Question

Differential Analysis for Machine Replacement

Kim Kwon Digital Components Company assembles circuit boards by using a manually operated machine to insert electronic components. The original cost of the machine is $72,900, the accumulated depreciation is $29,200, its remaining useful life is five years, and its residual value is negligible. On May 4 of the current year, a proposal was made to replace the present manufacturing procedure with a fully automatic machine that has a purchase price of $151,600. The automatic machine has an estimated useful life of five years and no significant residual value. For use in evaluating the proposal, the accountant accumulated the following annual data on present and proposed operations:

	Present Operations		Proposed Operations
Sales	$231,100		$231,100
Direct materials	$78,700		$78,700
Direct labor	54,700		—
Power and maintenance	5,100		27,000
Taxes, insurance, etc.	1,800		6,100
Selling and administrative expenses	54,700		54,700
Total expenses	$195,000		$166,500

a. Prepare a differential analysis dated May 4 to determine whether to continue with the old machine (Alternative 1) or replace the old machine (Alternative 2). Prepare the analysis over the useful life of the new machine. If an amount is zero, enter "0". For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Differential Analysis
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
May 4
	Continue with Old Machine (Alternative 1)	Replace Old Machine (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues:
Sales (5 years)	$	$	$
Costs:
Purchase price
Direct materials (5 years)
Direct labor (5 years)
Power and maintenance (5 years)
Taxes, insurance, etc. (5 years)
Selling and admin. expenses (5 years)
Income (Loss)	$	$	$

b. Based only on the data presented, should the proposal be accepted?

c. Differences in capacity between the two alternatives is   to consider before a final decision is made.

Answer 1

a. Calculate the differential analysis dated May4: Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) May-04 Continue Replace Differential with Old Old Effect Machine Machine on Income (Alternative 1) (Alternative 2) (Alternative 2) Revenues: Sales (5 years) 1155500 1155500 Costs: Purchase price 151600 -151600 Direct materials (5 years) 393500 393500 Direct labor (5 years) 2735001 273500 Power and maintenance (5 years) 255001 135000 -1095001 Taxes, insurance, etc. (5 years) 9000 30500 -21500 Selling and admin. expenses (5 years) 2735001 273500 Income (Loss) 180500 1 71400 9100 Hence, the decrease in Income is $9,100. Calculations:

А 1 Differential Analysis Continue with Old Machine (Alt. 1) 2 or Replace Old Machine (Alt. 2) Replace Old Machine (Alternative 2) Differential Effect on Income (Alternative 2) =231100*5 =+B9-C9 Continue with Old Machine (Alternative 1) 8 Revenues: 9 Sales (5 years) 231100*5 10 Costs: 11 Purchase price 12 Direct materials (5 years) =7870095 13 Direct labor (5 years) =54700*5 14 Power and maintenance (5 years) (=5100*5 15 Taxes, insurance, etc. (5 years) =1800*5 16 Selling and admin. expenses (5 years) =54700*5 17 Income (Loss) =+B9-SUM(B11:B16) 151600 =+B11-C11 =78700*5 =+B12-C12 =+B13-C13 =27000*5 =+B14-C14 =6100*5 =+B15-C15 =54700*5 +B16-C16 =+C9-SUM(C11:C16) =+B17-C17 As there is a decrease in profit that is loss due to replacement of machine of $9,100, the proposal for replacement should not be accepted. The differences in capacity between the two alternatives is $9,100 to be considered before a final decision is made.