Spring 2018 Chapter 7 Review Questions

Multiple Choice Questions

1. A cost not relevant to deciding whether to purchase a new machine is:

a) The cost of the new machine
b) Lower maintenance costs for the new machine
c) The cost of the old machine
d) Additional training required for operating the new machine

2. A cost incurred in the past that cannot be changed by any future action
is:
a) Opportunity cost
b) Sunk cost
c) Relevant cost
d) Avoidable cost

3. ABC Company is trying to decided if they should replace an old machine

with a new machine. The following data was analyzed. The purchase of a
new machine would have what effect on net income?

Cost savings per year on new $100,000

machine
New Machine Cost $150,000
Revenue from sale of old machine $10,000
Book Value of old machine $25,000
a) Net decrease of $15,000
b) Net increase of $15,000
c) Net decrease of $40,000
d) Net increase of $40,000

4. It costs L Company $14 of variable costs and $6 of allocated fixed costs

to produce an industrial trash can that sells for $30. A buyer in Mexico
offers to purchase 3,000 units at $18 each. L Company has excess
capacity and can handle the additional production. What effect will
acceptance of the offer have on net income?
a) Decrease $6,000
b) Increase $6,000
c) Increase $54,000
d) Increase $12,000
Spring 2018 Chapter 7 Review Questions

5. W Company can make 1,000 toy robots with the following costs:

Direct materials $70,000

Direct labor 26,000
Variable overhead 15,000
Fixed overhead 15,000

The company can purchase the 1,000 robots externally for $125,000. The
avoidable fixed costs are $5,000 if the units are purchased externally.
What is the cost savings if the company makes the robots?
a) $1,000
b) $5,000
c) $10,000
d) $9,000

6. Abel Company produces three versions of baseball bats: wood,

aluminum, and hard rubber. A condensed segmented income statement
for a recent period follows:

Wood Aluminum Hard Rubber Total

Total Sales $500,000 $200,000 $65,000 $765,000

Variable expenses 325,000 140,000 58,000 523,000

Contribution margin 175,000 60,000 7,000 242,000

Fixed expenses 75,000 35,000 22,000 132,000

Net income (loss) $100,000 $ 25,000 $(15,000) $110,000

Assume none of the fixed expenses for the hard rubber line are
avoidable. What will be total net income if the line is dropped?
a) $125,000
b) $103,000
c) $105,000
d) $140,000
Spring 2018 Chapter 7 Review Questions

7. W Company is operating at 75% of its manufacturing capacity of 140,000

product units per year. A customer has offered to buy an additional
20,000 units at $32 each. The following data are available:

Costs at 75% Capacity Per Unit Total

Direct materials $12.00 $1,260,000
Direct labor 9.00 945,000
Overhead applied 15.00 1,575,000
Total $36.00 $3,780,000

In producing 20,000 additional units, fixed overhead costs would remain

at their current level but incremental variable overhead costs of $6 per
unit would be incurred. What is the effect on income if Wade accepts this
order?
a) Income will decrease by $4 per unit.
b) Income will increase by $4 per unit.
c) Income will increase by $5 per unit.
d) Income will increase by $11 per unit.

The next 2 questions refer to the following information:

M Company manufactures a cat food product called Special Export. M

Company currently has 10,000 bags of Special Export on hand. The
variable production costs per bag are $1.80 and total fixed costs are
$10,000. The cat food can be sold as it is for $9.00 per bag or be
processed further into Prime Cat Food and Feline Surprise at an
additional $2,000 cost. The additional processing will yield 10,000 bags of
Prime Cat Food and 3,000 bags of Feline Surprise, which can be sold for
$8 and $6 per bag, respectively.

8. The net advantage (incremental income) of processing Special Export

further into Prime and Feline Surprise would be:
a) $98,000
b) $96,000
c) $8,000
d) $6,000
Spring 2018 Chapter 7 Review Questions

9. If Special Export is processed further into Prime Cat Food and Feline
Surprise, the total gross profit would be:
a) $68,000
b) $78,000
c) $96,000
d) $98,000

10. X Company has already incurred a $12,000 cost in partially producing its
two products. Their selling prices when partially and fully processed are
shown in the table below with the additional costs necessary to finish their
processing. Based on this information, should any products be processed
further?

Unfinished Selling Finished Selling Further Processing

Product Price Price Costs
A $78 $325 $168
B 85 600 555

a) Both product A and product B should be processed further.

b) Neither product A nor product B should be processed
further.
c) Only product B should be processed further.
d) Only product A should be processed further.

Practice Problems
Spring 2018 Chapter 7 Review Questions

Practice Problem #1

J Company is now making a small part used in one of its products. The unit costs of
producing the part internally are:

Direct materials $15.00

Direct labor 10.00
Variable manufacturing overhead 2.00
Fixed manufacturing overhead, traceable 4.00
Fixed manufacturing overhead, allocated 5.00
Unit product cost $36.00

Depreciation of special equipment represents 75% of the traceable fixed manufacturing

overhead cost with supervisory salaries representing the balance. The supervisory
salaries could be avoided if production of the part were discontinued. An outside
supplier has offered to sell the part to J Company for $30 each, based on an order of
5,000 parts per year.

Required: Should J Company accept this offer?

Practice Problem #2

T Company makes backpacking tents. It has the capacity to produce 10,000 tents per
year and currently is producing and selling 7,000 tents. Normal selling price for a tent is
$470. Unit-level costs are $100 for direct materials, $200 for direct labor, and $25 for
other manufacturing costs. Facility-level costs of $80 are allocated to each tent. T
Company has received a special order for 1,500 tents at $340 each.

Required: How much income will T Company make on the special order?

Practice Problem #3

V Company is trying to decide whether to replace a packing machine that it uses to

pack pasta into serving size packages. The current machine requires $1,000 worth of
repairs to be useful. If they purchase a new machine, there is potential to rent it out for
$600 per year. The following information is available:

Current New
Machine Machine
Original cost $13,000 $8,000
Accumulated depreciation 8,000
Annual operating costs 2,000 500
Current salvage value 700
Spring 2018 Chapter 7 Review Questions

Required: Compute the increase or decrease in total net income over the
five-year period if the company chooses to buy the new machine.

Practice Problem #4

C Company has two divisions whose most recent income statements are shown below:

Commercial Residential
Division Division
Unit sales 10,000 2,000
Sales $800,000 $200,000
Production costs 350,000 120,000
Depreciation expense, equipment 150,000 50,000
Traceable selling and administrative costs 80,000 20,000
Corporate office expenses 25,000 15,000
Net Income (Loss) $195,000 ($5,000)

Required: Compute the impact on profit if the Residential Division is

eliminated.

Practice Problem #5

Y Company has already incurred $93,000 cost in partially producing its three products.
Their selling prices when partially and fully processed are shown in the table below with
the additional costs necessary to finish their processing.

Further
Unfinished Finished Processing
Product Selling Price Selling Price Costs
A $31.27 $62.37 $33.76
B 42.56 96.11 49.82
C 89.01 102.72 17.29

Required: Based on this information, should any products be processed

further?
Spring 2018 Chapter 7 Review Questions

Solutions
1. C
2. B
3. C
4. D
5. D
6. B
7. C
8. D
9. A

10. D

Solution #1

Direct materials $15.00

Direct labor 10.00
Variable manufacturing overhead 2.00
Fixed manufacturing overhead, traceable 1.00
Purchase price $30.00
Unit product cost $28.00 $30.00
Units produced 5,000 5,000
Total cost $140,000 $150,000

Difference in favor of making: $10,000. The depreciation on the equipment and

common fixed overhead are not avoidable costs.

Solution #2

Differential revenues 1,500 x $340 = 1500*340 $510,000

Variable costs:
Materials 100*1500 150,000
Labor 200*1500 300,000
Other manufacturing costs 25*1500 37,500
Differential income (loss) 22,500

The special order would cause income to increase by $22,500; based on this
information, it should be accepted. Facility level costs are irrelevant.
Spring 2018 Chapter 7 Review Questions

Solution #3

Net Income
Retain Purchase
Increase
Machine Machine
(Decrease)
Original cost $8,000 ($8,000)
Repair costs 1,000 $1,000
Annual
operating 10,000 2500
costs $7,500
Current
-700
salvage value $700
Rental
-3000
Revenue $3,000

$4,200
Management should purchase the new machine.

Solution #4
Commercial Residential Company
Division Division Totals
Unit sales 10,000 10,000
Sales $800,000 800,000
Production costs 350,000 350,000
Contribution
Margin 450,000 450,000
Depreciation
expense, 150,000 50,000
equipment 200,000
Traceable selling
and administrative 80,000
costs 80,000
Corporate office
25,000 15,000
expenses 40,000
Net Income (Loss) $195,000 ($65,000) 130,000

Management should keep the residential division.

Spring 2018 Chapter 7 Review Questions

Solution #5

Product A Product B Product C

Finished selling price $62.37 $96.11 $102.72
Unfinished selling price 31.27 42.56 89.01
Incremental selling price 31.10 53.55 13.71
Further processing costs 33.76 49.82 17.29
Incremental profit (loss) (2.66) 3.62 (3.58)

Only Product B should be processed further as it has a positive incremental profit.