File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
_____________________________________________________________________________________________ Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 1 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Lesson FA-20-060-01
Incremental Analysis
Part 1 – Accept or Reject a Special Order
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File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 2 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Incremental Analysis – Part 1 – Accept or Reject a Special
Order
[Clip 01] Incremental Analysis Concepts
Pre-Requisites
Before watching this video, you should understand the concepts covered in video
lesson FA-20-010-xx on Managerial Cost Concepts, and video lesson FA-20-050-xx
on Cost Volume Profit Analysis
In particular you should understand the manufacturing cost classifications of
direct materials, direct labor, and manufacturing overhead, and the cost behavior
classifications of variable and fixed costs.
Objectives
The primary objectives of this lesson are:
Understand concepts related to short term, or incremental, decisions.
Illustrate common situations in which short term decision principles may be applied.
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 3 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Incremental Analysis
Incremental Analysis is a general term usually applied to the process of
determining relevant revenue and cost information for making short term
decisions
The basic approach involves:
o identifying the revenue and cost factors associated with two or more
choices for a decision
o selecting from these revenue and cost factors those that are relevant
to the decision given the time frame for the decision
o evaluating the relevant revenue and cost factors to determine the
relative impact of each choice on net income and/or total costs
o choosing the alternative that gives the highest net income or the
lowest total cost as appropriate
Incremental Analysis Scenarios
We usually find it helpful to think about incremental analysis in terms of
“scenarios”
There are five common scenarios in which we can apply incremental analysis
principles:
o Accept or Reject a Special Order Decision
o Make or Buy Decision (Insource or Outsource)
o Continue or Discontinue a Business Segment Decision
o Sell now or Process Further (and Sell later) Decision
o Retain or Replace Decision
We will discuss each of these scenarios and the important considerations
with regard to incremental revenue and incremental cost
Before discussing the scenarios, let’s establish the basic cost concepts that
will apply to these scenarios.
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 4 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Incremental Analysis Cost Factors
Relevant revenue or cost – is one which differs among the decision
alternatives and has characteristics that make it relevant
Opportunity cost – is the implied cost associated with passing up a benefit of
one decision alternative by making an alternate decision
Sunk cost – is a cost which has been incurred in the past and is not relevant
to a future decision
Direct fixed cost – is a cost which can be directly associated with a product,
service, or activity
o Direct fixed costs are usually relevant unless they are sunk costs
Indirect fixed cost – is a fixed cost which cannot be directly associated
with a product, service, or activity, and thus is allocated using a set of rules
or assumptions
o Are usually not relevant to a short-term decision
As we discuss each scenario for incremental analysis, keep in mind the three cost
concepts here.
In particular, keep in mind that fixed costs are fixed in total in the short run, and
thus are often not relevant to a short term decision.
In cases where a fixed cost is relevant to a short-term decision, sometimes we
have to differentiate between direct and indirect fixed costs since indirect fixed
costs are usually not relevant, but direct fixed costs may be relevant.
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 5 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Accept or Reject an Order at a Special Price
The first scenario we want to study is the “accept an order at a special
price” decision.
The basic scenario is one in which a buyer approaches our company and asks
for a special price lower than our normal price.
The question then is whether it is worthwhile to take the special order and
grant the special price.
In this scenario, we will want to consider the incremental revenue from
making the sale at the special price versus the revenue from not making the
sale; and the incremental costs from making the sale versus not making the
sale.
Since we typically have both revenue and costs to consider, our interest is in
evaluating the incremental effect on net income of accepting the special
order.
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 6 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
[Clip 02] Example 1 - Accept a Special Order Decision - Rochester Travel
Products - Case 1
Example 1. Rochester Travel Products – Case 1
Rochester Travel Products produces and sells a flight bag designed to allow the
traveler to conveniently complete the inspection and boarding process and to fit
neatly under the seat in most aircraft. In the current year, the company expects
to incur $600,000 in fixed costs ($12.00 per flight bag) and $400,000 in variable
costs ($8.00 per flight bag) in producing 50,000 flight bags while operating at 80%
capacity.
The company currently has orders from retailers in the United States for their
total year’s planned production at a price $25 each. A retailer in Bulgaria
approaches the sales manager of Rochester Travel Products and offers to buy
10,000 flight bags, but is willing to pay only $15.00 each including shipping. The
special order will add $2.00 per flight bag in special shipping costs to Bulgaria.
Sale of the flight bags to the Bulgarian retailer is not expected to affect
Rochester’s normal sales.
Should the sales manager accept the special order?
(see Appendix 1 for the Solution)
Summary of the facts:
Operating at 80% capacity, the company plans to produce and sell 50,000
flight bags at $25 each costing:
o $600,000 in fixed costs ($12.00 per flight bag)
o $400,000 in variable costs ($8.00 per flight bag)
The special order of 10,000 flight bags will add $2.00 per flight bag in
shipping costs and will yield $15.00 per bag in revenue.
Sale of the flight bags to the Bulgarian retailer is not expected to affect
Rochester’s normal sales.
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 7 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Example 1. Rochester Travel Products – Case 1
Special Order Decision Worksheet
Reject the
Special order
Accept the
Special Order
Change in
Revenue,
Costs, and Net
Income
Revenue
Costs:
Fixed Costs
Variable Costs
Special Shipping
Net Income
Example 1. Rochester Travel Products – Case 1
Special Order Decision Worksheet
(alternate incremental approach)
Reject the
Special order
Accept the
Special Order
Change in
Revenue,
Costs, and Net
Income
Revenue
Costs:
Fixed Costs
Variable Costs
Special Shipping
Net Income
[Clip 03] Example 2 - Accept a Special Order Decision - Rochester Travel
Products - Case 2
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 8 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Example 2. Rochester Travel Products – Case 2
Suppose all of the assumptions are the same as described, but in addition:
Rochester Travel Products is operating at 100% capacity and accepting the special
order would require installing an additional machine in the factory which could be
leased for $5,000 for the length of time needed to produce the additional 10,000
flight bags.
In addition, workers would be needed at overtime pay adding $2.00 per flight bag
for the additional 10,000 flight bags.
Should the sales manager accept the special order?
(see Appendix 1 for the Solution)
Summary of the facts:
Operating at 100% capacity, the company plans to produce and sell 50,000
flight bags at $25 each costing:
o $600,000 in fixed costs ($12.00 per flight bag)
o $400,000 in variable costs ($8.00 per flight bag)
The special order of 10,000 flight bags will add $2.00 per flight bag in
shipping costs and will yield $15.00 per bag in revenue.
Sale of the flight bags to the Bulgarian retailer is not expected to affect
Rochester’s normal sales.
Leasing of an additional machine to meet production of the special order will
cost $5000.
Employing workers at overtime pay will add $2.00 per flight bag for the
additional flight bags.
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 9 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Example 2. Rochester Travel Products – Case 2
Special Order Decision Worksheet
Reject the
Special order
Accept the
Special Order
Change in
Revenue,
Costs, and Net
Income
Revenue
Costs:
Fixed Costs
Variable Costs
Special Shipping
Net Income
Example 2. Rochester Travel Products – Case 2
Special Order Decision Worksheet
(alternate incremental approach)
Reject the
Special order
Accept the
Special Order
Change in
Revenue,
Costs, and Net
Income
Revenue
Costs:
Fixed Costs
Variable Costs
Special Shipping
Net Income
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 10 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
[Clip 04] Example 3 - Accept a Special Order Decision - Rochester Travel
Products - Case 3
Example 3. Rochester Travel Products – Case 3
Suppose all of the assumptions are the same as described in case 1 and case 2, but
in addition:
Suppose the Bulgarian retailer has an online store and there is a high
probability that 5,000 of the flight bags will be sold to retail customers in
the United States and that Rochester’s normal retailers will likely have to
cut back their orders by 5,000 flight bags
Should the sales manager accept the special order?
(see Appendix 1 for the Solution)
Hint: Use the approach where you cost out the total revenue and total costs for
each relevant item.
Summary of the facts:
Operating at 100% capacity, the company plans to produce and sell 50,000
flight bags at $25 each costing:
o $600,000 in fixed costs ($12.00 per flight bag)
o $400,000 in variable costs ($8.00 per flight bag)
The special order of 10,000 flight bags will add $2.00 per flight bag in
shipping costs and will yield $15.00 per bag in revenue.
Leasing of an additional machine to meet production of the special order will
cost $5000.
Employing workers at overtime pay will add $2.00 per flight bag for the
additional flight bags.
The special order will likely reduce normal sales by 5,000 units.
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 11 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
Example 3. Rochester Travel Products – Case 3
Special Order Decision Worksheet
Reject the
Special order
Accept the
Special Order
Change in
Revenue,
Costs, and Net
Income
Revenue
Costs:
Fixed Costs
Variable Costs
Special Shipping
Net Income
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 12 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
APPENDIX 1 – SOLUTIONS
Incremental Analysis – Part 1 – Accept or Reject a Special
Order
[Clip 02] Example 1 - Accept a Special Order Decision - Rochester Travel Products - Case 1
SOLUTION:
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 13 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
[Clip 03] Example 2 - Accept a Special Order Decision - Rochester Travel Products - Case 2
SOLUTION:
File: FA-20-060-01-Workbook.pdf
Title: Managerial Acctng – Incremental Analysis – Part 1 – Accept or Reject a Special Order
Copyright 2011 by Rocky Spears Enterprises LLC, All Rights Reserved Page 14 of 14 videos for this lesson are available at evideolearner.com Revised: 2011-05-24
[Clip 04] Example 3 - Accept a Special Order Decision - Rochester Travel Products - Case 3
SOLUTION: