Question

Problem 1 Bisha Corporation is considering trading a truck with a book value of SAR 52,000 with an estimated five-year life for a new truck that would cost SAR 80,000. The old truck could be sold for SAR 55,000. The new truck has a five-year life with no residual value. The new truck would reduce annual operating costs by SAR 4,300 per year. Prepare a differential analysis on whether to continue with the old machine (Alternative 1) or purchase the new machine (Alternative 2). Problem 2 A condensed income statement by product line for Yanbu Baking Inc. indicated the following for Almond Cookies for the past year: Sales SAR 1,200,000 Cost of goods sold 700,000 Gross profit 500,000 Operating expenses 570,000 Loss from operations (SAR 70,000) It is estimated that 20% of the cost of goods sold represents fixed factory overhead costs, and that 25% of the operating expenses are fixed. Because Almond Cookies is only one of the many products, the fixed costs will not be materially affected if the product is discontinued. Prepare a differential analysis to determine whether Almond Cookies should be continued (Alternative 1) or discontinued (Alternative 2). Should Almond Cookies be retained? Explain and indicate the dollar difference in favor or against. Problem 3 Asbtar Company manufactures various-sized plastic bottles for its medicinal product. The manufacturing cost for small bottles is SAR 65 per unit (100 bottles), including fixed costs of SAR 14 per unit. A proposal is offered to purchase small bottles from an outside source for SAR 42 per unit, plus SAR 3 per unit for freight. Prepare a differential analysis to determine whether the company should make (Alternative 1) or buy (Alternative 2) for bottles, assuming fixed costs are not affected by the decision. Problem 4 Product K12 is produced for SAR 14 per gallon. Product K12 can be sold without additional processing for SAR 22 per gallon or processed further into Product M27 at an additional cost of SAR 7 per gallon. Product M27 can be sold for SAR 27 per gallon. Prepare a differential analysis on whether to sell Product K12 (Alternative 1), or process further into Product M27 (Alternative 2). You must show all your work.

Answer 1

1) Cashflow analysis of buying new truck or continuing old truck:

option 1: buy new truck:

Particulars	Amount
Buying new truck	80000
Sale of old truck	(55000)
Reduction in Annual costs	(21500)
Net cashflow	3500

From the above it can be seen that buy option leads to net outflow of SAR 3,500 hence continuing with old truck shall be preferred.

2) Differential cost analysis:

Particulars	WIth Almond Cookies	Without Almond Cookies
Sales	1200000	0
Cost of Goods Sold	700000	140000 (Fixed Costs)
Operating Expenses	570000	142500 (Fixed Costs)
Net Loss	70000	282500

Hence, from the above analysis it advisable to continue with Production of almond cookies. Although almond cookies may not be a profitable product but it is contributing towards fixed overheads and therefore helping in reducing the losses. Hence, it is advisable to continue with almond cookies.

3) Irrespective of whether company buys or produces small bottles fixed costs are not going to change. Therefore decision shall be based upon variable cost comparison only.

Particulars	Make	Buy
Total Cost	65	0
(Less) Fixed Cost	(14)	0
Variable Cost / offered price	51	42
Add: Freight cost	0	03
Total variable cost	51	45

Per unit cost gets reduced to SAR 45 from SAR 51, hence buying shall be preferred.

4)

Particulars	K12 (Amounts in SAR)	M27 (Amounts in SAR)
Selling Price	22	27
Production cost of K12	14	14
Further processing cost into M27	0	07
Profit	08	06

Hence, it can be seen that profit has gone down from 08 SAR/gallon to 06 SAR/gallon by further processing the product. Hence further processing shall not be carried out.

This decision could also be reached as follows - Additional processing cost incurred - SAR 07

- Additional profits per unit by processing - SAR 05 (27-22)

Hence there is loss of SAR 2 in further processing.