ACT 600

Advanced Managerial Accounting

Chapter 3
Using Costs in Decision Making

Learning Objectives
After studying this chapter, you should be able
to:
Understand how cost information supports
important management decisions regarding
product pricing, product planning, budgeting,
and performance evaluation.
Understand the role of cost concept , and be
able to use it in make-or-buy, product and
department abandonment, costing orders, and
product mix decisions and be able to apply the
relevant cost concept in simple situations.
2

The Important Cost Related Concepts In

Management Accounting

The use of cost information is

pervasive in decision making for:
a) Pricing
b) Product planning
c) Budgeting
d) Performance evaluation
e) Contracting
3

a) Pricing

I. In case of market-determined price,

the organization will use product cost
information to decide whether its
cost structure allows it to compete
profitably.
II. In markets where organization can
set its price, the price is often set as
an increment of products cost. (cost
plus pricing)
4

b) Product Planning
Focus efforts in product and process
design, on developing a product that
has a good profit potential.

c) Budgeting

Projects or forecasts costs for various

levels of production, and sales
activity.

d) Performance Evaluation
Compare actual results to expectations
reflected in the budget to assess how well
the organization did in light of its
expectations.

Types of costs
A. Variable Costs
B. Fixed Costs

Types of costs
A. Variable costCost that increases or decreases
proportional with changes in the activity level of
a variable called a cost driver.
Example: the variable cost of producing a chair equals the cost
of wood number of units produced. As the number of
units produced increases, the variable cost increases. Other
variable manufacturing costs may include wages and other
supplies variable with units produced.
Variable cost of producing a unit of chair =
variable cost of wood + variable cost of labor + variable cost
of other supplies.

Types of costs
B. Fixed Costis a cost that does not vary in
the short run with a specified activity.
Examples: Depreciation of equipment;
Salaries of HO staff;
Depreciation of HO building.

10

What is Total Cost?

Total cost = Variable cost + Fixed cost

11

Cost /Volume/Profit Analysis (CVP)

(CVP) analysis uses the concepts of

variable and fixed cost to identify the profit
associated with various levels of activities.
Many decision makers use the probability
of at least breaking even or earning a
target profit as a measure of a projects
risk.
How many showings of a movie will be
required to recover a producers total
investment in a movie and earn a profit.
12

Example: Rose Furniture Co.

Assume that the rocking chair produced by the company is
sold for $300.
Assume that all rocking chairs produced in any period are
all sold.
Assume variable costs (VC) per unit = $80;
Fixed costs (FC) = $400,000
Determine The revenue and the profit
Revenue (Sales) =
$300 number of rocking chairs sold
Profit =
Revenue Total cost
=
Revenue VC FC
Profit =
$300 No of rocking chairs
- $80 No. of rocking chairs
- $400,000
13

Developing and Using the CVP Equation

The difference between total revenue and total variable cost
is called the contribution margin.
The contribution margin per unit is the contribution that the
sale of each unit makes towards covering fixed costs and
providing a profit.
The contribution margin per unit in our example is: $220;
($300 - $80); (Revenue Variable cost)
The contribution margin ratio =
The contribution margin per unit = 300-80 = 73.33%
The selling price per unit
300
The contribution margin ratio is the fraction of each dollar
sales that is available to cover fixed expenses and produce a
profit.
14

Developing and Using the CVP Equation

Profit = $300 No. of rocking chairs
- $80 No. of rocking chairs (Total Variable Cost)
- $400,000 (Fixed Cost)
The profit equation can be rewritten as follows:
Profit = ($300 - $80) No of rocking chairs - $400,000
CVP equation for a single product can be written as:
Profit = unit sales (price per unit variable cost per
unit) fixed cost
or:
PROFIT = (CONTRIBUTION MARGIN PER UNIT
UNITS PRODUCED AND SOLD) FIXED COSTS
For the Rose Furniture Company:
Profit = $220 no. of rocking chairs sold - $400,000
15

UNIT SALES REQUIRED TO PRODUCE A

TARGET PROFIT
To determine the unit sales required to produce a target
profit, the general profit equation is used as follows:
Profit = (contribution margin per unit units produced and
sold) fixed costs
Rearranged to get the following:
Target profit = contribution margin per unit required unit
sales fixed costs
Required unit sales = Target profit + Fixed cost
contribution margin per unit
For the Rose Furniture Company:
Rocking chairs needed to be sold = Target profit + $400,000

$220
16

BREAKEVEN VOLUME
Breakeven volume:
Using the CVP equation, how many chairs must be made
to breakeven (i.e., achieve a profit of 0; contribution
margin just equal to fixed costs)
Rocking chairs needed to be sold = Target profit + $400,000

$220
= 0+ $400,000 = 1,819
$220

Breakeven Point = Fixed cost / Contribution

margin per unit

17

TARGET PROFIT
Suppose target profit is set as 20% of revenues. How many chairs will
have to be sold to earn this target profit?
We have:
Target profit = contribution margin per unit required unit sales
fixed costs
20% Revenues = contribution margin per unit required unit
sales fixed costs
20% (Price per unit Required unit sales) = contribution margin
per unit required unit sales fixed costs
(contribution margin per unit - 20% Price per unit) Required unit
sales = fixed costs
Required unit sales =

Fixed Cost

contribution margin per unit (20% Price per unit)

18

TARGET PROFIT contd

Required unit sales =

Fixed Cost
contribution margin per unit (20% Price per unit)

For the Rose Furniture Company this will be:

Required unit sales =

$400,000 =
$220- (20% $300 )

= $400,000
$220 - $60

= 2,500 units

19

Financial Modeling & What-If Analysis

Suppose the sales manager Of the Rose Furniture Co. believes
that a $25,000 advertising campaign will increase chair sales by
5% over the current 3,000 units.
Is this financially attractive?
Incremental cost related to this initiative = $25,000
The incremental benefit will equal the chairs contribution
margin per unit ($220) multiplied by the sales increase of 150
chairs (3,000 5%) = $33,000
The expected incremental effect on profits will be:
Incremental profit = Incr Cont Marg units increased incr.cost
= $220 150 25,000 = $8,000
Incr. Revenue $300 150 units = $45,000
Incr. VC
= (12,000)
Incr. FC
= (25,000)
Incr. Profit
$ 8,000

It looks like an attractive proposition with 32% expected return

on investment; ($8,000/$25,000)
20

Exercise 3-26 Page 122

Klear Camera Company is considering introducing a new video
camera. Its selling price is projected to be $1,200 per unit.
Variable manufacturing costs are estimated to be $360 per unit.
Variable selling costs are 20% of sales dollars. The company
expects the annual fixed manufacturing costs of the new camera
to be $4,200,000.
Required:
(a)Compute Klears contribution margin per unit and contribution
margin ratio.
(b)Determine the number of units Klear must sell to break even.
(c)Klear is considering a design modification that would reduce
the variable cost of the camera by $200 per unit. Explain whether
this change will cause Klears breakeven point to increase or
decrease when compared to the initial plans.

21

Solution-Exercise 3-26 Page 122

(a) Contribution margin p.u. = Selling Price p.u. Variable cost p.u

= 1,200 (360 + 240)

= $ 600 p.u.
Contribution margin ratio = Contribution margin/Sales
= $600/$1200
= 0.5 or 50%
(b) Break-even units = Fixed costs/Contribution margin p.u.
= $4,200,000/600
= 7,000 units
22

Solution-Exercise 3-26 Page 122

(c) Revised variable costs p.u. (after design modification)
= $600 $200 = $400 p.u.
Revised contribution margin p.u. = $(1200 - 400) = $ 800
Revised Break-even units = fixed costs/ Revised Contribution margin
per unit

= $4,200,000/ 800= 5,250 units

The reduction in variable costs p.u. has resulted in
increased contribution margin p.u. So, the fixed costs
can be recovered by selling lesser number of units.
This has brought down the break-even level by 1750
(7,000 5,250) units.

23

The Multiproduct Firm

Suppose the company expanded and is making kitchen chairs in
addition to the rocking chairs. Fixed costs increased to
$624,000.
Rocking
Chair
$

Sale Price
Variable Cost
Contribution margin/unit
Number in bundle
Total contribution margin

Kitchen
Chair
$

300

200

80

60

220

140

Bundle
$

20units 80units
4,400

11,200

15,600
24

The Multiproduct Firm

What are the sales required to breakeven?
Profit = (contribution margin per unit units produced and sold)
fixed costs
With these two products the CVP equation is:
Profit = (Rocking chair contribution margin Rocking chair sales) +
(kitchen chair contribution margin Kitchen chair sales) - $624,000
Profit = ($220 Rocking chair sales) + ($140 Kitchen chair sales) $624,000
We have one equation with two unknowns, meaning there are many
combination of sales of the two types of chairs to break even.
The company decided on a target mix of 20% rocking chairs and 80%
kitchen chairs. Which means the number of kitchen chairs produced is
four times the number of rocking chairs produced.
So, if rocking chairs produced and sold are X, Kitchen chairs are
4X
We can now substitute kitchen chairs out of the profit equation.
25

The Multiproduct Firm

Substituting kitchen chairs out of the profit equation as follows:
Profit = ($220 rocking chair sales) + [$140 (4 rocking chair sales)] $624,000
Profit = ($220X) + [$140 (4 X)] - $624,000
Profit = 780X - 624,000
0 profit + 624,000 = 780X
X=800 chairs
The breakeven point is found when the profit is 0 implying that
rocking chair sales at breakeven will be 800 ($624,000/$780).
Because kitchen chair sales are 4 rocking chair sales, the breakeven
kitchen chair sales with this ratio will be 3,200 (4 800).
TEST
Profit = ($220 Rocking chair sales) + ($140 Kitchen chair sales) $624,000
Profit= ($220 800) + ($140 3,200) - $624,000
Profit= $176,000 + $448,000 - 624,000
Profit= 0

26

Assumptions Underlying CVP Analysis

A. The price per unit and the variable cost per
unit (and therefore the contribution margin
per unit) remain the same over all levels of
production.
B. All costs can be classified as either fixed or
variable.
C. Fixed costs remain the same over all
contemplated levels of production.
D. Sales equal production.
27

Exercise 3-30
Page 123
A&Z Company sells products both domestically and internationally.
Fixed costs totaled $5,000,000 last year. In an effort to increase its
total sales volume, A&Z plans to spend an additional $1,280,000 in
advertising next year. Expected average prices and variable costs
appear below.
Domestic
International
Price per unit
$50
$40
Variable cost per unit
$30
$16_____
Because of the increased advertising, A&Z expects to sell 300,000
units domestically and 200,000 units internationally next year.
Required:
Using the expected sales mix, determine the number of units that
A&Z must sell in each market in order to earn income of $200,000
next year.
28

Exercise 3-30
Solution
Domestic sales are 1.5 International sales (300/200).
The Domestic CM = $50 $30 = $20;
The International CM = $40 $16 = $24
Let X = total number of units that must be sold in the
International market to earn $200,000 before taxes,
assuming the stated sales mix
PROFIT = (CONTRIBUTION MARGIN PER UNIT
UNITS PRODUCED AND SOLD) FIXED COSTS
Total CM Fixed costs = $200,000
($20 1.5X) + $24X $5,000,000 $1,280,000= $200,000
$54X = $6,480,000
X = $6,480,000/$54 = 120,000 units in the International
market.
1.5 X = 180,000 units in the Domestic market
$
29

End of Part 1

30

Using Costs in Decision Making

Chapter 3
Part 2

31

PART 2

We will be considering how the various cost

concepts occur in common management
decisions.
We will look at FOUR types of decisions:
1.Make versus buy decisions and outsourcing.
2.Decision to drop a product.
3.Costing order decisions the floor price.
4.Short term product mix decisions.

32

1. Make or Buy Decision

Make or Buy Decision involves deciding whether to
contract out for a product or service.
A. Many qualitative considerations enter into a make or
buy decision, including:
1. Reliability of the supplier in meeting quality and delivery
requirements
2. The strategic importance of the activity being outsourced.
(this activity being outsourced could also be bought by a
competitor)
B. The financial focus in the make or buy decision is
whether the costs avoided internally are greater than the
external costs that will be incurred when purchasing
from a supplier.
33

Make or Buy Decision

Internal Costs Avoided
All variable costs.
Any avoidable fixed costs
such as the cost of
supervisory personnel who
would be laid off, or
machinery that would be
sold.

External Costs Incurred

The cost of purchasing the
part.
Any transportation costs.
Any other costs involved in
dealing with the outside
supplier, ordering the
product, and receiving and
inspecting it.

34

Examples of Manufacturing Costs Used in Our

Examples
Manufacturing Costs:
1. Direct materials involve materials that can
easily be traced to a unit of output and are of
significant economic consequences to the final
product.
2. Direct labor costs are those labor costs that can
be traced to the creation of a product. (Direct
laborers are those who physically construct a
unit of output).
3. Manufacturing overhead costs are all costs
incurred by a manufacturing facility that are not
direct material or direct labor costs. (Thread,
Glue)
35

Example Chaps Company

Per unit costs to make a component of a product:
Direct materials
$12.54
Direct labor
5.77
Manufacturing overhead
10.00
Total
$28.31
30% of the manufacturing overhead is variable. 10% of
the fixed cost is avoidable if the product is discontinued.
Rosa Co. proposed to supply the part for $21.80 per unit.
shipping cost will be $0.12 per unit. Modification required
on a tool, if Rosa is contracted, (cost=$25,000) is $5,000
to be paid by Chaps. The value of the tool at end of
process is 0. Units required are 250,000 units.
Is the offer from Rosa Co. financially attractive?
36

The relevant cost concept

The only relevant items in a decision

are those that will be affected or
changed as a result of the decision.

37

Example Chaps Company

Is the offer from Rosa Co financially attractive?
Cost Item
Direct Materials

Amount Relevant Why?

$12.54

Yes

Avoided if purchased
externally

Direct labor

5.77

Yes

Avoided if purchased
externally

Variable mfg overhead

(30% $10)

3.00

Yes

Avoided if purchased
externally

Fixed mfg overhead

(70% 10% $10)

0.70

Yes

Avoided if purchased
externally

(21.80)

Yes

Incurred if purchased
externally

Yes

Incurred if purchased
externally

Supply price
Shipping

(0.12)
Tool rework cost per
unit ($5,000/250,000)

Yes

Incurred if purchased

38

Example Anjlees Catering Services (pp 104-105)

Cost Item

Amount

Source and purchase food

$180,000

Kitchen costs ($15,000 12)

180,000

Rent for current store and equipment ($9,000

12)

108,000

Drivers salary
Delivery van operating cost
External supply price

60,000
7,500
500,000

Rent for new office ($2,500 1.12 12)

33,600

Contribution provided by new business

30,000
39

Example Anjlees Catering Services (pp 104-105)

Should Anjlee contract with the

external suppliers?

40

Cost Item

Amount

Source and purchase

food

$180,000

Yes

Avoided if purchased
externally

180,000

Yes

Avoided if purchased
externally

108,000

Yes

Avoided if purchased
externally

60,000

Yes

Avoided if purchased
externally

7,500

Yes

Avoided if purchased
externally

External supply price

(500,000)

Yes

Incurred if purchased
externally

Rent for new office

(2,500 1.12 12)

(33,600)

Yes

Incurred if purchased
externally

30,000

Yes

Earned if purchased externally

Kitchen costs
(15,000 12)
Rent for current store
(9,000 12)
Drivers salary
Delivery van operating
cost

Contribution provided
by new business

Relevant?

Why?

Depreciation , based on historical cost (a

41

2. The Decision to Drop a Product

Organizations drop products when it is
unprofitable, either because:
revenues no longer exceed costs or
because other organizations offer to buy the
rights to the product at a favorable price.
The relevant cost analysis involves
comparing the costs saved by abandoning
the product with the revenues forgone.

42

Example Messi Company (Industrial Lathes)

Income Statement
Model
X355

Sales
Variable costs
Fixed costs*
Operating income
*Avoidable fixed
costs

Model
X655

Model
X966

Total

$23,445 $49,288 $54,677 $127,410

4,772

10,001

14,987

29,710

14,233

29,722

40,711

84,666

$4,490

$9,565 ($1,021)

$13,034

55%

40%

20%

Messi is considering dropping Model X966 which shows

chronic losses.
All values are in thousands.
43

Example Messi Company

Income Statement
Model
X355

Sales

Model
X655

Model
X966

Total

$23,445 $49,288 $54,677 $127,410

Variable costs

(4,722) (10,001) (14,987)

(29,710)

Avoidable fixed
costs

(7,828) (11,889)

(8,142)

(27,859)

$10,895 $27,398 $31,548

69,841

Product
contribution
Fixed costs

(56,807)

Operating income

$13,034

All values are in thousands.

44

The Decision to Drop a Product

From table we can see that Model X966
provides the highest contribution, and
dropping the product will decrease the
companys profitability by $31,548.
In this case, sales, the variable costs and
avoidable fixed costs are all relevant in
evaluating the profitability of each product.
The allocated fixed costs that are not
avoidable do not change as a result of
dropping the product, and therefore are not
relevant to the decision.
45

3. COSTING ORDERS

Deals with estimating the cost of unique

orders.
Computing the floor price or the
minimum price that a company would
consider for an order.
Considers the costs that will change for
the company as a result of accepting that
order.
46

Example Pepper Industries

The company received a new order for 50,000 coffee
mugs.
Full cost analysis for filling this special order is as
follows:
Item

Cost $

Direct materials - 50,000@ $0.66 each

33,000

Direct labor - 50,000@ $0.23 each

11,500

Variable Mfg overhead - 50,000@ $0.15 each

7,500

Fixed Mfg overhead - 50,000@ $0.10 each

5,000

Design costs

1,800

Shipping costs

3,600

Other administrative costs

1,500

Total order costs

63,900
47

Example Pepper Industries

Additional Information
All variable costs are incremental costs relating to this
order.
The charge for Fixed Mfg overhead is the standard fixed
overhead allocated by the company to all cups it
produces.
Design costs are the estimated costs of designing the
product for this customer. They reflect a cost of $900 to
which is added the standard 100% markup to cover fixed
overhead in the design department.
Shipping costs are the estimated costs of shipping the
completed product to the customer.
The other administrative costs represent the cost added to
each order to reflect admin costs at the company.
48

Example Pepper Industries

What minimum price per cup should

Pepper Industries consider quoting on
this order?
Consider the relevant cost idea, i.e. the
costs that will change as a result of
taking the order.

49

Example Pepper Industries

Cost
Item
Direct materials - 50,000@ $0.66 each

Incremental

$33,000

$33,000

11,500

11,500

Variable Mfg overhead - 50,000@ $0.15 each

7,500

7,500

Fixed Mfg overhead - 50,000@ $0.10 each

5,000

Design costs

1,800

900

Shipping costs

3,600

3,600

Other administrative costs

1,500

$63,900

$56,500

Direct labor - 50,000@ $0.23 each

Total order costs

Cost per cup: $56,500 / 50,000 mugs

$1.13
50

Example Pepper Industries

The relevant (incremental) costs to fill this

order is $56,500 or $1.13 per cup.
This is the minimum price that the company
should consider for quoting on this order.

51

Example Pepper Industries

$1.13 per cup is the minimum price that the company

should consider for quoting on this order.
Actual price charged will reflect strategic factors such
as:
The amount of competition, (the more unique the
organization, the higher the price it can charge).
The amount of idle capacity, how eager the
organization is for new business.
the possibility of future orders with the new
customer.

52

4. Relevant Cost and Short-Term Product Mix Decisions

Example Freds Wood Products

Some organizations with limited

production resources face competing
demands for these resources. In order to
make a choice involves the application
of relevant cost concept.
The approach is to allocate production
capacity to the product with the highest
contribution margin per unit of the
constraining factor of production.
53

4. Relevant Cost and Short-Term Product Mix Decisions

Example Freds Wood Products
Produce cutting boards among a number of wood products.
Sales manager believes that the product should be
upgraded and sold exclusively in high-end stores.
Table shows a higher profit for the proposed product.
Existing
Product
Price
Direct materials

Proposed
Product

$20.00

$35.00

$3.00

$5.00

Labor cost per unit

6.00

12.00

Selling

1.00

1.75

Manufacturing overhead

4.50

Per unit profit

14.50
$5.50

7.50

26.25
$8.75
54

Example Freds Wood Products

Additional Informaton

All workers are paid a flat wage irrespective of

hours worked.
Labor costs are charged to products at the rate of
$24 per hour.
Selling costs are 5% of the product price.
Overhead is charged at the rate of 150% of direct
material costs.
Variable manufacturing overhead costs are about
10% of direct material costs.
Maximum number of labor hrs that can be
used to produce cutting boards is 10,000.
55

Should Fred abandon the existing product in favor of the

proposed product?
Only the costs that will change as a result of changing to
new product should be considered in this decision.
Only variable overhead, direct materials and selling costs
are relevant and must be considered.
Labor costs are fixed, and will not change as a result of this decision.

New product looks like the preferred alternative.

Existing
Product
Price
Direct materials

Proposed
Product

$20.00

$35.00

$3.00

$5.00

Selling (5% of price)

1.00

1.75

Variable overhead (10% of DM)

0.30

Contribution margin

4.30
$15.70

0.50

7.25
$27.75
56

Example Freds Wood Products

Amount of labor hrs available = 10,000 hrs. (constraining factor)
Labor costs allocated to product = $24 per hr.
Existing product uses 0.25 labor hrs per unit ($6/$24); proposed
product uses 0.50hrs/unit ($12/$24). Contribution of new product per
labor hr is lower, (see table).
Existing
Product
Price
Direct materials

Proposed
Product

$20.00

$35.00

$3.00

$5.00

Selling

1.00

1.75

Variable overhead

0.30

4.30

0.50

7.25

Contribution

$15.70

$27.75

Labor hours

0.25

0.50

Contribution per labor hour

$15.7
4

$62.80

$27.75
2

$55.50
57

Example Freds Wood Products

This means that if 10,000 labor hrs are allocated to existing product,
total contribution to fixed cost will be $628,000 (10,000$62.80),
whereas it will be $555,000 for the proposed product.
In this case labor is the constraining factor of production. The approach
is to allocate production capacity to the product with highest
contribution margin per unit of the constraining factor of production.
Existing
Product
Price
Direct materials

Proposed
Product

$20.00

$35.00

$3.00

$5.00

Selling

1.00

1.75

Variable overhead

0.30

4.30

0.50

7.25

Contribution

$15.70

$27.75

Labor hours

0.25

0.5

$62.80

$55.50

Contribution per labor hour

58

-Exercises-

59

Exercise 3-32
Page 124

60

61

Exercise 3-39
Page 126

62

3-39 Make-or-buy
Kane Company is considering outsourcing a key component. A
reliable supplier has quoted a price of $75.50 per unit. The
following costs of the component when manufactured in-house
are expressed on a per unit basis:
Direct materials $25.50
Direct labor
15.00
Variable overhead 28.50
Fixed overhead
10.00
Total costs
$79.00
Required
(a) What assumptions need to be made about the behavior of
overhead costs for Kane in order to analyze the outsourcing
decision?
(b) Should Kane Company outsource the component?
(c) What other factors are relevant to this decision?
63

EXERCISE 3-46
PROFITABILITY OF ORDER AND EXTRA SHIFT DECISIONS
The manufacturing capacity of Ritter Rotator Companys plant facility is 60,000 rotators
per quarter. Operating results for the first quarter of this year are as follows.
Sales (36,000 units at $10)
$360,000
Variable manufacturing and selling costs
198,000
Contribution margin
162,000
Fixed costs
99,000
Operating income
$ 63,000
A foreign distributor has offered to buy 30,000 units at $9 per unit during the second
quarter of this year. Domestic demand is expected to remain the same as in the first
quarter.
Required
(a) Determine the impact on operating income if Ritter accepts this order. Assume that if
the company accepts the order, it foregoes sales to regular domestic customers. What other
considerations are relevant in this decision?
(b) Assume that Ritter decides to run an extra shift so that it can accept the foreign order
without forgoing sales to its regular domestic customers. The proposed extra shift would
increase capacity by 25% and increase fixed costs by $25,000. Determine the impact on
operating income if Ritter operates the extra shift and accepts the export order. What other
considerations are relevant in this decision?
64

Exercise 3-33 Page 124

Hearth specializes in lunches for health-conscious people. The company
produces a small selection of lunch offerings each day. The menu
selections may vary from day to day, but Healthy Hearth charges the
same price per menu selection because it adjusts the portion sizes
according to the cost of producing the selection. Healthy Hearth
currently sells 5,000 meals per month. Variable costs are $3 per meal,
and fixed costs total $5,000 per month. A government agency has
recently proposed that Healthy Hearth provide 1,000 meals next month
for senior citizens at $3.50 per meal. Volunteers will deliver the meals to
the senior citizens at no charge.
Required:
(a) Suppose Healthy Hearth has sufficient idle capacity to accommodate
the government order for next month. What will be the impact on
Healthy Hearths operating income if it accepts this order?
(b) Suppose that Healthy Hearth would have to give up regular sales of
500 meals, at a price of $4.50 each, to accommodate the government
order for next month. What will be the impact on Healthy Hearths
operating income if it accepts the government order?

65

Problem 3-49 Page 130

Walts Woodwork Company makes and sells wooden shelves. Walts carpenters make the
shelves in the companys rented building. Walt has a separate office at another location that
also includes a showroom where customers can view sample shelves and ask questions of
salespeople. The company sells all the shelves it produces each year and keeps no
inventories. The following information pertains to Walts Woodwork Company for the past
year:
a. Units produced and sold
b. Sales price per unit
c. Carpenter labor to make shelves
d. Wood to make the shelves
e. Sales staff salaries
f. Office and showroom rental expenses
g. Depreciation on carpentry equipment
h. Advertising
i. Sales commissions based on number of units sold
j. Miscellaneous fixed manufacturing overhead
k. Rent for the building where the shelves are made
l. Miscellaneous variable manufacturing overhead
m. Depreciation for office equipment

50,000
$70
600,000
450,000
80,000
150,000
50,000
200,000
180,000
150,000
300,000
350,000
10,000

Required
Make appropriate assumptions about cost behavior and assume that direct labor costs vary
directly with the number of units produced. How many units must the company sell in
order to earn a pretax profit of $500,000?
66

-END-

67