a positive operating income. The company should consider
taking the special order one time, but should not make it a continuing
practice. Instead, management should either scale back capacity
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Case 8-33, continued

(and direct fixed costs) or look for ways to use capacity to make a
different product.

e. The outsourcing arrangement makes financial sense only if the

contribution margin is higher than the planned total contribution
margin of $1,380,000.

Household = ($22 – $13 – $4)  80,000 = $400,000

Commercial = ($30 – $21)  100,000  90% = 810,000
Extra Strength = ($40 – x – $7)  45,000 = 1,485,000 – 45,000x
$1,380,000

$400,000 + $810,000 + $1,485,000 – 45,000x = $1,380,000

x = 29.22

As long as the product costs $29.22 or less to produce, the company

is no worse off financially than it is now. When the company designs
the process to make the Extra Strength product, it will probably want
to have a target cost much lower than $29.22. Altering the production
process and product mix is a much riskier proposition than continuing
existing operations. In addition, managers need to be assured that
the quality and timeliness of delivery for the outsourced Household
product is as good or better than what Karpet Kleen does now.

f.
Household Commercial Total
Units sold 50,000 35,000

Sales revenue ($23/$35) $1,150,000 $1,225,000 $2,375,000

Variable costs ($16/$21) (800,000) (735,000) (1,535,000)
Contribution margin 350,000 $490,000 840,000
Direct fixed costs (400,000) (500,000) (900,000)
Segment margin ($50,000) ($10,000) (60,000)
Fixed selling and
administrative costs (600,000)
Operating income ($660,000)

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Case 8-33, continued

g. The company will only save money by shutting down operations if it

can save the direct fixed costs. Even then, laying off workers for half
a year, only to try to get them back at the beginning of next year, is
not a viable option. Workers will try to find other jobs, replacement
hires will need to be trained, and the community outcry is likely to add
to the company’s woes. It would be best to keep operating and work
on a long-term solution to the company’s financial problems.

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Case 8-34

Wilson is not necessarily faced with an ethical conflict, as his advisory

committee has not asked him to participate in any unethical behavior.
The committee’s disagreement with Wilson primarily concerns
prudent business practice. Nevertheless, Wilson can find direction in
the IMA’s Statement of Ethical Professional Practice.

In section 3 of the statement, members are instructed to mitigate

actual conflicts of interest. Wilson’s bonus based on cost savings is
such a conflict of interest, though it is not necessarily one that
prejudices his judgment. However, the appearance of a conflict may
be enough to prevent Wilson from credibly carrying out his
responsibilities. Though it is not uncommon for upper management
to receive bonuses based on financial performance, no part of the
bonus mentions the necessary trade-off between cost savings and
quality care. It may be time for Wilson to review with his bosses a
change to his incentive package, recognizing that his decisions can
appear to be self-serving.

If Wilson truly believes this outsourcing arrangement is in the best

interest of the organization and shareholders, he needs to investigate
the outsourcing arrangement with respect to the issues the committee
raised: privacy and accuracy. If the committee has concerns, Wilson
can be assured that patients and the community will have concerns
as well. Section 1 of the statement requires members to provide
decision support information that is accurate, clear, concise and
timely. Wilson has more work to do in gathering information, testing
the proposed system without using private information, and
benchmarking against other hospitals.

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