Complete the following descriptions using terms a through e.
a. Opportunity cost b. Avoidable costs c. Sunk cost d. Relevant benefits e. Out-of-pocket cost
1. A arises from a past decision and cannot be avoided or changed; it is irrelevant to future decisions.
2. refer to the incremental revenue generated from taking one particular action over another.
3. Relevant costs are also known as .
4. An requires a future outlay of cash and is relevant for current and future decision making.
5. An is the potential benefit lost by taking a specific action when two or more alternativechoices are available.
The sunk cost has no effect on the future decisions.
The relevant cost is the cost that is relevant to the future decision
Farrow Co. expects to sell 150,000 units of its product in the next period with the following results.
Sales (150,000 units) $2,250,000
Costs and expenses
Direct materials . 300,000
Direct labor 600,000
Overhead . 150,000
Selling expenses . 225,000
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 385,500
Total costs and expenses 1,660,500
Net income . $ 589,500
The company has an opportunity to sell 15,000 additional units at $12 per unit. The additional sales would not affect its current expected sales. Direct materials and labor costs per unit would be the same for the additional units as they are for the regular units. However, the additional volume would create the following incremental costs: (1) total overhead would increase by 15% and (2) administrative expenses would increase by $64,500. Prepare an analysis to determine whether the company should accept or reject the offer to sell additional units at the reduced price of $12 per unit.
Elegant Decor Company’s management is trying to decide whether to eliminate Department 200, which
has produced losses or low profits for several years. The company’s 2017 departmental income statements
show the following:Year Ended December 31, 2017
Dept. 100 Dept. 200 Combined
Sales . $436,000 $290,000 $726,000
Cost of goods sold 262,000 207,000 469,000
Gross profit 174,000 83,000 257,000
Advertising 17,000 12,000 29,000
Store supplies used 4,000 3,800 7,800
Depreciation—Store equipment . 5,000 3,300 8,300
Total direct expenses 26,000 19,100 45,100
Sales salaries . 65,000 39,000 104,000
Rent expense 9,440 4,720 14,160
Bad debts expense 9,900 8,100 18,000
Office salary . 18,720 12,480 31,200
Insurance expense 2,000 1,100 3,100
Miscellaneous office expenses . 2,400 1,600 4,000
Total allocated expenses 107,460 67,000 174,460
Total expenses . 133,460 86,100 219,560
Net income (loss) . $ 40,540 $ (3,100) $ 37,440
In analyzing whether to eliminate Department 200, management considers the following:
a. The company has one office worker who earns $600 per week, or $31,200 per year, and four salesclerks
who each earns $500 per week, or $26,000 per year for each salesclerk.
b. The full salaries of two salesclerks are charged to Department 100. The full salary of one salesclerk is
charged to Department 200. The salary of the fourth clerk, who works half-time in both departments,
is divided evenly between the two departments.
c. Eliminating Department 200 would avoid the sales salaries and the office salary currently allocated to
it. However, management prefers another plan. Two salesclerks have indicated that they will be quitting
soon. Management believes that their work can be done by the other two clerks if the one office
worker works in sales half-time. Eliminating Department 200 will allow this shift of duties. If this
change is implemented, half the office worker’s salary would be reported as sales salaries and half
would be reported as office salary.
d. The store building is rented under a long-term lease that cannot be changed. Therefore, Department
100 will use the space and equipment currently used by Department 200.
e. Closing Department 200 will eliminate its expenses for advertising, bad debts, and store supplies; 70%
of the insurance expense allocated to it to cover its merchandise inventory; and 25% of the miscellaneous
office expenses presently allocated to it.
1. Prepare a three-column report that lists items and amounts for (a) the company’s total expenses (including
cost of goods sold)—in column 1, (b) the expenses that would be eliminated by closing
Department 200—in column 2, and (c) the expenses that will continue—in column 3.
2. Prepare a forecasted annual income statement for the company reflecting the elimination of
Department 200 assuming that it will not affect Department 100’s sales and gross profit. The statement
should reflect the reassignment of the office worker to one-half time as a salesclerk.
3. Reconcile the company’s combined net income with the forecasted net income assuming that
Department 200 is eliminated (list both items and amounts). Analyze the reconciliation and explain
why you think the department should or should not be eliminated.
A company must decide between scrapping or reworking units that do not pass inspection. The company has 22,000 defective units that cost $6 per unit to manufacture. The units can be sold as is for $2.00 each, or theycan be reworked for $4.50 each and then sold for the full price of $8.50 each. If the units are sold as is, the company will be able to build 22,000 replacement units at a cost of $6 each, and sell them at the full price of $8.50 each. (1) What is the incremental income from selling the units as scrap? (2) What is the incremental income from reworking and selling the units? (3) Should the company sell the units as scrap or rework them?
Label each of the following statements as either true (“T”) or false (“F”).
1. Relevant costs are also known as unavoidable costs.
2. Incremental costs are also known as differential costs.
3. An out-of-pocket cost requires a current and/or future outlay of cash.
4. An opportunity cost is the potential benefit that is lost by taking a specific action when two
or more alternative choices are available.
5. A sunk cost will change with a future course of action.
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