Relevant Costing Module [PDF]

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Relevant Costing: Karim Abitago

MS08

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RELEVANT COSTING TOPIC OUTLINE

LECTURE NOTES BASIC CONCEPTS Definition Relevant costs are expected future cash costs which differs between decision alternatives. Simply stated, relevant costs are future differential cash costs. NOTES: (1) If the cost is a past cost, automatic, it is irrelevant such as sunk costs. SUNK COSTs are past costs that are have been incurred and are not relevant for future decision. (2) Not all future costs are relevant, it should be differential to be relevant. (3) Generally, only cash costs are relevant since most of the non-cash expenses (i.e. depreciation) are incurred expenses already. But if the non-cash expense is differential, then it is relevant. (e.g. depreciation of an item of PPE to be acquired in the future). (4) A cost may be relevant in one decision but may be irrelevant in another. Examples of Relevant Costs: (a) Differential costs – are the difference in costs between alternatives. (b) Marginal costs – are costs of producing or selling one more unit of product and added to total costs. (c) Avoidable costs – are costs that will not be incurred if an activity is suspended. (d) Out-of-pocket costs - are costs required for immediate or near future cash. (e) Imputed costs – costs that do not entail cash outlay and are not recorded in the books but relevant for decision making process. (f) Opportunity costs – are the foregone benefits from an alternative not selected. These costs are NOT RECORDED on the books. MANAGEMENT DECISIONS REMINDER: in any management actions or decision, the alternative to be chosen should lead the company to a HIGHER PROFIT. (i.e. HIGHER REVENUE / LOWER COSTS) MAKE OR BUY A COMPONENT / PART (OUTSOURCING DECISION) DECISION: Where can we save? Choose the ALTERNATIVE with LOWER TOTAL COSTS.

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Relevant Costing: Karim Abitago SOLUTION GUIDE: RELEVANT COSTS TO MAKE Variable Manufacturing Costs AVOIDABLE Fixed Factory Overhead AVOIDABLE Non-Manufacturing Costs Opportunity Costs Variable Handling Costs

TO BUY Purchase Price Variable Handling Costs

NOTES: (1) Non-manufacturing costs are generally irrelevant to this decision since it is a make or manufacturing decision. (2) Opportunity costs may be: (a) Rent income from released facilities; (b) Contribution margin of new product; (c) Savings if part is bought. (3) Variable handling costs is relevant in both sides since it is usually stated in percentage. ACCEPT OR REJECT A SPECIAL ORDER Characteristics of a Special Order (a) NON-RECURRING, one time (b) Customer is NOT REGULAR (c) Market is distinguishable. This is the reason why generally a special order DOES NOT AFFECT REGULAR SALES. (d) The PRICE IS USUALLY LOWER than regular sales DECISION: What matters is profit. If there is INCREMENTAL PROFIT, ACCEPT the order; otherwise, reject. SOLUTION GUIDE: Incremental Sales (SP of Special Order x units of order) Incremental Costs: Variable Costs (manufacturing and non-manufacturing) Incremental Fixed Costs Opportunity Costs (Lost units from regular sales x UCM of regular sales) Incremental Profit

xxx (xxx) (xxx) (xxx) xxx

NOTES: (1) Opportunity costs on this decision arise only if there is no excess capacity or if there is, it is insufficient to accommodate the order. Thus, the company will sacrifice its regular sales just to accommodate the special order. KEEP OR DROP A SEGMENT DECISION: If the SEGMENT MARGIN is POSITIVE, DO NOT DROP the segment because it would reduce the overall profit. But also CONSIDER COMPLIMENTARY EFFECTS. How to compute segment margin? Sales Variable Costs Contribution Margin Direct Fixed Costs Segment Margin Allocated / Indirect Fixed Costs Operating Income

xxx (xxx) xxx (xxx) xxx (xxx) xxx

NOTES: (1) If the problem is silent as to type of fixed costs, all fixed costs are considered to be allocated for conservatism purposes. Thus, SEGMENT MARGIN IS CONTRIBUTION MARGIN. (2) The segment itself is being evaluated based on segment margin while the SEGMENT MANAGER is being evaluated based on CONTROLLABLE MARGIN (this concept is usually discussed in Responsibility Accounting topic). (3) ALLOCATED FIXED COSTS are NOT RELEVANT since it is unavoidable whether the segment is dropped or not BASIC GUIDE IN SOLVING KEEP OR DROP PROBLEMS: • The starting point of the computation is the segment margin. IF SEGMENT MARGIN IS NEGATIVE, the effect of dropping it is INCREASE IN OVERALL PROFIT. • IF SEGMENT MARGIN IS POSITIVE, the effect of dropping it is DECREASE IN OVERALL PROFIT. • Then EVALUATE COMPLIMENTARY AND OTHER EFFECTS.

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Relevant Costing: Karim Abitago

SELL AS IS OR PROCESS FURTHER A PRODUCT DECISION: If there is INCREMENTAL PROFIT, then PROCESS IT FURTHER, otherwise sell the product as is at split-off point. SOLUTION GUIDE: Incremental Sales (Final Sales Value – Sales Value @ Split-off) Incremental Costs (Further Processing Costs) Incremental Profit

xxx (xxx) xxx

NOTES: (1) JOINT or COMMON costs are SUNK COSTs because they are already incurred and unavoidable since the decision is to be made at split-off point. (2) SPLIT-OFF POINT is the point where the joint products and by-products, if any, become specifically identifiable from each other. This is also the point where the joint costs are allocated to the products SCRAP OR REWORK DEFECTIVE UNITS DEFECTIVE UNITS – are products that do not meet the standard production specification. DECISION: If there is INCREMENTAL PROFIT, REWORK; otherwise scrap it. SOLUTION GUIDE: Incremental Sales (Sales value after Rework – Sales value if scrapped) Incremental Costs (Rework Costs – Cost of disposal if scrapped) Incremental Profit

xxx (xxx) xxx

NOTE: PRODUCTION COSTS are SUNK COSTS since they are all already incurred. CONTINUE OPERATE OR SHUTDOWN OPERATIONS DECISION: Choose the option with the LESSER AMOUNT OF LOSS since in this type of decision, the business will have a loss in either way. In making a decision, compare the operating loss if operations are continued with the shutdown costs. BASIC GUIDE IN SOLVING SHUTDOWN OR OPERATE PROBLEMS: • In making a decision, compare the operating loss if operations are continued with the shutdown costs. SHUTDOWN COSTS – Total FIXED COSTS that is unavoidable or that WILL CONTINUE PLUS START-UP COSTS. •

Compute the SHUTDOWN POINT and compare it with actual sales or demand. SHUTDOWN POINT – is the point where the loss from continuing operations is equal to the loss from discontinuing. Essentially, this is the INDIFFERENCE POINT. If shutdown point is GREATER than actual sales, SHUTDOWN OPERATIONS. If shutdown point is LOWER than actual sales, CONTINUE OPERATIONS. SHUTDOWN POINT = UNAVOIDABLE FC + START-UP COSTS UCM

PRODUCT MIX DECISION / OPTIMIZATION OF RESOURCES DECISION: Choose the product combination mix that will maximize contribution margin. (1) If there is NO SCARCE RESOURCE, priority is on the product(s) with HIGHEST CM. (2) If there is SCARCE RESOURCE, priority is on the product(s) with HIGHEST CM PER SCARCE RESOURCE. NOTE: In every decision, always consider the market limitation or the demand for the products. CM PER SCARCE RESOURCE CAN BE COMPUTED AS: UCM / No. of scarce resource per unit or UCM x No. of units per scarce resource The first formula is commonly used in problem solving. FREQUENTLY ASKED QUESTIONS: (1) No of units produced. • If there is NO MARKET LIMITATION, allocate ALL THE SCARCE RESOURCE to the product under priority. Thus, the other products will not be produced. • If there is MARKET LIMITATION, allocate the scarce resource in the order of priority. Under this scenario, the other products can be produced. (2) Total contribution margin

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Relevant Costing: Karim Abitago After computing the units to be produced on each product, just multiply them to their respective UCMs to compute the total contribution margin.

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Relevant Costing: Karim Abitago DISCUSSION EXERCISES STRAIGHT PROBLEMS: MAKE OR BUY DECISION 1. From the previous years, DARK MAGICIAN INC. has been manufacturing its own wheels for its skateboards. DARK MAGICIAN’s skateboards have the highest demand on the market since it can be used also for water activities. Due to a convention attended by the company’s CFO in London, he met an outside supplier who has offered to produce and sell the same type of wheels DARK MAGICIAN is using for its skateboards. DARK MAGICIAN’s present cost to manufacture one wheel is given below (based on 60,000 wheels per year): Direct material P10.00 Materials handling (10% of direct material cost) 1.00 Direct labor 6.00 Variable overhead 2.20 Fixed overhead (P2.80 general company overhead, P2.45 depreciation and, P0.75 supervision) 6.00 Total cost per drum P25.20 Material handling represents the direct variable costs of the Receiving Department that are applied to direct materials and purchased components on the basis of their cost. A decision about whether to make or buy the wheels is especially important at this time since the equipment being used to make the drums is completely worn out and must be replaced. Thus if the company will chose to continue making the wheels, it should buy a new equipment costing P600,000 to be depreciated over its 5 year useful life using straight-line method. The old equipment has no resale value. A supervisor would have to be hired to oversee production of the wheels and the company’s total general company overhead would be unaffected by this decision. If the wheels were to be purchased at P22 DARK MAGICIAN could use the freed capacity to launch a new product generating a segment margin of P200,000. REQUIREMENTS: (a) Prepare computations helping DARK MAGICIAN if it will accept the outside supplier’s offer? (b) Would your recommendation in (a) above be the same if the company’s needs were: (1) 73,000 wheels per year; (2) 86,000 wheels per year ACCEPT OR REJECT A SPECIAL ORDER 2. BLUE EYES INC. makes outdoor shirts. Data relating to the coming year’s planned operations are as follows. Sales (230,000 shirts) P4,140,000 Cost of goods sold 2,760,000 Gross profit P1,380,000 Selling and administrative expenses 805,000 Income P575,000 The factory has capacity to make 250,000 shirts per year. Fixed costs included in cost of goods sold are P690,000. The only variable selling, general and administrative expenses are a 10% sales commission and a P1.50 per shirt licensing fee paid to the designer. A chain store manager has approached the sales manager of BLUE EYES INC. offering to buy 15,000 shirts at P15 per shirt. These shirts would be sold in areas where BLUE EYES’ shirts are not now sold. The sales manager believes that accepting the offer would result in a loss because the average total cost of the shirt is P15.50 ([2,760,000 + P805,000]/230,000). He feels that even though sales commissions would not be paid on the order, a loss would still result. REQUIREMENTS: 1. Determine whether the company should accept the offer. 2. Suppose that the order was for 40,000 shirts instead of 15,000. What would the company’s income be if it accepted the order? 3. Assuming the same facts as in requirement 1, what is the lowest price that the company could accept and still earn P575,000? 4. How many units of sales at the regular price could the company loss before it become unprofitable to accept the order in requirement 2?

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Relevant Costing: Karim Abitago 3.

YUGI CORP. manufactures and sells a single product call a Ret. Operating at capacity, the company can produce and sell 30,000 Rets per year. Costs associated with this level of production and sales are given below: Per Unit Total Direct materials P15 P450,000 Direct labor 8 240,000 Variable manufacturing overhead 3 90,000 Fixed manufacturing overhead 9 270,000 Variable selling expense 4 120,000 180,000 Fixed selling expense 6 Total cost P45 P1,350,000 The Rets normally sell for P50 each. Fixed manufacturing overhead is constant at P270,000 per year within the range of 25,000 through 30,000 Rets per year. REQUIREMENTS: (a) Assume that due to a recession, YUGI expects to sell only 25,000 Rets through regular channels next year. A large retail chain has offered to purchase 5,000 Rets if YUGI is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, YUGI would have to purchase a special machine to engrave the retail chain’s name on the 5,000 units. This machine would cost P10,000. YUGI has no assurance that the retail chain will purchase additional units any time in the future. Determine the impact on profits next year if this special order is accepted. (b) Refer to the original data. Assume again that YUGI expects to sell only 25,000 Rets through regular channels next year. One organization would like to make a one-time only purchase of 5,000 Rets. The organization would pay a fixed fee of P1.80 per Ret, and in addition it would reimburse YUGI for all costs of production (variable and fixed) associated with the units. Since the organization would pick up the Rets with its own trucks, there would be no variable selling expenses of any type associated with this order. If YUGI accepts the order, by how much will profits be increased or decreased for the year? (c) Assume the same situation as that described in (2) above, except that the company expects to sell 30,000 Rets through regular channels next year. Thus, accepts the organization’s order would require giving up regular sales of 5,000 Rets. If the organization’s order is accepted, by how much will profits be increased or decreased from what they would be if the 5,000 Rets were sold through regular channels?

KEEP OR DROP A SEGMENT 4. BABY DRAGON MERCHANDISING COMPANY has products, A and B. A recent monthly income statement for the company follows: TOTAL PRODUCT A PRODUCT B No. of units sold 250,000 150,000 100,000 Sales P4,000,000 P3,000,000 P1,000,000 Less: Variable expenses 1,300,000 900,000 400,000 Contribution Margin 2,700,000 2,100,000 600,000 Less: Fixed expenses 2,200,000 1,400,000 800,000 Net operating income (loss) P 500,000 P 700,000 P(200,000) A study indicates that P340,000 of the fixed expenses being charged to PRODDUCT B are sunk costs or allocated costs that will continue even if B is dropped. REQUIREMENTS: Answer each of the following questions independently, unless otherwise instructed. (a) Management is considering dropping PRODUCT B but will result in a 10% decrease in the sales of PRODUCT A. If the company will push through the proposed action, what would be its effect on the company’s net income as a whole? (b) The managers are considering increasing advertising for product A by P40,000. They expect to achieve a 10% increase in volume for product A with no change in selling price, but some of that increase will be the expense of product B. Sales of B are expected to decline by 5%. What will total profit be if the managers approve the proposed action? (c) What is the maximum percentage decline in volume of product B that would leave the action in requirement (b) just barely desirable? (d) The managers are considering dropping product B and replacing it with product C. Introducing product C would increase total fixed costs by P175,000. C’s contribution margin percentage is 40% and is expecting sales of P1,500,000. What is the expected new profit of the company after approving the proposal? (e) The company is considering increasing the sales price of B is increased to P15 with a decrease in the number of units sold to 90,000. What is the effect on income of the proposed action? (f) Part of the plant in which A is produced can easily be adapted to the production of B, but changes in quantities may make changes in sales prices advisable. If production of A is reduced

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Relevant Costing: Karim Abitago to 100,000 units (to be sold at P25 each) and production of B is increased by 50,000 units (to be sold at P8.00 each), the total effect on income will be? SELL AS IS OR PROCESS FURTHER A PRODUCT 5. BLADE SKATER CORP. manufactures three products from a common input in a joint processing operation. Joint processing cost up to the split-off point total P500,000 per quarter. The company allocates these costs to the joint products on the basis of their total sales value at the split-off point. Unit selling prices and total output at the split-off point are as follows: Product Selling Price Quarterly Output Economy P16 per pound 15,000 pounds Deluxe 8 per pound 20,000 pounds Supreme 25 per gallon 4,000 gallons Batch product can be processed further after the split-off point. Additional processing costs (per quarter) and unit selling prices after further processing are given below: Product Additional Processing Costs Selling Price Economy P55,000 P19 per pound Deluxe 115,000 14 per pound Supreme 26,000 31 per gallon REQUIREMENT: Which product(s) should BLADE SKATER sell at the split-off point and which product(s) should it continue processing? SHUTDOWN OR CONTINUE OPERATIONS 6. DANCING ELF INC. produces white glue (a wood glue) that is used by furniture manufacturers. The company normally produces and sells 10,000 gallons of the glue each month. White Glue is sold for P280 per gallon, variable costs is P168 per gallon, fixed factory overhead cost totals P460,000 per month, and the fixed selling costs totals P620,000 per month. Labor strikes in the furniture manufacturers that buy the bulk of White Glue have caused the monthly sales of DANCING ELF to temporarily decrease to only 30% of its normal monthly volume. DANCING ELF's management expects that the strikes will last for about 2 months, after which, sales of White Glue should return to normal. However, due to the dramatic drop in the sales level, DANCING ELF’s management is considering to close down its plant during the two-month period that the strikes are on. If DANCING ELF INC. will temporarily shut down its operations, it is expected that the fixed factory overhead costs can be reduced to P340,000 per month and that the fixed selling costs can be reduced by P62,000 per month. Start-up costs at the end of the shut-down period would total P56,000. DANCING ELF uses the JIT system, so no inventories are on hand. REQUIREMENTS: (a) At the sales level of only 30% of the normal volume, should the company continue operating or shutdown temporarily for two months? (b) Compute for the shut-down point SCRAP OR REWORK DEFECTIVE PRODUCTS 7. The following information is related to PRODUCT ABC of DRAGON ZOMBIE CO.: Selling price P20 Variable manufacturing costs 8 Variable selling costs 2 Fixed manufacturing costs P100,000 Fixed administrative and selling costs P50,000 The company has a defective 1,000 units of PRODUCT ABC. These units can be scrapped at P10 per unit and incurring the necessary incremental selling costs. On the other hand, these units can be reworked at a cost of P5,000. REQUIREMENT: What would be the incremental effect on the company's overall profit of reworking and selling the material rather than selling it as is as scrap? PRODUCT MIX DECISION 8. ELEMENTAL HERO CORP. makes three products in a single facility. Data concerning these products follow: Product A Product B Product C Selling price per unit P64.50 P64.80 P63.30 Direct materials P20.90 P14.50 P18.30 Direct labor P30.80 P33.40 P26.00 Variable manufacturing overhead P1.60 P1.90 P2.10 Variable selling cost per unit P1.00 P3.40 P1.50 Mixing minutes per unit 3.50 3.10 3.50 Monthly demand in units 4,000 2,000 4,000 The mixing machines are potentially the constraint in the production facility. A total of 32,400 minutes are available per month on these machines. Direct labor is a variable cost in this company.

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Relevant Costing: Karim Abitago REQUIREMENTS: (a) How many minutes of mixing machine time would be required to satisfy demand for all products? (b) Which orders would you advise the company to accept first, second and third? (c) How many units of each product should be produced to maximize net operating income? (Round off to the nearest whole unit.) (d) What is the expected total contribution margin of ELEMENTAL HERO if it will follow the proposed action maximizing its net income? (e) Up to how much should the company be willing to pay for one additional hour of mixing machine time if the company has made the best use of the existing mixing machine capacity?

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Relevant Costing: Karim Abitago

COMPREHENSIVE 9. FAIRY DRAGON CORP. has been producing two bearings, components B12 and B18, for use in production, data regarding these two components are: B12 B18 Machine hours required per unit 2.5 3.0 Standard cost per unit Direct Material P2.25 P3.75 Direct labor 4.00 4.50 Manufacturing overhead Variable* 2.00 2.25 Fixed** 3.75 4.50 P12.00 P15.00 *Variable manufacturing overhead is applied on the basis of direct labor hours. **Fixed manufacturing overhead is applied on the basis of machine hours. FAIRY DRAGON’s annual requirement for these components is 8,000 units of B12 and 11,000 units of B18. Recently, FAIRY DRAGON’s management decided to devote additional machine time to other product lines resulting in only 41,000 machine hours per year that can be dedicated to the production of the bearings. An outside company has offered to sell FAIRY DRAGON the annual supply of the bearings at prices of P11.25 for B12 and P13.50 for B18. FAIRY DRAGON wants to schedule the otherwise idle 41,000 machine hours to produce bearings so that the company can minimize its costs (maximize its net benefits). REQUIREMENTS: (a) The net benefit (loss) per machine hour that would result if FAIRY DRAGON accepts the supplier’s offer of P13.50 per unit for component B18 is (b) How many units of B12 and B18 should the company purchased or produced to maximize its net benefits? MULTIPLE CHOICE: THEORIES 1. Which of the following best defines the concept of a relevant cost? A. A past cost that is the same among alternatives. B. A past cost that differs among alternatives. C. A future cost that is the same among alternatives. D. A future cost that differs among alternatives. E. A cost that is based on past experience. 2.

Statement 1: In general, all variable costs are relevant to decisions, but all fixed costs are not. Statement 2: Fixed costs need not be considered in making a decision unless they are expected to be altered by that decision, either immediately or in the future. Statement 3: Costs that are relevant to management decision making usually include all expected future costs. A. B. C. D. Statement 1 True False True False Statement 2 True True False False Statement 3 True False True True

3. A. B. C. D.

In a make-or-buy decision, which of the following is true? Variable costs are the only relevant costs. Allocated fixed costs are relevant. Alternative uses of space and machinery are relevant. Making is the correct decision when there is idle capacity.

A. B. C. D.

Which of the following statements is true regarding opportunity cost? (E) Opportunity cost is recorded in the accounts of an organization that has a full costing system. The potential benefit is not sacrificed when selecting an alternative. Idle space that has no alternative use has an opportunity cost of zero. Opportunity cost is representative of actual dollar outlay.

4.

Use the following information in answering the next two questions: I. Unavoidable Fixed Factory Overhead II. Avoidable Fixed Factory Overhead III. Variable Factory Overhead IV. Variable Selling Cost 5. A. B.

In a make or buy decision, which of the above cost is considered to be relevant? I and III D. III and IV II and III E. I, II, III and IV

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Relevant Costing: Karim Abitago C.

II, III and IV

A. B. C.

In a decision to accept or reject a special order, determine which of the above cost is relevant. I and III D. III and IV II and III E. I, II, III and IV II, III and IV

1. 2. 3. A. B C

Indicate which of the following would be avoided if a segment is eliminated. (M1**) variable manufacturing costs 4. variable selling costs direct fixed costs 5. direct fixed selling costs common fixed costs 6. common fixed selling costs 2, 3, 5, and 6 D. 1, 4, 5, and 6 1, 2, 4, and 5 E. 2, 3, 4, and 5. 2, 3, 4, and 5

6.

7.

8.

A company is within plant capacity. It is contemplating whether a special order should be accepted. The order will not impact regular sales. If the company accepts the special order, what will occur? A. Incremental costs will not be affected. B. Net income will increase if the special sales price per unit exceeds the unit variable costs. C. There are no incremental revenues. D. Both fixed and variable costs will increase.

9.

Which of the following is NOT relevant in deciding whether to process a joint product beyond its split-off point? A. The split-off value. C. The cost of further processing. B. The price after additional processing. D. The cost of operating the joint process.

10.

Statement 1: As a general guide, it is profitable to continue processing joint products after the split-off point if their total revenues exceed the joint costs. Statement 2: All fixed costs are irrelevant in decisions about whether a product line should be dropped. Statement 3: A cost may be relevant for one decision making situation but irrelevant for another situation. A. B. C. D. Statement 1 True False False True Statement 2 False True False True Statement 3 True False True True

11.

The Mark X Corp. contemplates the temporary shutdown of its plant facilities in a provincial area which is economically depressed due to natural disasters. Below are certain manufacturing and selling expenses. 1. Depreciation 5. Sales commissions 2. Property tax 6. Delivery expenses 3. Interest expense 7. Security of premises 4. Insurance of facilities Which of the following expenses will continue during the shutdown period? A. All expenses in the list. C. Items 1, 2 and 3 only. B. All except 5 and 6. D. Items 1, 2, 3, 4, 6, and 7 only

12.

Assume a company produces three products: A, B, and C. It can only sell up to 3,000 units of each product. Production capacity is unlimited. The company should produce the product (or products) that has (have) the highest A. contribution margin per hour of machine time. B. gross margin per unit. C. contribution margin per unit. D. sales price per unit.

13. A. B C D E 14.

If a firm is at full capacity, the minimum special order price must cover (M1) variable costs associated with the special order variable and fixed manufacturing costs associated with the special order variable and incremental fixed costs associated with the special order variable costs and incremental fixed costs associated with the special order plus foregone contribution margin on regular units not produced both c and d.

When management must decide to accept or reject a one-time-only special order, given sufficient idle capacity, which one of the following is not relevant to the decision? (E) A. Absorption costs. C. Direct costs.

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Relevant Costing: Karim Abitago B. 15.

Differential costs.

D.

Variable costs.

Statement 1: Incremental costs can be either fixed or variable. Statement 2: Opportunity cost is usually the amount paid for a resource. A. Only the first statement is true. C. Both statements are true. B. Only the second statement is true. D. Both statements are false.

QUIZZER (DO-IT-YOURSELF DRILL) THEORIES 1. The manner of determining whether favorable results of an alternative are sufficient to justify the cost of taking that alternative A. Cost behavior analysis C. Cost center analysis B. Cost benefit analysis D. Cost control analysis 2. A. B. C. D.

In the development of accounting data for decision-making, relevant costs are Budgetary costs authorized for the administrative year. Standard costs developed by time and motion experts. Future costs which will differ under each alternative course of action. Historical costs which are the best available basis for estimating future costs.

A. B.

The relevance of a particular cost to a decision is determined by Amount of the cost. C. Potential effect on the decision. Number of decision variables. D. Riskiness of the decision.

A. B. C. D.

The term relevant cost applies to all of the following decision situations except the Replacement of equipment. Determination of product price. Acceptance of special product order. Manufacture or purchase of a component part.

3.

4.

5.

Management accountants are concerned with incremental unit costs. These costs are similar to the following except A. The cost to produce an additional unit. C. The manufacturing unit cost. B. The economic marginal cost. D. The variable cost

6. A. B.

A fixed cost is relevant if it is a future cost. a product cost.

A. B.

The distinction between avoidable and unavoidable costs is similar to the distinction between discretionary costs and committed costs. C. variable costs and fixed costs. step-variable costs and fixed costs. D. variable costs and mixed costs.

A. B.

The type of cost vital to decision making but not recorded in the accounting records Direct costs C. Out of pocket costs Opportunity costs D. Sunk costs

7.

8.

9. the A. B. C. D. 10.

avoidable. sunk.

What is the opportunity cost of making a component part in a factory given no alternative use of capacity? Zero. The total variable cost of the component. The total manufacturing cost of the component. The variable manufacturing cost of the component.

A. B.

If a cost is irrelevant to a decision, the cost could not be a future cost. C. a variable cost. a sunk cost. D. an incremental cost.

A. B. C. D.

All of the following are examples of imputed costs except Decelerated depreciation. The stated interest paid on a bank loan. The use of the firm's internal cash funds to purchase assets. Assets that are considered obsolete that maintain a net book value.

11.

12.

C. D.

In analyzing whether to build another regional service office, the salary of the Chief Executive Officer (CEO) at the corporate headquarters is A. Relevant because salaries are always relevant. B. Irrelevant since another imputed costs for the same will be considered. C. Relevant because this will probably change if the regional service office is build. D. Irrelevant because it is future cost that will not differ between the alternatives under consideration.

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Relevant Costing: Karim Abitago 13. A. B. C. D.

Total unit costs are Irrelevant in marginal analysis. Relevant for cost-volume-profit analysis. Needed for determining product contribution. Independent of the cost system used to generate them.

A. B. C. D.

Sunk costs Are fixed costs. Are relevant to decision making. Are substitute for opportunity costs. In and of themselves are not relevant to decision making.

A. B.

The variable cost of a unit of product made yesterday is A differential cost. C. An incremental cost. A sunk cost. D. An opportunity cost.

14.

15.

16.

Assume a company produces three products: A, B, and C. It can only sell up to 3,000 units of each product. Production capacity is unlimited. The company should produce the product (or products) that has (have) the highest A. sales price per unit. C. contribution margin per unit. B. gross margin per unit. D. contribution margin per hour of machine time.

17.

There is a market for both product X and product Y. Which of the following costs and revenues would be most relevant in deciding whether to sell product X or process it further to make product Y? A. Total cost of making Y and the revenue from sale of Y. B. Total cost of making X and the revenue from sale of X and Y. C. Additional cost of making X, given the cost of making Y, and additional revenue from Y. D. Additional cost of making Y, given the cost of making X, and additional revenue from Y.

18. A. B. C. D.

When there is one scarce resource, the product that should be produced first is the product with the highest demand the highest contribution margin per unit the highest sales price per unit of scarce resource the highest contribution margin per unit of the scarce resource

A. B. C. D.

Fixed costs are ignored in allocating scarce resources because they are sunk. fixed costs only apply to long-run decisions. they are unaffected by the allocation of scarce resources. there are no fixed costs associated with scarce resources.

A. B.

Which of the following activities within an organization would be least likely to be outsourced? accounting C. product design data processing D. transportation

19.

20.

21.

Among the costs relevant to a make-or-buy decision include variable manufacturing costs as well as A. Avoidable fixed costs. C. Real estate taxes. B. Plant depreciation. D. Unavoidable costs.

22. A. B. C. D. 23.

A purchasing agent has two potential firms to buy materials from for production. If both firms charge the same price, the material cost is A. a committed cost. C. an irrelevant cost B. a sunk cost D. an opportunity cost

24. A. B. C. D. 25.

In a make or buy decision, the opportunity cost of capacity could be considered to increase the price of units purchased from suppliers. be considered to decrease the price of units purchased from suppliers. be considered to decrease the cost of units manufactured by the company. not be considered since opportunity costs are not part of the accounting records.

Which of the following costs are relevant to a make-or-buy decision? annual depreciation of the equipment original cost of the production equipment the amount that would be received if the production equipment were sold the cost of direct materials purchased last month and used to manufacture the component

Which of the following is NOT relevant in a make-or-buy decision about a part the entity uses in some of its products? A. The reliability of the outside supplier.

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Relevant Costing: Karim Abitago B. C. D. 26.

When only differential manufacturing costs are taken into account for special-order pricing, an essential assumption is that A. Manufacturing fixed and variable costs are linear. B. Acceptance of the order will not affect regular sales. C. Selling and administrative fixed and variable costs are linear. D. Acceptance of the order will not cause unit selling and administrative variable costs to increase.

27.

E.

If a firm is at full capacity, the minimum special order price must cover variable costs associated with the special order variable and incremental fixed costs associated with the special order variable and fixed manufacturing costs associated with the special order variable costs and incremental fixed costs associated with the special order plus foregone contribution margin on regular units not produced both B and D.

sales A. B. C. D.

Idle capacity in the interim (normally temporary) will generate short-term benefit in accepting at price that Increase total fixed costs. Positively motivate employees. Result in less than normal contribution margin. Reduce the overall operating income to sales ratio.

A. B. C. D.

28.

29.

The number of units of the part needed each period. The outside supplier’s per-unit variable cost to make the part. The alternative uses of owned equipment used to make the part.

Pinoy Company temporarily has excess production capacity, the idle plant facilities can be used to manufacture a low-margin item. The low-margin item should be produced if it can be sold for more than its A. Fixed costs. B. Variable costs. C. Variable costs plus opportunity cost of idle facilities. D. Indirect costs plus any opportunity cost of idle facilities.

30. A. B. C. D.

An opportunity cost commonly associated with a special order is The variable costs of the order. The contribution margin on lost sales. Additional fixed costs related to the increased output. Any of the above.

PROBLEMS Use the following information in answering the next item(s): BLUE EYES CORP. produces a single product. The cost of producing and selling a single unit of this product at the company's normal activity level of 80,000 units per month is as follows: Direct materials P37.50 Direct labor P6.00 Variable manufacturing overhead P1.00 Fixed manufacturing overhead P11.50 Variable selling & administrative expense P1.80 Fixed selling & administrative expense P8.00 The normal selling price of the product is P71.10 per unit. An order has been received from an overseas customer for 1,000 units to be delivered this month at a special discounted price. This order would have no effect on the company's normal sales and would not change the total amount of the company's fixed costs. The variable selling and administrative expense would be P1.50 less per unit on this order than on normal sales. Direct labor is a variable cost in this company. 1.

Suppose there is ample idle capacity to produce the units required by the overseas customer and the special discounted price on the special order is P63.70 per unit. By how much would this special order increase (decrease) the company's net operating income for the month? A. P7,400 C. P18,900 B. (P5,900) D. (P2,100)

2.

Suppose the company is already operating at capacity when the special order is received from the overseas customer. What would be the opportunity cost of each unit delivered to the overseas customer? A. P24.80 C. P7.40 B. P6.80 D. P5.30

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Relevant Costing: Karim Abitago

3.

Suppose there is not enough idle capacity to produce all of the units for the overseas customer and accepting the special order would require cutting back on production of 400 units for regular customers. The minimum acceptable price per unit for the special order is closest to: A. P56.00 C. P71.10 B. P65.80 D. P54.72

4.

Listed below are a company’s monthly unit costs to manufacture and market a particular product. Unit Costs Variable Cost Fixed Costs Direct materials P2.00 Direct labor 2.40 Indirect Manufacturing 1.60 P1.00 Marketing 2.50 1.50 The company must decide to continue making the product or buy it from an outside supplier. The supplier has offered to make the product at the same level of quality that the company can make it. Fixed marketing costs would be unaffected, but variable marketing costs would be reduced by 30% if the company were to accept the proposal. What is the maximum amount per unit that the company can pay the supplier without decreasing its operating income? A. P5.25 C. P7.75 B. P6.75 D. P8.50

5.

FERAL IMP CORP. is a multi-product company that currently manufactures 30,000 units of Part QS42 each month for use in production. The facilities now being used to produce Part QS42 have fixed monthly cost of P150,000 and a capacity to produce 84,000 units per month. If FERAL IMP were to buy Part QS42 from an outside supplier, the facilities would be idle, but its fixed costs would continue at 40% of their present amount. The variable production costs of Part QS42 are P11 per unit. If FERAL IMP is able to obtain Part QS42 from an outside supplier at a unit purchase price of P12.875, the monthly usage at which it will be indifferent between purchasing and making Part QS42 is A. 30,000 units. C. 48,000 units B. 32,000 units. D. 80,000 units

6.

FAITH BIRD CORP. has some material that originally cost P74,600. The material has a scrap value of P57,400 as is, but if reworked at a cost of P1,500, it could be sold for P54,400. What would be the incremental effect on the company's overall profit of reworking and selling the material rather than selling it as is as scrap? A. -P79,100 C. -P4,500 B. -P21,700 D. P52,900

7.

FLYING FISH CORP. can sell all the units it can produce of either Plain or Fancy but not both. Plain has a unit contribution margin of P96 and takes two machine hours to make and Fancy has a unit contribution margin of P120 and takes three machine hours to make. There are 2,400 machine hours available to manufacture a product. What should FLYING FISH do? A. Make Fancy which creates P24 more profit per unit than Plain does. B. Make Plain which creates P8 more profit per machine hour than Fancy does. C. Make Plain because more units can be made and sold than Fancy. D. The same total profits exist regardless of which product is made.

8.

FROSTOSAURUS CHEMICAL CORP. manufactures three chemicals (TX14, NJ35, and KS63) from a joint process. The three chemicals are in industrial grade form at the split-off point. They can either be sold at that point or processed further into premium grade. Costs related to each batch of this chemical process is as follows: TX14 NJ35 KS63 Sales value at split-off point P16,000 P12,000 P5,000 Allocated joint costs P6,000 P6,000 P6,000 Sales value after further processing P20,000 P18,000 P9,000 Cost of further processing P5,000 P3,000 P2,000 For which product(s) above would it be more profitable for FROSTOSAURUS to sell at the split-off point rather than process further? A. TX14 only C. TX14 and KS63 only B. KS63 only D. NJ35 and KS63 only

Use the following information to answer the next item(s): GATEKEEPER COMPANY makes two products, X and Y, in a joint process. At the split-off point, 60,000 units of product X and 70,000 units of product Y are available each month. Monthly joint production costs total P200,000. Product X can be sold at the split-off point for P3.20 per unit. Product Y can be either sold at the split-off point for P2.60 per unit or it can be processed further and sold for P5.80

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Relevant Costing: Karim Abitago per unit. If product Y is processed further, additional processing costs of P2.30 per unit will be incurred.

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Relevant Costing: Karim Abitago

9.

If product Y is processed further, rather than being sold at the split-off point, the impact on monthly operating income should be: A. P137,000 decrease C. P63,000 increase B. P245,000 increase D. P244,000 increase

10.

What would the unit selling price of product Y need to be at the split-off point in order for GATEKEEPER to be economically indifferent between selling Y at split-off or processing Y further before sale? A. P3.80 C. P3.20 B. P3.50 D. P2.90

11.

GAIA CORP. produces a part that has the following costs per unit: Direct material P9 Direct labor 4 Variable overhead 2 Fixed overhead 6 Total P21 FIERCE KNIGHT INC. can provide the part to GAIA for P23 per unit. GAIA CORP. has determined that 50 percent of its fixed overhead would continue if it purchased the part. However, if GAIA no longer produces the part, it can rent that portion of the plant facilities for P70,000 per year. GAIA currently produces 12,000 parts per year. Which alternative is preferable and by what margin? A. Make-P24,000 C. Buy-P10,000 B. Make-P60,000 D. Buy-P46,000

Use the following information to answer the next item(s): GEMINI ELF CORP. sells a product for P21 per unit, and the standard cost card for the product shows the following costs: Direct material P2 Direct labor 3 Overhead (70% fixed) 10 Total P15 12. GEMINI ELF received a special order for 1,200 units of the product. The only additional cost to GEMINI ELF would be foreign import taxes of P2 per unit. If GEMINI ELF is able to sell all of the current production domestically, what would be the minimum sales price that GEMINI ELF would consider for this special order? A. P10.00 C. P21.00 B. P15.00 D. P23.00 13.

Assume that GEMINI ELF has sufficient idle capacity to produce the 1,200 units. If GEMINI ELF wants to increase its operating profit by P6,000, what would it charge as a per-unit selling price? A. P15.00 C. P21.00 B. P17.00 D. P23.00

14.

HARPIE LADY CORP. has 3 divisions: A, B, and C. Division A's income statement shows the following for the year ended December 31: Sales P1,500,000 Cost of Goods Sold 1,125,000 Gross Profit 375,000 Selling Expenses P125,000 Administrative Expenses 350,000 475,000 Net Loss (P100,000) Cost of goods sold is 80 percent variable and 20 percent fixed. Of the fixed costs, 50 percent are avoidable if the division is closed. All of the selling expenses relate to the division and would be eliminated if Division A were eliminated. Of the administrative expenses, 85 percent are applied from corporate costs. If Division A were eliminated, HARPY’s income would A. increase by P100,000. C. decrease by P310,000. B. decrease by P197,500. D. decrease by P422,500.

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Relevant Costing: Karim Abitago 15.

JUDGE MAN INC. is a manufacturer operating at 95% of capacity. JUDGE MAN has been offered a new order at P7.25 per unit requiring 15% of capacity. No other use of the 5% current idle capacity can be found. However, if the order were accepted, the subcontracting for the required 10% additional capacity would cost P7.50 per unit. The variable cost of production for JUDGE MAN on a per-unit basis follows: Materials P3.50 Labor 1.50 Variable overhead 1.50 P6.50 In applying the contribution margin approach to evaluating whether to accept the new order, assuming subcontracting, what is the average variable cost per unit? A. P6.83 C. P7.17 B. P7.00 D. P7.25

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Relevant Costing: Karim Abitago 16.

A company produces and sells three products: PRODUCTS C J P Sales P200,000 P150,000 P125,000 Separable (product) fixed costs 60,000 35,000 40,000 Allocated fixed costs 35,000 40,000 25,000 Variable costs 95,000 75,000 50,000 The company lost its lease and must move to a smaller facility. As a result, total allocated fixed costs will be reduced by 40%. However, one of its products must be discontinued in order for the company to fit in the new facility. Because the company's objective is to maximize profits, what is its expected net profit after the appropriate product has been discontinued? A. P10,000 C. P20,000 B. P15,000 D. P25,000

17.

KOZAKY INC. currently operates two divisions which had operating results last year as follows: West Troy Division Division Sales P600,000 P300,000 200,000 Variable costs 310,000 Contribution margin 290,000 100,000 Traceable fixed costs 110,000 70,000 Allocated common corporate costs 90,000 45,000 Net operating income (loss) P 90,000 (P 15,000) Since the Troy Division also sustained an operating loss in the prior year, KOZAKY's president is considering the elimination of this division. Troy Division's traceable fixed costs could be avoided if the division were eliminated. The total common corporate costs would be unaffected by the decision. If the Troy Division had been eliminated at the beginning of last year, KOZAKY’s operating income for last year would have been: A. P15,000 higher C. P45,000 lower B. P30,000 lower D. P60,000 higher

18.

Product U23N has been considered a drag on profits at LUSTER DRAGON CORP. for some time and management is considering discontinuing the product altogether. Data from the company's accounting system appear below: Sales P730,000 Variable expenses P350,000 Fixed manufacturing expenses P234,000 Fixed selling and administrative expenses P161,000 In the company's accounting system all fixed expenses of the company are fully allocated to products. Further investigation has revealed that P144,000 of the fixed manufacturing expenses and P93,000 of the fixed selling and administrative expenses are avoidable if product U23N is discontinued. What would be the effect on the company's overall net operating income if product U23N were dropped? A. Overall net operating income would increase by P15,000. B. Overall net operating income would increase by P143,000. C. Overall net operating income would decrease by P143,000. D. Overall net operating income would decrease by P15,000.

19.

The MAGICAL GHOST CORP. produces three products. “Tic,” “Tac.”, and “Toc.” The owner desires to reduce production load to only one product line due to prolonged absence of the production manager. Depreciation expense amounts to P600,000 annually. Other fixed operating expenses amount to P660,000 per year. The sales and variable cost data of the three products are (000’s omitted) Tic Tac Toc Sales P6,600 P5,300 P10,800 Variable costs 3,900 1,700 8,900 Which product must be retained and what is the opportunity cost of selecting such product line? A. Retain product “Tac”; opportunity cost is P3.14 million. B. Retain product “Tac”; opportunity cost is P4.6 million. C. Retain product “Tic”; opportunity cost is P4.04 million. D. Retain product “Toc”; opportunity cost is P4.84 million.

20.

MEDA BAT CO. makes three products that use compound W, the current constrained resource. Data concerning those products appear below: VP YI WX Selling price per unit P248.04 P230.66 P505.44 Variable cost per unit P190.71 P172.14 P388.80 Centiliters of compound W 3.90 3.80 8.10

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Relevant Costing: Karim Abitago Rank the products in order of their current profitability from most profitable to least profitable. In other words, rank the products in the order in which they should be emphasized. A. WX, VP, YI C. WX, YI, VP B. YI, VP, WX D. VP, WX, YI 21.

METAL FISH INC. has only 30,000 hours of machine time each month to manufacture its two products. Product X has a contribution margin of P60, and Product Y has a contribution margin of P72. Product X requires 6 hours of machine time, and Product Y requires 10 hours of machine time. If METAL FISH wants to dedicate 85 percent of its machine time to the product that will provide the most income, the company will have a total contribution margin of A. P216,000 C. P287,400 B. P228,600. D. P300,000

22.

METEOR DRAGON CORP. purchased a machine 5 years ago for P527,000 when it launched product M08Y. Unfortunately, this machine has broken down and cannot be repaired. The machine could be replaced by a new model 310 machine costing P545,000 or by a new model 240 machine costing P450,000. Management has decided to buy the model 240 machine. It has less capacity than the model 310 machine, but its capacity is sufficient to continue making product M08Y. Management also considered, but rejected, the alternative of dropping product M08Y and not replacing the old machine. If that were done, the P450,000 invested in the new machine could instead have been invested in a project that would have returned a total of P532,000. In making the decision to invest in the model 240 machine, the opportunity cost was: A. P545,000 C. P532,000 B. P450,000 D. P527,000

23.

MYSTIC CLOWN INC. produces 1,000 units of a part per year which are used in the assembly of one of its products. The unit cost of producing these parts is: Variable manufacturing cost P15 Fixed manufacturing cost 12 Total manufacturing cost P27 The part can be purchased from an outside supplier at P20 per unit. If the part is purchased from the outside supplier, two thirds of the total fixed costs incurred in producing the part can be eliminated. The annual increase or decrease on the company's operating incomes as a result of buying the part from the outside supplier would be: A. P3,000 increase C. P7,000 increase B. P1,000 decrease D. P5,000 decrease

24.

OCUBEAM INC., a manufacturer of computer peripherals, has excess capacity. The company's Utah plant has the following per-unit cost structure for item no. 89: Variable manufacturing P40 Fixed manufacturing 15 Variable selling 8 Fixed selling 11 Traceable fixed administrative 4 Allocated administrative 2 The traceable fixed administrative cost was incurred at the Utah plant; in contrast, the allocated administrative cost represents a "fair share" of OCUBEAM's corporate overhead. Utah has been presented with a special order of 5,000 units of item no. 89 on which no selling cost will be incurred. The proper relevant cost in deciding whether to accept this special order would be: A. P40. D. P80. B. P59. E. some other amount. C. P61.

25.

OPTICLOPS INC. manufactures A and B from a joint process (cost = P80,000). Five thousand pounds of A can be sold at split-off for P20 per pound or processed further at an additional cost of P20,000 and then sold for P25. Ten thousand pounds of B can be sold at split-off for P15 per pound or processed further at an additional cost of P20,000 and later sold for P16. If OPTICLOPS decides to process B beyond the split-off point, operating income will: A. increase by P10,000. D. decrease by P20,000. B. increase by P20,000. E. decrease by P58,000. C. decrease by P10,000.

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Relevant Costing: Karim Abitago 26.

PALE BEAST CORP. manufactures coolers of 10,000 units that contain a freezable ice bag. For an annual volume of 10,000 units, fixed manufacturing costs of P500,000 are incurred. Variable costs per unit amount are direct materials – P80; direct labor – P15, and variable factory overhead – P20 PARROT DRAGON INC. offered to supply the assembled ice bag for P40 with a minimum order of 5,000 units. If Picnic accepts the offer, it will be able to reduce variable labor and overhead by 50%. The direct materials for the freezable bag will cost Picnic P20 if it will produce it. Considering PARROT DRAGON offer, PALE BEAST should A. Buy the freezable bag due to P50,000 advantage. B. Buy the freezable ice bag due to P150,000 advantage. C. Produce the freezable ice bag due to P25,000 advantage. D. Produce the freezable ice bag due to P50,000 advantage.

Use the following information to answer the next item(s):

27.

PHANTASM INC. has just completed a hydro-electric plant at a cost of P21,000,000. The plant will provide the company's power needs for the next 20 years. PHANTASM will use only 60% of the power output annually. At this level of capacity, PHATASM's annual operating costs will amount to P1,800,000, of which 80% are fixed. SPIRAL CORP. currently purchases its power from DRAGON CO. at an annual cost of P1,200,000. PHANTASM could supply this power, thus increasing output of the plant to 90% of capacity. This would reduce the estimated life of the plant to 14 years. If PHANTASM decides to supply power to SPIRAL, it wants to be compensated for the decrease in the life of the plant and the appropriate variable costs. PHANTASM has decided that the charge for the decreased life should be based on the original cost of the plant calculated on a straight-line basis. The minimum annual amount that PHANTASM would charge SPIRAL would be A. P450,000. C. P800,000 B. P630,000. D. P990,000.

28. A. B.

The maximum amount SPIRAL would be willing to pay PHANTASM annually for the power is P600,000. C. P1,050,000. P1,000,000 D. P1,200,000.

29.

Tagaytay Open-Air Flea Market is along the highway leading to Taal Vista Lodge. PROTON has a stall which specializes in hand-crafted fruit baskets that sell for P60 each. Daily fixed costs are P15,000 and variable costs are P30 per basket. An average of 750 baskets are sold each day. PROTON has a capacity of 800 baskets per day. By closing time, yesterday, a bus load of teachers who attended a seminar at the Development Academy of the Philippines stopped by PROTON’s stall. Collectively, they offered PROTON P1,500 for 40 baskets. PROTON should have A. Rejected the offer since he could have lost P500. B. Rejected the offer since he could have lost P900. C. Accepted the offer since he could have P300 contribution margin. D. Accepted the offer since he could have P700 contribution margin.

30.

The QUEEN BIRD INC. is considering dropping its Doombug toy due to continuing losses. Revenue and cost data on the toy for the past year follow: Sales of 15,000 units P150,000 Variable expenses 120,000 Contribution margin 30,000 Fixed expenses 40,000 Net operating loss (P 10,000) If the toy were discontinued, then QUEEN BIRD could avoid P8,000 per year in fixed costs. Also, if the Doombug toy is dropped, the production and sale of other QUEEN BIRD toys would increase so as to generate a P16,000 increase in the contribution margin received from these other toys. At what selling price per Doombug should QUEEN BIRD be indifferent (on economic grounds) between dropping the Doombug or continuing its production and sale? (All other conditions remain the same, including annual sales of 15,000 units of the Doombug toy.) A. P8.33 C. P9.60 B. P9.25 D. P10.70 - END OF HANDOUTS -

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