Bain Corporation makes and sells state-of-the-art electronics products. One of its segments produces The Math Machine, an inexpensive calculator. The company’s chief accountant recently prepared the following income statement showing annual revenues and expenses associated with the segment’s operating activities. The relevant range for the production and sale of the calculators is between 30,000 and 60,000 units per year.

Bain Corporation makes and sells state-of-the-art electronics products. One of its segments produces The Math Machine, an inexpensive calculator. The company’s chief accountant recently prepared the following income statement showing annual revenues and expenses associated with the segment’s operating activities. The relevant range for the production and sale of the calculators is between 30,000 and 60,000 units per year.
 

Revenue (40,000 units × $10.80)	$	432,000
Unit-level variable costs
Materials cost (40,000 × $2.70)		(108,000	)
Labor cost (40,000 × $1.20)		(48,000	)
Manufacturing overhead (40,000 × $1.20)		(48,000	)
Shipping and handling (40,000 × $0.30)		(12,000	)
Sales commissions (40,000 × $1.20)		(48,000	)
Contribution margin		168,000
Fixed expenses
Advertising costs		(24,000	)
Salary of production supervisor		(72,000	)
Allocated company-wide facility-level expenses		(96,000	)
Net loss	$	(24,000	)

Required

1. a. A large discount store has approached the owner of Bain about buying 5,000 calculators. It would replace The Math Machine’s label with its own logo to avoid affecting Bain’s existing customers. Because the offer was made directly to the owner, no sales commissions on the transaction would be involved, but the discount store is willing to pay only $6.60 per calculator. Calculate the contribution margin from the special order. Based on quantitative factors alone, should Bain accept the special order?
   
2. b-1. Bain has an opportunity to buy the 40,000 calculators it currently makes from a reliable competing manufacturer for $6.72 each. The product meets Bain’s quality standards. Bain could continue to use its own logo, advertising program, and sales force to distribute the products. Calculate the total cost for Bain to make and buy the 40,000 calculators.
   
3. b-2. Should Bain buy the calculators or continue to make them?
   
4. b-3. Should Bain buy the calculators or continue to make them, if the volume of sales were increased to 60,000 units?
   
5. c. Because the calculator division is currently operating at a loss, should it be eliminated from the company’s operations? Support your answer with appropriate computations. Specifically, by what amount would the segment’s elimination increase or decrease profitability?
   

Explanation

a.
Since Bain doesn’t have to pay sales commissions in this situation, the company should remove that item from consideration.  All of the fixed expenses must be eliminated from consideration because they cannot be avoided regardless of whether the special order is accepted or rejected. The differential revenue and relevant (i.e., avoidable) costs are shown below:
 

Revenue (5,000 units × $6.60)	$	33,000
Variable costs:
Materials cost (5,000 × $2.70)		(13,500	)
Labor cost (5,000 × $1.20)		(6,000	)
Manufacturing overhead (5,000 × $1.20)		(6,000	)
Shipping and handling (5,000 × $0.30)		(1,500	)
Contribution margin	$	6,000

Since the revenue is greater than the avoidable costs, the special order should be accepted.

b-1 & b-2.
The revenue, shipping and handling, sales commissions, advertising costs, and general company expenses must be eliminated from consideration because they do not differ between the alternatives. The relevant information is as follows:

Decision		Make			Buy
Unit-level costs
Purchase price (40,000 × $6.72)				$	268,800
Materials cost (40,000 × $2.70)	$	108,000
Labor cost (40,000 × $1.20)		48,000			0
Manufacturing overhead (40,000 × $1.20)		48,000			0
Fixed expenses
Salary of production supervisor		72,000			0
Total cost	$	276,000		$	268,800

At 40,000 units, Bain should buy the calculators.

b-3.
Relevant data at 60,000 units of product:

Decision		Make			Buy
Unit-level costs
Purchase price (60,000 × $6.72)				$	403,200
Materials cost (60,000 × $2.70)	$	162,000
Labor cost (60,000 × $1.20)		72,000			0
Manufacturing overhead (60,000 × $1.20)		72,000			0
Fixed expenses
Salary of production supervisor		72,000			0
Total cost	$	378,000		$	403,200

At a volume of 60,000 units, it becomes cheaper to make the units than to buy them. This result occurs because the fixed cost (production supervisor’s salary) is spread over a larger number of units, thereby reducing the average cost per unit.

c.
The general company expenses must be eliminated from consideration because they do not differ between the alternatives. The differential revenue and avoidable costs are shown below:

Revenue (40,000 units × $10.80)	$	432,000
Variable costs:
Materials cost (40,000 × $2.70)		(108,000	)
Labor cost (40,000 × $1.20)		(48,000	)
Manufacturing overhead (40,000 × $1.20)		(48,000	)
Shipping and handling (40,000 × $0.30)		(12,000	)
Sales commissions (40,000 × $1.20)		(48,000	)
Contribution margin		168,000
Fixed expenses
Advertising costs		(24,000	)
Salary of production supervisor		(72,000	)
Impact on profitability	$	72,000

The analysis shows that the production and sale of calculators is contributing $72,000 toward the profitability of the enterprise. The current net loss that appears on the income statement results from the general company expenses that would continue regardless of whether the segment is eliminated. Accordingly, Bain should continue to operate the segment.

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