Problem for Self-Study

Wally Lewis is manager of the engineering development division of Goldcoast Products. Lewis has just received a proposal signed by his engineers to replace workstations with networked personal computers (networked PCs). Lewis is not enthusiastic about the proposal.

Data on workstations and networked PCs are as follows:

<p>A table shows data on workstations and networked PCs for Goldcoast Products.</p>

The table depicts original cost, useful life, current age, remaining useful life, accumulated depreciation, current book value, current disposal value in cash, terminal disposal value in cash 3 years from now, annual computer-related operating costs, annual revenues, and annual non-computer-related cash operating costs for workstations and networked PCs. The details of the table are as follows:

  1. Original cost
    • Workstations: 300,000 dollars
    • Networked PCs: 135,000 dollars
  1. Useful life
    • Workstations: 5 years
    • Networked PCs: 3 years
  1. Current age
    • Workstations: 2 years
    • Networked PCs: 0 years
  1. Remaining useful life
    • Workstations: 3 years
    • Networked PCs: 3 years
  1. Accumulated depreciation
    • Workstations: 120,000 dollars
    • Networked PCs: Not acquired yet
  1. Current book value
    • Workstations: 180,000 dollars
    • Networked PCs: Not acquired yet
  1. Current disposal value in cash
    • Workstations: 95,000 dollars
    • Networked PCs: Not acquired yet
  1. Terminal disposal value in cash 3 years from now
    • Workstations: 0 dollars
    • Networked PCs: 0 dollars
  1. Annual computer-related cash operating costs
    • Workstations: 40,000 dollars
    • Networked PCs: 10,000 dollars
  1. Annual revenues
    • Workstations: 1,000,000 dollars
    • Networked PCs: 1,000,000 dollars
  1. Annual non-computer-related cash operating costs
    • Workstations: 880,000 dollars
    • Networked PCs: 880,000 dollars

Lewis’s annual bonus includes a component based on division operating income. He has a promotion possibility next year to become a group vice president of Goldcoast Products.

Required

  1. Compare the costs of workstations and networked PCs. Consider the cumulative results for the 3 years together, ignoring the time value of money and income taxes.
  2. Why might Lewis be reluctant to purchase the networked PCs?

Solution

  1. The table below considers all cost items when comparing future costs of workstations and networked PCs:
<p>A table shows future costs of workstations versus networked PCs when considering all cost items for three years together.</p>

The table depicts revenues, operating costs, and operating income or loss when considering three years with workstations, three years with networked PCs, and the difference between the two. The details of the table are as follows:

  1. Revenues
    • Workstations: 3,000,000 dollars
    • Networked PCs: 3,000,000 dollars
    • Difference: Blank
  1. Operating costs, non-computer-related cash operating costs, 880,000 dollars per year times 3 years
    • Workstations: 2,640,000 dollars
    • Networked PCs: 2,640,000 dollars
    • Difference: Blank
  1. Operating costs, computer-related cash operating costs
    • Workstations, 40,000 dollars per year times 3 years: 120,000 dollars
    • Networked PCs, 10,000 dollars per year times 3 years: 30,000 dollars
    • Difference: 90,000 dollars
  1. Operating costs, workstations&rsquo; book value, periodic write-off as depreciation:
    • Workstations: 180,000 dollars
    • Networked PCs: Blank
    • Difference: Blank
  1. Operating costs, workstations&rsquo; book value, lump-sum write-off:
    • Workstations: Blank
    • Networked PCs: 180,000 dollars
    • Difference: Blank
  1. Operating costs, current disposal value of workstations:
    • Workstations: Blank
    • Networked PCs: 95,000 dollars loss
    • Difference: 95,000 dollars
  1. Operating costs, networked PCs written off periodically as depreciation:
    • Workstations: Blank
    • Networked PCs: 135,000 dollars
    • Difference: 135,000 dollars loss
  1. Total operating costs:
    • Workstations: 2,940,000 dollars
    • Networked PCs: 2,890,000 dollars
    • Difference: 50,000 dollars
  1. Operating income or loss:
    • Workstations: 60,000 dollars
    • Networked PCs: 110,000 dollars
    • Difference: 50,000 dollars loss
  1. Alternatively, the analysis could focus on only those items in the preceding table that differ between the alternatives.
<p>A table shows future costs of workstations versus networked PCs when considering only cost items that differ between the two alternatives and when measured for three years together.</p>

The table depicts computer-related cash operating costs, current disposal value of workstations, networked PCs written off periodically as depreciation, and total relevant costs when considering three years with workstations, three years with networked PCs, and the difference between the two. The details of the table are as follows:

  1. Computer-related cash operating costs
    • Workstations, 40,000 dollars per year times 3 years: 120,000 dollars
    • Networked PCs, 10,000 dollars per year times 3 years: 30,000 dollars
    • Difference: 90,000 dollars
  1. Current disposal value of workstations:
    • Workstations: Blank
    • Networked PCs: 95,000 dollars loss
    • Difference: 95,000 dollars
  1. Networked PCs written off periodically as depreciation:
    • Workstations: Blank
    • Networked PCs: 135,000 dollars
    • Difference: 135,000 dollars loss
  1. Total relevant costs:
    • Workstations: 120,000 dollars
    • Networked PCs: 70,000 dollars
    • Difference: 50,000 dollars
  1. The analysis suggests that it is cheaper to replace the workstations with the networked PCs.
  2. 2. The accrual-accounting operating incomes for the first year under the alternatives of “keep workstations” versus the “buy networked PCs” are as follows:
<p>A table shows accrual-accounting operating incomes under the alternatives of “keep workstations” versus “buy networked PCs” for the first year.</p>

The table depicts revenues, operating costs, and operating income or loss under the alternatives of &ldquo;keep workstations&rdquo; versus &ldquo;buy networked PCs&rdquo; for the first year. The details of the table are as follows:

  1. Revenues
    • Keep workstations: 1,000,000 dollars
    • Buy networked PCs: 1,000,000 dollars
  1. Operating costs, non-computer-related cash operating costs
    • Keep workstations: 880,000 dollars
    • Buy networked PCs: 880,000 dollars
  1. Operating costs, computer-related cash operating costs
    • Keep workstations: 40,000 dollars
    • Buy networked PCs: 10,000 dollars
  1. Depreciation
    • Keep workstations: 60,000 dollars
    • Buy networked PCs: 45,000 dollars
  1. Loss on disposal of workstations
    • Keep workstations: Blank
    • Buy networked PCs: 85,000 dollars loss (book value of workstations, 180,000 dollars minus current disposal value, 95,000 dollars)
  1. Total operating costs:
    • Keep workstations: 980,000 dollars
    • Buy networked PCs: 1,020,000 dollars
  1. Operating income or loss:
    • Keep workstations: 20,000 dollars
    • Buy networked PCs: 20,000 dollars loss
  1. Lewis would prefer to show an operating income of $20,000 if the workstations are kept than the operating loss of $20,000 if the networked PCs are purchased. Buying the networked PCs would eliminate the component of his bonus based on operating income. He might also perceive the $20,000 operating loss as reducing his chances of being promoted to group vice president.