MANAGEMENT ACCOUNTING CONCEPTS AND TECHNIQUES
By Dennis Caplan, University at Albany (State University of New York)
CHAPTER 3: Exercises and Problems:
Discussion Question 3-1:
Part A: You are a big fan of rock musician David Bowie. (There’s no accounting for taste.) You decide to spend $200 for you and your friend to go to an upcoming David Bowie concert, and you buy a pair of tickets. On your way to the concert, you realize that you have lost the tickets! At first, you panic. Then you realize that, most likely, your little sister put the tickets down the kitchen disposal the other day when she was mad at you. Anyhow, she put something down the disposal, and seemed to derive great satisfaction from it. You make a mental note to kidnap her beanie baby collection. In the meantime, at the box office, you learn that seats are still available, and you can buy new tickets that are comparable to the ones you lost, for $200. Evaluate the logic, in terms of the relevant cost concepts of incremental cost, sunk cost and/or opportunity cost, with respect to each of the following responses to the question of “What should you do?”
a. You should forego the concert, because although the concert was worth $200 to attend, it’s not worth $400 to attend.
b. You should buy the tickets, even though you never would have spent $400 to attend, because at this point, the incremental cost is only $200.
c. You should buy the tickets, even though you never would have spent $400 to attend, because at this point, if you don’t, your friend will be very disappointed in you.
Part B: You decide that it is not worth another $200 to
attend the concert, and you and your friend decide to go bowling. On the way
out of the lobby, a wealthy and happy-looking couple whom you have never seen before
confront you, tell you they have decided to fly to
a. You should attend the concert, since you are now in exactly the same situation you were in when you were driving to the concert and thought you had the original tickets.
b. You should sell the tickets for $200, since you had already decided, only a few minutes ago, that you didn’t want to spend another $200 to buy the tickets.
3-2: Assume that last semester you bought a textbook new for $77. Today, the same book sells new for $100, and used copies in the bookstore now sell for $75. The bookstore offers to buy back your book for $45. You would like to sell your book, and a student who will be taking the course next semester wants to buy your book directly from you. At what range of prices should a sale take place between you and the other student?
3-3: Roulex has 500 watches that cost $15 each to manufacture. The watches are out of fashion and cannot be sold as is. They can be refitted at a cost of $4 per watch, and then sold for $18 each. Alternatively, the watches can be donated to charity for a net financial benefit (i.e., a reduction in the company’s tax liability) of 20% of the original production cost.
A) Identify a sunk cost in the scenario described above.
B) What should the company do?
C) Quantify the opportunity cost associated with the course of action you recommended above.
3-4: The Uris Deli purchased a machine for $67,000. Current accumulated depreciation on the machine is $33,000. Management is thinking about buying a new machine at a cost of $85,000. The disposal of the old machine would cost $21,000. Which of the following choices most accurately describes which costs are sunk and which costs are relevant?
(A) Sunk costs consist of the $67,000 purchase price of the old machine, and the $33,000 accumulated depreciation on the old machine. Relevant costs consist of the $85,000 purchase price of the new machine, and the $21,000 disposal cost of the old machine.
(B) Sunk costs consist of the $67,000 purchase price of the old machine. Relevant costs consist of the $85,000 purchase price of the new machine.
(C) Sunk costs consist of the $67,000 purchase price of the old machine. Relevant costs consist of the $85,000 purchase price of the new machine, and the $21,000 disposal cost of the old machine.
(D) Sunk costs consist of the $67,000 purchase price of the old machine, and the $34,000 book value of the old machine. Relevant costs consist of the $85,000 purchase price of the new machine, and the $21,000 disposal cost of the old machine.
3-5: The year is 2001. Arthur Andersen has ordered some custom-made furniture from Lane Furniture Company. Lane recently completed manufacturing ten executive desks that had the Arthur Andersen logo carved into the front and sides of the desk. Lane’s manufacturing costs were $2,000 per desk, which consist of $400 in materials, $600 in labor, and $1,000 of other manufacturing-related costs. Arthur Andersen had agreed to pay $3,000 per desk, but has now informed Lane that it can no longer honor the agreement. Lane’s options are as follows. Lane can rework the desks, removing the Arthur Andersen logo at a labor cost of $750 per desk, and sell each desk for $1,500. Alternatively, Lane can sell each desk, as is, to collectors, for $800.
Should Lane (1) rework the desks and sell them; (2) sell them with the logo to collectors; or (3) not sell the desks at all?
3-6: Smith Company makes widgets. Newman Company has approached Smith with a proposal to sell the company one of the components used to make widgets at a price of $100,000 for 50,000 units. Smith is currently making these components in its own factory. The following costs are associated with this part of the process when 50,000 units are produced:
Materials used to make the widgets
Labor incurred to make the widgets
Other manufacturing costs
The category “other manufacturing costs” includes $28,000 of costs that will be eliminated if the components are no longer produced by Smith. The remaining costs in this category will continue to be incurred, whether or not Smith makes the components.
Required: How much better off or worse off will Smith be, if Smith buys the components from Newman, versus continuing to make the components in-house? Should Smith make the components or buy them from Newman?
3-7: SunFun makes beach equipment, including frisbees. The cost to make each frisbee (assuming 100,000 are produced each year) is as follows: materials of $0.50 per unit; labor of $0.10 per unit, variable overhead (such as factory electricity) of $0.15 per unit, and allocated fixed overhead of $0.25 per unit (an allocation of costs such as factory rent and insurance). An Australian company approaches SunFun for a large order in February (typically a slow month) and offers to buy 10,000 frisbees for $0.90 each. Regular sales would not be affected and capacity is available to produce them. Total fixed costs will be unaffected. The normal selling price is $1.25 each. What will be the effect on profits from accepting the order?
3-8: The Jennie Mae Frog Farm incurs production costs of $2 each time a frog is produced. In addition, the farm spends a lump-sum $5,000 each month for expenditures such as insurance, property taxes, and equipment leases, regardless of how many frogs are produced. Times are good: Jennie Mae is operating at capacity, and she is producing and selling 1,000 frogs per month. Jennie Mae’s usual sales price is $9 per frog. The U.S. Army has approached Jennie Mae and proposed a one-time purchase of 300 frogs.
A) What is the lowest price Jennie Mae should be willing to charge the Army per frog?
B) Disregard your answer to part (A) and assume the Army offers to pay $6 per frog. What is the opportunity cost associated with each frog sold to the Army at this price?
C) Now assume that times are not so good, and Jennie Mae has excess capacity to make 500 frogs. The Army offers to buy 300 frogs at $6 each. What is the opportunity cost associated with each frog sold to the Army at this price?
3-9: Refer to the previous question. Now assume that the market for frogs crashes, and Jennie Mae changes over to making platypuses. She has an aging inventory of frogs sufficient to meet market demand for ten months (300 frogs per month), but unfortunately, frogs only have a useful life of five months and her inventory becomes obsolete after that. What is the lowest price Jennie Mae should accept from the Army for a one-time-only purchase of 300 frogs?
3-10: Joe can stock his cooler with beer, soda or juice, and sell everything in it at the beach on a hot Saturday in June. The beer costs $1 per bottle, and he can sell beer for $2 per bottle. The soda costs $0.25 per can, and he can sell soda for $1.50 per can. The juice costs $1.25 per carton, and he can sell each carton for $1.75. The cooler has a capacity of 12 cubic feet. Each cubic foot can hold 16 juice cartons, six soda cans, or eight bottles of beer. What should Joe do in order to maximize his profits?
3-11: Refer to the previous question. Now assume that Joe has to pay for parking and for a vendor’s license. How will these lump-sum costs, which do not depend on how Joe stocks his cooler, affect your answer to the previous question?
Management Accounting Concepts and Techniques; copyright 2006; most recent update: November 2010
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