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 $90,600, the accumulated depreciation is $36,200, 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 $188,400. 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	$287,200		$287,200
Direct materials	$97,800		$97,800
Direct labor	68,000		—
Power and maintenance	6,300		33,500
Taxes, insurance, etc.	2,300		7,500
Selling and administrative expenses	68,000		68,000
Total expenses	$242,400		$206,800

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.

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)	287,200 x 5 = 1,436,000	287,200 x 5 = 1,436,000	0
Costs:
Purchase price	0	-188,400	-188,400
Direct materials (5 years)	97,800 x 5 = -489,000	97,800 x 5 = -489,000	0
Direct labor (5 years)	68,000 x 5 = -340,000	0	340,000
Power and maintenance (5 years)	6,300 x 5 = -31,500	33,500 x 5 = -167,500	-136,000
Taxes, insurance, etc. (5 years)	2,300 x 5 = -11,500	7,500 x 5= -37,500	-26,000
Selling and admin. expenses (5 years)	68,000 x 5 = -340,000	68,000 x 5 = -340,000	0
Income (Loss)	$224,000	$213,600	($10,400)

b)

Proposal should not be accepted.

c)

Difference in capacity between the two alternatives is relevant to consider before a final decision is made.