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Chapter 25: 9E (page 1410)

Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of \(3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another \)4,500,000. Jacobs is afraid to bring this new equipment to the company president鈥檚 attention because he convinced the president to invest $3,000,000 in the machinery last year.

Explain what is relevant and irrelevant to Jacobs鈥檚 dilemma. What should he do?

Short Answer

Expert verified

The production manager must prepare anincremental analysis before making any decision.

Step by step solution

01

Meaning of Relevant Information

Relevant information is an important requirement to draft effective decisions associated with thefuture activities of a business concern. Such information enables an administration to make a purchase or make decisions when anoutsourcing alternative is available.

02

Bifurcation of relevant and irrelevant information

The information associated with theadditional cost and double production output is relevant for the business to make necessary decisions.

Also, the cost spent by the business on the old machinery is sunk cost, which has becomeirrelevant information for the business entity.

Hence, Dan Jacobs, the production manager must prepare adifferential analysis to determine the annualoperating income between the two machines.

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Most popular questions from this chapter

Members of the board of directors of Security Check have received the following operating income data for the year ended May 31, 2018:

SECURITY CHECK

Income Statement

For the Year Ended May 31, 2018

Product Line

Industrial Systems

Household Systems

Total

Net Sales Revenue

\( 360,000

\) 380,000

\( 740,000

Cost of Goods Sold:

Variable

37,000

47,000

84,000

Fixed

260,000

63,000

323,000

Total Cost of Goods Sold

297,000

110,000

407,000

Gross Pro铿乼

63,000

270,000

333,000

Selling and Administrative Expenses:

Variable

64,000

73,000

137,000

Fixed

44,000

26,000

70,000

Total Selling and Administrative Expenses

108,000

99,000

207,000

Operating Income (Loss)

\) (45,000)

\( 171,000

\) 126,000

Members of the board are surprised that the industrial systems product line is not profitable. They commission a study to determine whether the company should drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by \(80,000 and decrease fixed selling and administrative expenses by \)12,000.

Requirements

1. Prepare a differential analysis to show whether Security Check should drop the industrial systems product line.

2. Prepare contribution margin income statements to show Security Check鈥檚 total operating income under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternatives鈥� income numbers to your answer to Requirement 1.

3. What have you learned from the comparison in Requirement 2?

Suppose the Baseball Hall of Fame in Cooperstown, New York, has approached Collector-Cardz with a special order. The Hall of Fame wishes to purchase 56,000 baseball card packs for a special promotional campaign and offers \(0.38 per pack, a total of \)21,280. Collector-Cardz鈥檚 total production cost is \(0.58 per pack, as follows:

Variable costs:

Direct materials \)0.11

Direct labor 0.09

Variable overhead 0.08

Fixed overhead 0.30

Total cost \(0.58

Collector-Cardz has enough excess capacity to handle the special order.

Requirements

1. Prepare a differential analysis to determine whether Collector-Cardz should accept the special sales order.

2. Now assume that the Hall of Fame wants special hologram baseball cards. Collector-Cardz will spend \)5,700 to develop this hologram, which will be useless after the special order is completed. Should Collector-Cardz accept the special order under these circumstances, assuming no change in the special pricing of $0.38 per pack?

Doherty Company is considering replacing the individual printers each employee in the corporate office currently uses with a network printer located in a central area. The network printer is more efficient and would, therefore, cost less to operate than the individual printers. However, most of the office staff think having to use a centralized printer would be inconvenient. They prefer to have individual printers located at each desk. Identify the following information as financial or nonfinancial and relevant or irrelevant. The first item has been completed as an example.

Financial

Nonfinancial

Relevant

Irrelevant

  1. Amount paid for current printers
  1. Resale value of current printers
  1. Cost of new printer
  1. Operating costs of current printers
  1. Operating costs of new printer
  1. Employee morale

Elm Petroleum has spent \(204,000 to refine 61,000 gallons of petroleum distillate, which can be sold for \)6.30 per gallon. Alternatively, Elm can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Elm must pay a sales commission of \(0.10 per gallon and a transportation charge of \)0.16 per gallon.

Requirements

1. Diagram Elm鈥檚 decision alternatives, using Exhibit 25-18 as a guide.

2. Identify the sunk cost. Is the sunk cost relevant to Elm鈥檚 decision?

3. Should Elm sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.

What makes information relevant to decision making?
See all solutions

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