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I’m working on a accounting question and need an explanation and answer to help me learn.

Problem 1

Kassel Corporation is considering trading a truck with a book value of SAR 85,000 with an estimated five-year life for a new truck that would cost SAR 200,000. The old truck could be sold for SAR 75,000. The new truck has a seven-year life with no residual value. The new truck would reduce annual operating costs by SAR 20,200 per year.

Required:

Prepare a differential analysis on whether to continue with the old machine (Alternative 1) or purchase the new machine (Alternative 2).

Problem 2

A condensed income statement by product line for Brion Sporting Goods indicated the following for baseball equipment for the past year:

(All amounts in SAR)

Sales

5,400,000

Cost of goods sold

3,700,000

Gross profit

1,700,000

Operating expenses

1,850,000

Loss from operations

(150,000)

It is estimated that 15% of the cost of goods sold represents fixed factory overhead costs, and that 20% of the operating expenses are fixed. Because sporting equipment is only one of the many products, the fixed costs will not be materially affected if the product is discontinued.

Required:

Prepare a differential analysis to determine whether Baseball Equipment should be continued (Alternative 1) or discontinued (Alternative 2). Should Baseball Equipment be retained? Explain and indicate the dollar difference in favor or against.

Problem 3

Marburg Manufacturing produces various-sized plastic panels for its main product. The manufacturing cost for small bottlesis SAR 200 per unit, including fixed costs of SAR 65 per unit. A proposal is offered to purchase plastic panels from an outside source for SAR 180 per unit, plus SAR 6 per unit for freight.

Required

:

Prepare a differential analysis to determine whether the company should make (Alternative 1) or buy (Alternative 2) for bottles, assuming fixed costs are not affected by the decision.

Problem 4

Whole milk is produced for SAR 17 per gallon. Whole milk can be sold without additional processing for SAR 24 per gallon or processed further into ice cream at an additional cost of SAR 8 per gallon. Ice cream can be sold for SAR 32 per gallon.

Required

:

Prepare a differential analysis on whether to sell whole milk (Alternative 1), or process further into ice cream (Alternative 2).

Chapter 11
Differential
Analysis and
Product Pricing
Differential Analysis
(slide 1 of 6)
•
Managerial decision making involves choosing between
alternative courses of action.
•
Differential analysis, sometimes called incremental
analysis, analyzes differential revenues and costs in
order to determine the differential impact on profit of two
alternative courses of action.
o
Differential revenue is the amount of increase or decrease in
revenue that is expected from a course of action compared to an
alternative.
o
Differential cost is the amount of increase or decrease in cost
that is expected from a course of action as compared to an
alternative.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Differential Analysis
(slide 2 of 6)
o
Differential profit (loss) is the difference between
the differential revenue and differential costs.
â–ª Differential profit indicates that a decision is expected to
increase income.
â–ª Differential loss indicates that a decision is expected to
decrease income.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Differential Analysis
(slide 3 of 6)
•
The differential analysis is prepared in three columns,
where positive amounts indicate the differential effect is to
increase profit and income and negative amounts indicate
the effect is to decrease profit and income.
o
The first column is the revenues, costs, and profit (loss) for
maintaining floor space for tables (Alternative 1).
o
The second column is the revenues, costs, and profit (loss)
for using that floor space for a salad bar (Alternative 2).
o
The third column is the difference between the revenues,
costs, and profit (loss) of two alternatives.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Differential Analysis
(slide 4 of 6)
•
The salad bar (Alternative 2) is being considered over
keeping the existing tables (Alternative 1).
o
The differential revenue of a salad bar over tables is
$20,000 ($120,000 − $100,000). Because the salad bar
would increase revenue and profit, it is entered as a positive
$20,000 in the Differential Effects column.
o
The differential cost of a salad bar over tables is $5,000
($65,000 − $60,000). Because the salad bar would increase
costs and decrease profit, the $5,000 is entered as a
negative $(5,000) in the Differential Effects column.
o
The differential effect of a salad bar over tables is
determined by subtracting the differential costs from the
differential revenues in the Differential Effects column.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Differential Analysis
(slide 5 of 6)
•
The differential profit of a salad bar is $15,000 ($20,000 −
$5,000).
•
Based upon the differential analysis, Bryant Restaurants
should decide to replace some of its tables with a salad
bar.
o
•
Doing so will increase its profit and income by $15,000.
Over time, Bryant Restaurants should review its decision
based upon actual revenues and costs.
o
If the actual revenues and costs differ significantly from
those shown in Slide 5, another differential analysis should
be performed.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Differential Analysis
(slide 6 of 6)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Lease or Sell
(slide 1 of 2)
•
Management may lease or sell a piece of
equipment that is no longer needed.
o
•
This may occur when a company changes its
manufacturing process and can no longer use the
equipment in the manufacturing process.
In making a decision, differential analysis can
be used.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Lease or Sell
(slide 2 of 2)
•
Only the differential revenues and differential
costs associated with the lease-or-sell decision
are included in the differential analysis.
•
Sunk costs are costs that have been incurred in
the past, cannot be recouped, and are not
relevant to future decisions.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Discontinuing a Segment or Product
•
A product, department, branch, territory, or other segment
of a business may be generating losses. As a result,
management may consider discontinuing (eliminating) the
product or segment.
•
Discontinuing the product or segment usually eliminates all
of the product’s or segment’s variable costs such as direct
materials, direct labor, variable factory overhead, and sales
commissions.
•
However, fixed costs such as depreciation, insurance, and
property taxes may not be eliminated.
o
Thus, it is possible for total company income to decrease rather
than increase if the unprofitable product or segment is
discontinued.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Make or Buy
•
Companies that manufacture products made up
of components that are assembled into a final
product, such as automobile manufacturers,
must decide whether to make a part or
purchase it from a supplier.
•
Differential analysis can be used to decide
whether to make or buy a part.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Replace Equipment
(slide 1 of 2)
•
The usefulness of a fixed asset may decrease
before it is worn out.
o
•
For example, old equipment may no longer be as
efficient as new equipment.
Differential analysis can be used for decisions
to replace fixed assets such as equipment and
machinery.
o
The analysis normally focuses on the costs of
continuing to use the old equipment versus replacing
the equipment.
â–ª The book value of the old equipment is a sunk cost and,
thus, is irrelevant.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Replace Equipment
(slide 2 of 2)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Process or Sell
•
During manufacturing, a product normally progresses
through various stages or processes. In some cases, a
product can be sold at an intermediate stage of production,
or it can be processed further and then sold.
•
Differential analysis can be used to decide whether to sell
a product at an intermediate stage or to process it further.
o
In doing so, the differential revenues and costs from further
processing are compared.
o
The costs of producing the intermediate product do not change,
regardless of whether the intermediate product is sold or
processed further.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Accept Business at a Special Price
•
A company may be offered the opportunity to sell its
products at prices other than normal prices.
o
•
For example, an exporter may offer to sell a company’s products
overseas at special discount prices.
Differential analysis can be used to decide whether to
accept additional business at a special price.
o
o
The differential revenue from accepting the additional business is
compared to the differential costs of producing and delivering the
product to the customer.
The differential costs of accepting additional business depend on
whether the company is operating at less than capacity.
â–ª If the company is operating at less than full capacity, then the
additional production does not increase fixed manufacturing costs.
– However, selling and administrative expenses may change because of the
additional business.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Setting Normal Product Selling Prices
(slide 1 of 3)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Setting Normal Product Selling Prices
(slide 2 of 3)
•
Managers can use one of two market methods to
determine selling price.
o
Demand-based method
â–ª The demand-based method sets the price according to the
demand for the product.
– If there is high demand for the product, then the price is set high.
– Likewise, if there is low demand for the product, then the price is
set low.
o
Competition-based method
â–ª The competition-based method sets the price according to
the price offered by competitors.
– For example, if a competitor reduces the price, then
management adjusts the price to meet the competition.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Setting Normal Product Selling Prices
(slide 3 of 3)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cost-Plus Methods
•
Cost-plus methods determine the normal
selling price by estimating a cost amount per unit
and adding a markup, computed as follows:
Normal selling price = Cost amount per unit + Markup
o
Management determines the markup based on the
desired profit for the product.
o
The markup should be sufficient to earn the desired
profit plus cover any costs and expenses that are not
included in the cost amount.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Product Cost Method
(slide 1 of 5)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Product Cost Method
(slide 2 of 5)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Product Cost Method
(slide 3 of 5)
•
The product cost method is applied using the
following steps:
o
Step 1: Estimate the total product cost as follows:
Product costs:
Direct materials
Direct labor
XXX
Factory overhead
XXX
Total product cost
o
$XXX
$XXX
Step 2: Estimate the total selling and administrative
expenses.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Product Cost Method
(slide 4 of 5)
o
Step 3: Divide the total product cost by the number of
units expected to be produced and sold to determine
the total product cost per unit, computed as follows:
Product cost per unit =
o
Total product cost
Estimated units produced and sold
Step 4: Compute the markup percentage as follows:
Markup percentage =
Desired profit + Total selling and administrative expenses
Total product cost
â–ª The desired profit is normally computed based on a rate of
return on assets as follows:
Desired profit = Desired return × Total assets
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Product Cost Method
(slide 5 of 5)
Step 5: Determine the markup per unit by multiplying
the markup percentage times the product cost per unit
as follows:
Markup per unit = Markup percentage ï‚´ Product cost per unit
o
o
Step 6: Determine the normal selling price by adding
the markup per unit to the product cost per unit as
follows:
Product cost per unit
Markup per unit
Normal selling price per unit
$XXX
XXX
$XXX
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Target Costing Method
(slide 1 of 2)
•
Target costing is a method of setting prices that
combines market-based pricing with a costreduction emphasis.
•
Under target costing, a future selling price is
anticipated, using the demand-based or the
competition-based methods.
•
The target cost is then determined by subtracting
a desired profit from the expected selling price,
computed as follows:
Target cost = Expected selling price − Desired profit
•
Target costing tries to reduce costs.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Target Cost Method
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Target Costing Method
(slide 2 of 2)
•
•
The target cost is normally less than the
current cost.
Managers must try to reduce costs from the
design and manufacture of the product.
o
o
The planned cost reduction is sometimes referred
to as the cost drift.
Costs can be reduced in a variety of ways such
as the following:
â–ª
â–ª
â–ª
â–ª
Simplifying the design
Reducing the cost of direct materials
Reducing the direct labor costs
Eliminating waste
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Production Bottlenecks
(slide 1 of 2)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Production Bottlenecks
(slide 2 of 2)
•
When a company has a production bottleneck in
its production process, it should attempt to
maximize its profits, subject to the production
bottleneck.
o
•
In doing so, the unit contribution margin of each product
per production bottleneck constraint is used.
In a production bottleneck operation, the best
measure of profitability is the unit contribution
margin per production bottleneck constraint.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Total Cost Method
(slide 1 of 4)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Total Cost Method
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Total Cost Method
(slide 2 of 4)
•
The total cost method is applied using the following
steps:
o
Step 1: Estimate the total manufacturing cost as follows:
Manufacturing costs:
$XXX
Direct materials
XXX
Direct labor
XXX
Factory overhead
XXX
Total manufacturing cost
o
$XXX
Step 2: Estimate the total selling and administrative
expenses.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Total Cost Method
(slide 3 of 4)
o
Step 3: Estimate the total cost as follows:
Total manufacturing costs
Selling and administrative expenses
Total cost
o
$XXX
XXX
$XXX
Step 4: Divide the total cost by the number of units expected
to be produced and sold to determine the total cost per unit,
as follows:
Total cost per unit =
Total cost
Estimated units produced and sold
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Total Cost Method
(slide 4 of 4)
o
Step 5: Compute the markup percentage as follows:
Markup percentage =
Desired profit
Total cost
â–ª The desired profit is normally computed based on a rate of return on
assets as follows:

Desired profit = Desired return ï‚´ Total assets
o
Step 6: Determine the markup per unit by multiplying the
markup percentage times the total cost per unit as follows:
Markup per unit = Markup percentage ï‚´ Total cost per unit
o
Step 7: Determine the normal selling price by adding the
markup per unit to the total cost per unit as follows:
Total cost per unit
Markup per unit
Normal selling price per unit
$XXX
XXX
$XXX
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Variable Cost Method
(slide 1 of 4)
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Variable Cost Method
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Variable Cost Method
(slide 2 of 4)
•
The variable cost method is applied using the following
steps:
o
Step 1: Estimate the total variable product cost as follows:
Variable product costs:
$XXX
Direct materials
XXX
Direct labor
XXX
Variable factory overhead
XXX
Total variable product cost
$XXX
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Variable Cost Method
(slide 3 of 4)
o
Step 2: Estimate the total variable selling and administrative
expenses.
o
Step 3: Determine the total variable cost as follows:
Total variable product cost
Total variable selling and administrative expenses
Total variable cost
o
$XXX
XXX
$XXX
Step 4: Compute the variable cost per unit as follows:
Total variable cost
Variable cost per unit =
Estimated units produced and sold
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix: Variable Cost Method
(slide 4 of 4)
o
Step 5: Compute the markup percentage as follows:
Markup percentage =
Desired profit + Total fixed costs and expenses
Total variable cost
â–ª The desired profit is normally computed based on a rate of return on
assets as follows:
Desired profit = Desired return × Total assets
o
Step 6: Determine the markup per unit by multiplying the markup
percentage times the variable cost per unit as follows:
Markup per unit = Markup percentage × Variable cost per unit
o
Step 7: Determine the normal selling price by adding the markup
per unit to the variable cost per unit as follows:
Variable cost per unit
Markup per unit
$XXX
XXX
Normal selling price per unit $XXX
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Yield Pricing in Service Businesses
•
Yield pricing is a type of “accepting business at a
special price” differential analysis.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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