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TUTORIAL

DECISION MAKING

Question 1

Carter Company manufactures cappuccino makers. For the first eight months of
1999 the company reported the following operating results while operating at 80% of
plant capacity:

Sales (500,000 units) RM75,000,000


Cost of goods sold 45,000,000
Gross profit 30,000,000
Operating expenses 24,000,000
Net income RM 6,000,000

An analysis of costs and expenses reveals that variable cost of goods sold is RM80
per unit and variable operating expenses are RM30 per unit.

In September, Carter Company receives a special order for 40,000 machines at


RM120 each from a major coffee shop franchise. Acceptance of the order would
result in RM10,000 of shipping costs but no increase in fixed expenses.

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Carter Company accept the special order? Justify your answer.

Solution :

a. Incremental analysis

Special order price – Variable cost


= (RM120 x 40,000units) – [(RM80+30)x 40,000 units] – RM10,000
= RM390,000

b. Accepted the special order due to incremental in net income by RM390,0000.

Question 2

Company has the capacity to produce 15,000 tires each month. Current regular
production and sales are 10,000 tires per month at a selling price of RM15 each.
Based on this level of activity, the following unit costs are incurred:
Direct materials...................................... RM5.00
Direct labor............................................. RM3.00
Variable manufacturing overhead........... RM0.75
Fixed manufacturing overhead............... RM1.50
Variable selling expense......................... RM0.25

The fixed costs, both manufacturing and administrative, are constant in total within
the relevant range of 10,000 to 15,000 tires per month.

The Company has received a special order from a customer who wants to pay a
reduced price of RM10 tires. There would be no selling expense in connection with
this special order. And, this order would have no effect on the company's other sales.

Required & Solution:

i. Calculate the avoidable costs based on the current production level = RM9 per
unit x 10,000 units = RM90,000 at current level of production.

ii. Calculate the relevance cost per unit based on the current production level =
RM9.00 per unit

iii. Compute the company’s operating income for the month if the company
accepts the special order is for 4,000 tires this month = (RM10 – RM9) x 4,000
tires = RM4,000 incremental income.

iv. Compute the company’s operating income for the month if the company
accepts the special order is for 6,000 tires this month = (RM10 – RM9) x 6,000
tires = RM6,000 incremental income

Question 3

Benson Company produced and sold 20,000 units of product and is operating at 80%
of plant capacity. Unit information about its product is as follows:

Sales Price RM70


Variable manufacturing cost RM45
Fixed manufacturing cost (RM300,000 ÷ 20,000) 15 60
Profit per unit RM10

The company received a proposal from a foreign company to buy 4,000 units of
Benson Company's product for RM50 per unit. This is a one-time only order and
acceptance of this proposal will not affect the company's regular sales. The
president of Benson Company is reluctant to accept the proposal because he is
concerned that the company will lose money on the special order.

Instructions
Prepare a schedule reflecting an incremental analysis of this proposal and indicate
the effect the acceptance of this order might have on the company's income.

Solution:

Special order price – Variable cost – Any other costs


(RM50 – RM45) x 4,000 units = RM20,000

Therefore accept the special order due to incremental in net income RM20,000
Question 4

The MJ Digital Racquet makes wheels that it uses in the production of tennis racket.
MJ Digital's costs to produce 1,000 racquets annually are:
Direct materials........................... RM30,000
Direct labor................................. RM50,000
Variable overhead....................... RM20,000
Fixed overhead............................ RM70,000

If the racquets are purchased from the outside supplier, RM15,000 of annual fixed
overhead could be avoided and the facilities now being used could be rented to
another company for RM45,000 per year. An outside supplier has offered to sell MJ
Digital similar racquets for RM12.50 per racquet.

Requirement and solution:

a. Calculate the monthly avoidable costs (costs that will no longer be


incurred) total If MJ Digital’s Racquet accepts the offer from the outside
supplier = (RM30,000 + RM50,000 + RM20,000 + RM15,000) / 12 months
= RM9,583.33 per month.

b. Compute monthly operating income if MJ Digital’s Racquet purchases


1,000 components from the outside supplier per month = RM45,000 –
(RM12.5 x 1,000 units) = RM32,500 / 12month = RM2,708.33 per month

c. Compute the maximum price that MJ Digital’s Racquet should be willing to


pay the outside supplier? = (RM30,000 + RM50,000 + RM20,000 +
RM45,000) / 1,000 units = RM14.5 per unit.

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