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Chapter 25: 25-2TI (page 1384)

Thomas Company makes a product that regularly sells for \(12.50 per unit. The product has variable manufacturing costs of \)8.50 per unit and fixed manufacturing costs of \(2.00 per unit (based on \)200,000 total fixed costs at current production of 100,000 units). Therefore, the total production cost is \(10.50 per unit. Thomas Company receives an offer from Wesley Company to purchase 5,000 units for \)9.00 each. Selling and administrative costs and future sales will not be affected by the sale, and Thomas does not expect any additional fixed costs.

1. If Thomas Company has excess capacity, should it accept the offer from Wesley? Show your calculations.

2. Does your answer change if Thomas Company is operating at capacity? Why or why not?

Short Answer

Expert verified
  1. The offer should be accepted if the Thomas company has excess capacity.
  2. The offer should be rejected if the Thomas company is operating at capacity.

Step by step solution

01

Meaning of Fixed Cost

In accounting, fixed cost refers to the cost that isindependent and is not affected by the level of production or quantity of goods produced by a business. Such a cost remains the same for zero production and other levels.

02

Decision on the order acceptance

Particulars

Amounts ($)

Expected increase in revenue (5,000*$9)

45,000

Less: Expected increase in variable manufacturing cost (5,000*$8.50)

(42,500)

Expected increase in operating income

$2,500

03

The company operating at its capacity

Particulars

Amounts ($)

Revenue at capacity sales price (5,000*$9)

45,000

Less: Revenue at regular sales price (5,000*$12.50)

(62,500)

Expected decrease in sales revenue

($17,500)

In the second scenario, Thomas Company should reject the offer because it will result in decreased sales revenue.

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Most popular questions from this chapter

Top managers of Video Avenue are alarmed by their operating losses. They are considering dropping the DVD product line. Company accountants have prepared the following analysis to help make this decision:

VIDEO AVENUE

Income Statement

For the Year Ended December 31, 2018

Total Blu-ray Discs DVD Discs

Net Sales Revenue \(437,000 \)308,000 \(129,000

Variable Costs 250,000 154,000 96,000

Contribution Margin 187,000 154,000 33,000

Fixed Costs:

Manufacturing 132,000 76,000 56,000

Selling & Administrative 65,000 51,000 14,000

Total Fixed Expenses 197,000 127,000 70,000

Operating Income (Loss) \)(10,000) \(27,000 \)(37,000)

Total fixed costs will not change if the company stops selling DVDs.

Requirements

1. Prepare a differential analysis to show whether Video Avenue should drop the DVD product line.

2. Will dropping DVDs add $37,000 to operating income? Explain.

What does the target full product cost include?

Mary Tan is the controller for Duck Associates, a property management company in Portland, Oregon. Each year, Tan and payroll clerk Toby Stock meet with the external auditors about payroll accounting. This year, the auditors suggest that Tan consider outsourcing Duck Associates鈥檚 payroll accounting to a company specializing in payroll processing services. This would allow Tan and her staff to focus on their primary responsibility: accounting for the properties under management. At present, payroll requires 1.5 employee positions鈥攑ayroll clerk Toby Stock and a bookkeeper who spends half her time entering payroll data in the system.

Tan considers this suggestion, and she lists the following items relating to outsourcing payroll accounting:

  1. The current payroll software that was purchased for \(4,000 three years ago would not be needed if payroll processing were outsourced.

  2. Duck Associates鈥� bookkeeper would spend half her time preparing the weekly payroll input form that is given to the payroll processing service. She is paid \)450 per week.

  3. Duck Associates would no longer need payroll clerk Toby Stock, whose annual salary is \(42,000.

  4. The payroll processing service would charge \)2,000 per month.

Requirements

1. Would outsourcing the payroll function increase or decrease Duck Associates鈥� operating income?

2. Tan believes that outsourcing payroll would simplify her job, but she does not like the prospect of having to lay off Stock, who has become a close personal friend. She does not believe there is another position available for Stock at his current salary. Can you think of other factors that might support keeping Stock, rather than outsourcing payroll processing? How should each of the factors affect Tan鈥檚 decision if she wants to do what is best for Duck Associates and act ethically?

Priscilla Smiley manages a fleet of 250 delivery trucks for Daniels Corporation. Smiley must decide whether the company should outsource the fleet management function. If she outsources to Fleet Management Services (FMS), FMS will be responsible for maintenance and scheduling activities. This alternative would require Smiley to lay off her five employees. However, her own job would be secure; she would be Daniels鈥檚 liaison with FMS. If she continues to manage the fleet, she will need fleet management software that costs \(9,500 per year to lease. FMS offers to manage this fleet for an annual fee of \)300,000. Smiley performed the following analysis:

Retain in-house Outsource to FMS Difference

Annual leasing fee for \(9,500 \)9,500

Software

Annual maintenance of

Trucks 147,000 147,000

Total annual salaries of

Five laid-off employees 185,000 185,000

Fleet management

Service鈥檚 annual fee \(300,000 (300,000)

Total differential cost of

Outsourcing \)341,500 \(300,000 \)41,500

Requirements

1. Which alternative will maximize Daniels鈥檚 short-term operating income?

2. What qualitative factors should Daniels consider before making a final decision?

Explain the difference between price-takers and price-setters.
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