Decision-Making: Short-term Planning

1. Incremental vs. Total Analysis Approaches. Kramer Company currently handles 8,000
information requests per month. Financial data for the last month are:
Sales P 240,000
Variable costs 144,000
Fixed costs 60,000
The company needs to expand its operations to serve 9,000 requests per month. Fixed
costs would increase P15,000 because of the expansion.

Required:
Prepare both a total analysis approach and an incremental analysis approach to evaluate
the decision. Compare the results.

2. Make or Buy Analysis. Stace Company needs 20,000 units of a certain part to use in its
production cycle. If Stace buys the part from Vaz Copany instead of making it, Stace
could rent the released facilities as storage to another manufacturing firm for P10,000.
Sixty percent of the fixed overhead applied will continue to be incurred regardless of
what decision is made. The following information is available:
Cost to Stace to make the part:
Direct material P 4
Direct labor 16
Variable overhead 8
Fixed overhead applied 10
P 38
Cost to buy the part from the
Vaz Company P 36
Required:
1. Which alternative is more desirable for Stace and what amount?
2. What assumptions about cost behavior might be troublesome be either buying or
making?

3. Make or Buy. Li Lieu, owner of Emperor of Xi’an Restaurant in Xi’an, PRC, uses 5,000
fancy dumplings per month. Current costs in Chinese yuan are
Ingredient costs P2
Labor and other variable expenses P1

Wang Cao offers to sell Mr. Li dumplings at P3 each. If Mr. Li buys dumplings, he can
eliminate P4,000 per month in fixed making costs. He thinks he can also earn an
additional P3,000 per month in contribution margin by adding three tables where the
dumpling had been made.

Required: Should Mr. Li make or buy? Comment on concerns you might have.

4. Make or Buy Indifference Point. Stephen Wegener contracted a Malaysian

manufacturer that will charge P40 per unit plus P200,000 for special equipment and dies
for a lens assembly for an overhead projector. But he thinks he can make it himself for
the following costs:
Prime costs P 21
Other variable costs 3
Total variable costs 24
Steve knows that incremental salaries, equipment rentals, and other fixed costs to make
the assembly will run P360,000 per year. Common costs of manufacturing are applied to
products at 60 percent of prime costs. Steve plans to sell these projectors for P150 per
unit.
Required: Find sales volume in units where Wegener would be indifferent between
making the lens assembly or buying it.
 Page 2

5. Make or Buy. Slowik, Inc. makes steel blades for lawn mowers that it heat treats,
assembles, and sells. The cost accounting system gives the following data:
Prime costs P 80,000
Variable factory overhead 60,000
Fixed factory overhead 90,000
Units produced 100,000 units

Slowik has an opportunity to purchase its 100,000 blades from an outside supplier at a
cost of P2.20 per blade. Inspection of the purchased blades will cost an additional P5,000
in the quality assurance department. Certain leased equipment, which costs P30,000 and
is included in fixed overhead, can be avoided if the blades are purchased. The released
price could be used to make a part that is now purchased, which would net Slowik a
savings of P46,000.

Required:
1. In quantitative terms, should Slowik but the blades from the outside supplier? Explain
your decision.
2. What major factors might change the decision?

6. Make or Buy Decision. Ling Automotive Systems developed a new windshield cleaning
system for the original-equipment auto market. The system requires an electronic motor
that the firm does not currently produce but is available from suppliers. The best bid if
from Fiero Electronics, an Italian firm, at P23 per unit for any volume within the firm’s
relevant range.
Ling’s production manager believes that the motor can be made in-house, although
additional space and machinery would be required. The firm now leases, for P80,000 per
year, space that could be used to make the new motors. However, another subsystem is
now assembled in this space. Ling would have to lease additional space which rents for
P175,000 per year in an adjacent building for the assembly process. It is suitable for
assembly work but not for motor production. Additional equipment needed would rent for
P200,000 per year.

The controller has developed the following unit costs based on the expected demand of
100,000 units per year:
Prime costs P 14.00
Rent for space .80
Machinery rental 2.00
Variable overhead 4.00
Allocated fixed overhead 6.00
Total costs P 26.80

Required: Should Ling make or buy the motors? What assumptions are you making?

7. Department Profits. Plesz Sales runs several small department stores. The Toledo store
showed the following “poor” results:
Dept1 Dept2 Dept3 Dept4
Totals
Sales P 700 P1,000 P 800 P1,500 P4,000
Cost of goods sold (350) (500) (450) (800) ( 2,100)
Gross margin P350 P500 P350 P700 P1,900
Direct expenses (100) (400) (400) (300) (1,200)
Common expenses (100) (300) (100) (300) (800)
Net income P 150 P (200) P (150) P 100 P (100)

Required: Comment on the impact of each of the following actions.

 page 3
(a) Delete Department 2.
(b) Delete Department 3.
(c) Delete Department 2 and 3.
(d) Replace Departments 2 and 3 with a new Department 5 that would earn a positive
direct contribution margin of P25.
(e) Reallocate the common expenses.

8. Eliminating a Department. ABCDE Department Store has five departments – A, B, C,

D, and E. Department E’s future is being evaluated using the data below.
All Others Department Total
E
Sales P 4,500,000 P 500,000 P 5,000,000
Cost of sales 2,200,000 300,000 2,500,000
Gross margin P 2,300,000 P 200,000 P 2,500,000
Rent and services P 800,000 P 200,000 P 1,000,000
Direct salaries 450,000 50,000 500,000
Advertising expenses 450,000 50,000 500,000
Total expenses P 1,700,000 P 300,000 P 2,000,000
Net profit (loss) P 600,000 P (100,000) P 500,000

Rent and services are corporate committed fixed expenses and are allocated evenly to the
five departments. Half of the advertising expenses varies with sales; the other half will
not change regardless of the decision and is allocated using sales peso.

Required: Comment on the following statements:

(a) Department E is earning P150,000 in variable contribution margin for ABCDE.
(b) Department E is earning P100,000 in direct contribution margin for ABCDE.
(c) The company’s overall profitability without Department E would be P600,000.

9. Segment Profit Performance Analysis. Blaufuss Sausages has a central processing plant
and three stores. Recently, profits have been declining. The projected income statement
for the three store is as follows:
Main Street King Queen Total
Street Street
Sales P 200 P 175 P 190 P 565
Product cost of sausages -120 -100 -110 -330
Gross margin P 80 P 75 P 80 P 235
Direct store expenses -60 -85 -35 -180
Allocated administrative -25 -15 -20 -60
expenses
Net income P(5) P ( 25 ) P 25 P(5)

Required: What will each of the following actions do to Blaufuss’ profits?

(a) Eliminate Main Street store.
(b) Eliminate King Street store.
(c) Eliminate Main and King Street stores.
(d) Close all stores.
(e) Open a fourth store and divide allocated administrative expenses among four stores.
(Assume that the new store will have a zero net income.)

10. Dropping a Product. Bob Leverenz, an old prospector, runs a side business. He buys
rattlesnakes from “snake hunters” in west Texas, paying an average of P10 per snake. Each
snake comes complete. He produces canned snake meat, cures hides, and makes souvenir
rattles. At the end of a recent season, Bob is evaluating his financial results:
 Meat Hides Rattles Total
Sales P 30,000 P 8,000 P 2,000 P 40,000
Cost of snakes 18,000 4,800 1,200 24,000
Gross profit P 12,000 P 3,200 P 800 P 16,000
Processing expenses P 6,000 P 900 P 600 P 7,500
Common expenses 4,000 600 400 5,000
Operating expenses P 10,000 P 1,500 P 1,000 P 12,500
Income (loss) P 2,000 P 1,700 P ( 200 ) P 3,500

Cost of snakes assigned to each product is based on a ration of cost to revenue.

Processing expenses are direct costs. Common expenses are allocated on the basis of
direct processing expenses and are Bob’s basic living expenses. Bob has a philosophy of
“every tub on its own bottom” and is determined to cut his losses on rattles.

Required:
1. Is he really “losing” money on rattles? Explain.
2. An old miner has offered to but every rattle “as is”, without processing, for P0.50 per
rattle. Will this eliminate the “loss” problem and improve Bob’s profitability?

11. Elimination of a Department. The Halverson’s Old General Store is currently divided into
three departments. Over the past several months, sales and profit have declined, although
the situation is now considered stable. Department 2 has begun to show a loss; and the
owner, Joan Halverson, is thinking of discontinuing it. The space could be rented to a chain
store which could pay a flat fee of P12,000 a month.
Below is last month’s income statement, considered to be typical. Sales salaries are
fixed but traceable to each department and could be avoided if the department were
eliminated. Total fixed administrative costs (allocated equally to all departments) are
common costs.
Department 1 Department 2 Department 3 Total
Sales P 185,000 P 80,000 P 135,000 P 400,000
Costs:
Cost of goods sold P 96,000 P 44,000 P 70,000 P 210,000
Sales salaries 28,000 8,000 24,000 60,000
Administrative expenses 30,000 30,000 30,000 90,000
Total costs P 154,000 P 82,000 P 124,000 P 360,000
Net income before taxes P 31,000 P ( 2,000 ) P 11,000 P 40,000
Required:
Prepare an analysis to show Halverson whether Department 2 should be discontinued and
the space rented.

12. Changing Product Lines. Dale Kim, president of Kim’s Department Store, thinks that the
Paint Department should be dropped. He wants to add a Peanut Butter Boutique in the
same space. Data for next year in thousands are:
All Other Proposed
Paint Department Store Total Peanut Butter
Boutique
s
Sales P 10,000 P 90,000 P 100,000 P 20,000
Cost of sales - 6,000 -54,000 -60,000 -15,000
Gross margin P 4,000 P 36,000 P 40,000 P 5,000
Direct expenses -1,000 -14,000 -15,000 -3,000
Allocated expenses -4,000 -16,000 -20,000 -1,000
Net income - P 1,000 P 6,000 P 5,000 P 1,000
Allocated expenses are common costs and are assigned by a mathematical formula.
 Required: Ignoring your attitude toward peanut butter, what should he do to maximize
profits? Explain.

13. Equipment Replacement. Merle Murphy, owner of Murphy Farms, is considering plans to
rent a new sprinkler system for his navy bean business. He currently uses a system that
rents for P25,000 per year and has annual operating costs of P20,000 plus P100 per acre.
The new system will rent for P10,000 per year and have annual operating costs of P30,000
plus P40 per acre. Both systems will perform the same function. He will plant 200 acres of
beans. The contribution margin next year from beans is estimated to be P125,000.

Required: Should Murphy change to the new system? Explain your conclusion.

14. Equipment Replacement. Las week Souza Enterprises purchased a new irrigation
system called Spray costing P60,000. Its annual cash operating costs are estimated to be
P35,000. It has a four-year useful life and no residual value. Today, a salesman has offered
Souza a new system called Sprinkle that will cost P60,000 and will also have a four-year
useful life with no residual value. The Spray equipment can be used as a trade-in for a
P10,000 allowance. The annual cash operating costs of Sprinkle are estimated to be
P20,000. Sales of P400,000 and other operating expense of P180,000 per year will be the
same under either alternative.

Required:
Ignoring the time value of money to be discussed in Chapter 11, should Souza purchase
the Sprinkle system? Explain.

15. Process Further Decision. Silver Bullet Refining produces naphtha, kerosene, and other
distillates from a joint process costing P120,000 for a certain volume of crude oil. From this
process, 1,000 barrels of naphtha can be produced and are allocated P35,000 of joint
costs. This can be sold at the split-off point for P60 per barrel or further processed into
other products and sold for P85 per barrel. The processing cost for further refining 1,000
barrels of naphtha is P20,000.
The other distillates can be sold now for P80,000 or processed further for P40,000
and sold for P10,000. Kerosene can be sold for P60,000 at the split-off point. Kerosene is
also allocated P35,000 of the joint costs. Other distillates are allocated the remaining joint
costs.

Required:
1. Which products should be sold at the split-off point or processed further?
2. What is the most Silver Bullet can pay for crude oil and not lose money on the refining
process?

16. Sell Now or Later. Ballou Corporation uses a joint process to produce products A, B, and
C. Each product may be sold at its split-off point or processed further. Additional processing
costs are entirely variable and are traceable to the respective products. Annual joint
production costs were P50,000 and are allocated equally to A, B, and C.
If Processed Further
Units Sales Value Sales Additional
Product Produced at Value Costs
Split-Off
A 20,000 P 45,000 60,000 20,000
B 15,000 75,000 98,000 20,000
C 15,000 30,000 62,000 18,000
P 150,000
 Required: To maximize profits, which products should Ballou process further?
17. Scarce Resource Decision. The DeClercq Company performs three different services:
Able, Baker, and Charlie. Because of unusual demand, all service requests cannot be filled.
Fixed cost allocations are based on service hours. DeClercq has 2,000 hours of available
service time.

Able Baker Charlie

Sales price P 50 P 40 P 30
Variable costs 30 25 20
Allocated fixed costs 10 10 10
Service time per request 0.8 hour 0.5 hour 0.2 hour

Required:
1. Assume that DeClercq must meet at least 500 requests for each type of service for
regular customers. What quantities of each service should be performed to meet
regular customer needs while maximizing profits?
2. Assume that DeClercq can generate 3,000 service requests for each type of service.
What priorities should Soma set to maximize profits?

18. Product Combination Decision. Data concerning four product lines are as follows:

Product Line
A B C D
Selling price per unit P 300 P 250 P 130 P 70
Variable cost per unit 250 80 50 40
Hours required for each unit 5 10 4 2
Maximum market potential (units) No limit 6,000 8,000 4,000
Total fixed costs P 100,000
Total hours available 96,000 hours

Required:
1. Based on these data, choose the best product combination.
2. How would the answer change if the company were required to deliver 2,000 units of
each product line to a major distributor? The maximum potential includes the
distributor’s units.

19. Scarce Resources with Other Constraints. Data for four products are given below:

Product A Product B Product C Product D

Selling price per unit P 13 P 20 P5 P 25
Variable cost per unit 5 7 2 16
Allocated costs per unit 4 8 1 3
Units produced per hour 4 units 2 units 10 units 3 units
Maximum sales limit 5,000 units 5,000 units 10,000 units No limit
Minimum requirements 1,000 units None 2,000 units 1,200 units

Total capacity is 6,000 hours. Minimum requirements meet existing sales commitments.
Marketing has provided a “best estimate” of maximum sales expected for each product.

Required: Based on the above data, choose the best product combination.