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 $54,600, the accumulated depreciation is $21,800, 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 $113,600. 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	$173,100		$173,100
Direct materials	$59,000		$59,000
Direct labor	41,000		—
Power and maintenance	3,800		20,200
Taxes, insurance, etc.	1,400		4,500
Selling and administrative expenses	41,000		41,000
Total expenses	$146,200		$124,700

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 zero "0".

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?
________ (should be accepted or should not be accepted)

c. Differences in capacity between the two alternatives is ____ (relevant or not relevant) to consider before a final decision is made.

Answer 1

Ans 1
	(Alternative 1)	(Alternative 2)	(Alternative 2)
Revenues:
Sales (5 years)	865500	865500	0
	(173100*5)	(173100*5)
Costs:
Purchase price	0	113600	-113600
Direct materials (5 years)	295000	295000	0
	(59000*5)	(59000*5)
Direct labor (5 years)	205000		205000
	(41000*5)
Power and maintenance (5 years)	19000	101000	-82000
	(3800*5)	(20200*5)
Taxes, insurance, etc. (5 years)	7000	22500	-15500
	(1400*5)	(4500*5)
Selling and admin. expenses (5 years)	205000	205000	0
	(41000*5)	(41000*5)
Income (Loss)	134500	128400	6100
b) Yes the proposal must be accepted as there is increase in income by $6100
c) Is relevant

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