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Q7E

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Financial & Managerial Accounting
Found in: Page 1053
Financial & Managerial Accounting

Financial & Managerial Accounting

Book edition 7th
Author(s) John J Wild, Ken W. Shaw, Barbara Chiappetta
Pages 1096 pages
ISBN 9781259726705

Short Answer

Varto Company has 7,000 units of its sole product in inventory that it produced last year at a cost of $22 each. This year’s model is superior to last year’s, and the 7,000 units cannot be sold at last year’s regular selling price of $35 each. Varto has two alternatives for these items: (1) they can be sold to a wholesaler for $8 each or (2) they can be reworked at a cost of $125,000 and then sold for $25 each. Prepare an analysis to determine whether Varto should sell the products as is or rework them and then sell them.

The company should sell the product to the wholesaler as it is.

See the step by step solution

Step by Step Solution

Step 1: Definition of incremental income

The incremental income is the company’s income after choosing various courses of action.

 Step 2: Calculation of incremental income

Sell as is

Process Further

Sales

$56,000

$175,000

Relevant Costs:

Cost of Process Further

$125,000

Total Relevant Costs

$125,000

Incremental Income

$56,000

$50,000

The incremental income by selling it to a wholesaler is $56,000

Most popular questions for Business-studies Textbooks

Esme Company’s management is trying to decide whether to eliminate Department Z, which has produced

low profits or losses for several years. The company’s 2017 departmental income statements show

the following.

ESME COMPANY

Departmental Income Statements

For Year Ended December 31, 2017

Dept. A Dept. Z Combined

Sales . $700,000 $175,000 $875,000

Cost of goods sold 461,300 125,100 586,400

Gross profit 238,700 49,900 288,600

Operating expenses

Direct expenses

Advertising 27,000 3,000 30,000

Store supplies used 5,600 1,400 7,000

Depreciation—Store equipment . 14,000 7,000 21,000

Total direct expenses 46,600 11,400 58,000

Allocated expenses

Sales salaries . 70,200 23,400 93,600

Rent expense 22,080 5,520 27,600

Bad debts expense 21,000 4,000 25,000

Office salary . 20,800 5,200 26,000

Insurance expense . 4,200 1,400 5,600

Miscellaneous office expenses . 1,700 2,500 4,200

Total allocated expenses 139,980 42,020 182,000

Total expenses . 186,580 53,420 240,000

Net income (loss) . $ 52,120 $ (3,520) $ 48,600

In analyzing whether to eliminate Department Z, management considers the following items:

a. The company has one office worker who earns $500 per week or $26,000 per year and four salesclerks

who each earns $450 per week, or $23,400 per year for each salesclerk.

b. The full salaries of three salesclerks are charged to Department A. The full salary of one salesclerk is

charged to Department Z.

c. Eliminating Department Z 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 two remaining clerks if the one office

worker works in sales half-time. Eliminating Department Z 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 A

will use the space and equipment currently used by Department Z.

e. Closing Department Z will eliminate its expenses for advertising, bad debts, and store supplies; 65%

of the insurance expense allocated to it to cover its merchandise inventory; and 30% of the miscellaneous

office expenses presently allocated to it.

Required

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 Z—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 Z assuming that it will not affect Department A’s sales and gross profit. The statement

should reflect the reassignment of the office worker to one-half time as a salesclerk.

Analysis Component

3. Reconcile the company’s combined net income with the forecasted net income assuming that

Department Z is eliminated (list both items and amounts). Analyze the reconciliation and explain why

you think the department should or should not be eliminated.

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