Saint Paul School of Business and Law Materials – Management Services Campetic, Palo, Leyte Relevant Costing
Review Decision Maing and
Decision-making is an integral part of all management functions. It is the process of choosing among alternative courses of action. Managers have to spend a considerable amount of time and thought in making decisions. Costs, which affect the managerial decisions, are called relevant costs. Relevant costs, also referred to as differential costs, are costs that will be different when one alternative is selected over competing alternatives. All types of costs are not relevant. nly the costs, which are futuristic in nature and differ among alternatives, are considered as relevant costs. !hile making decisions, management compares two or more alternatives. Differential cost analysis or differential costing is a special techni"ue to help management in decision-making which shows how costs and revenues would be differ under different alternative courses of action. Costs for Decision Making: Cost figures drawn from the cost accounting system are often not relevant since they are historical costs. #emember that costs, which differ between the alternatives in future alone, are seen as relevant. $et us "uickly recapitulate the costs classified for the purpose of decision making. Sunk Cost • A sunk cost is an e%penditure made in the past that cannot be changed. &hese are past costs, thus these costs are not relevant for decision-making. 'or e%ample, the cost of machinery purchased in ())* is not relevant now in deciding whether to sell the machinery or not. Variable Cost • +ariable riable costs costs are the costs costs that that vary vary with with the level level of activi activity ty.. If they vary with with diffe differen rentt alternatives they are relevant for decision-making i.e. all variable costs are not r elevant for decision making Fixed Cost • 'or the purposes of short-term decision-making, fi%ed costs may be either relevant or irrelevant. !hen a fi%ed cost is incurred only if a certain decision is taken, it is relevant. &hus, it should be remembered that all fi%ed costs are not irrelevant for decision-making. • Opportunity Cost It represents the benefit foregone in sacrificing the best alternative. pportunity cost is a pure decision-making cost. It is an imputed cost, which does not re"uire cash outlay, and it is not entered in the accounting books. Out-of-ocket Cost • &here are certain costs, which re"uire cash payment to be made like salaries and wages, rent whereas many costs do not re"uire cash outlay like depreciation. ut-of-pocket costs are those costs that involve cash outlays or re"uire the utiliation of current resources/ &hese are relevant for making decisions like make or buy, price fi%ation during depression etc. Differential Cost • In management management accounting accounting,, differential differential cost is used as synonym to relevant relevant cost. &his can be defined as the change in the cost due to change in the level of activity or pattern or method of production. In other words, it is the difference between between the cost resulting from the contemplated contemplated change. If the change in the cost is in the increasing form, it is called incremental cost, if it is decreasing with the decrease in output, it is called decremental cost !ypes of roduct Decisions Make or "uy A firm that is presently buying a product or part from outside may consider manufacturing that product or part in the firm itself. 0uch a decision-making decision-making alternate re"uires the firm to know through marginal costing what contribution to fi%ed costs will results from a 1make2 . 3efore taking any decision one need to consider certain things and those are as follows4 &he capacity of the company in terms of people, plant, space etc., to achieve the re"uired "uantity and "uality. &he differential cost of making or buying the item. &he opportunity cost of using e%isting capacity to manufacture alternative items &he level of variable overheads, which are charged to the item. #ccept or Re$ect Special orders A(5nd 6 7778
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&he companies may get special orders from its customers for the supply of its regular products. In such cases the companies have to take decision whether the order should be accepted or re:ected. &he companies usually takes decision in such circumstances on the basis of differential cost analysis. 0o the company compares the incremental revenue with the differential cost. A company should consider the following factors before taking the accept/re:ect decision. &he effect on the future revenue due to temporary reduction in selling price. &he impact of reduced selling price on the e%isting customers when they come to know the price reduction for special order. 9ossibility of selling e%tra units for new customers other than the special order. #eliability of the cost estimates for the special order. &he effect of the present and future capacity in terms of plant e%pansion, finance, human resources etc urc'asing or (easing In case of capital investment decision, the management of the companies will consider two alternatives. &hat is whether the asset should be purchased or it should be leased. 'or the decision-making purpose, the total cost of the two alternatives will be compared to know the additional savings. Sell or rocess Decisions Differential cost analysis can be used for this purpose to know whether the product can be sold profitably or it re"uires further processing to charge a premium for the product. If there is no further capital investment, the decision can be taken by comparing differential cost for processing and the incremental revenue. roduct Mix Decisions under Capacity Constraints In determining the optimum or profitable sales mi%, the products, which give the ma%imum contribution, are to be retained and their production should be increased. &he production of products, which gives comparatively lesser contribution, should be reduced or dropped altogether. Closing do)n of a factory or a seg*ent &he decision regarding closing down will depend on whether products making a contribution towards fi%ed costs or not. If the products are making a contribution towards fi%ed cost, it is not advisable to close the factory or segment to minimie the losses. ;ven though the factory is closed down, some fi%ed costs could not be avoided, for instance maintenance of plant or overhauling etc. 0o these must be taken into account while making this decision. Dropping or #dding a roduct (ine In a multi-product company, the management may have to decide on adding or dropping a product line. If a new product line is added, its sales and certain costs will also be increase and reverse will happen when a product line is dropped. In order to arrive at such a decision, the management should compare the differential cost and incremental revenue and study its effect on the overall profit position of the organiation.
MULTIPLE CHOICE (THEORIES & PROBLEMS)
(. In the development of accounting data for decision-making, relevant costs are a. . !hat is the opportunity cost of making a component part in a factory given no alternative use of the capacity? a. &he variable manufacturing cost of the component. b. &he total manufacturing cost of the component. c. &he total variable cost of the component. d. @ero. 8. In analying whether to build another regional service office, the salary of the Chief ;%ecutive fficer C; at the corporate head"uarters is a. #elevant because salaries are always relevant. b. #elevant because this will probably change if the regional service office is build. c. Irrelevant because it is future cost that will not differ between the alternatives under consideration. d. Irrelevant since another imputed costs for the same will be considered. A(5nd 6 7778
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*. &he distinction between avoidable and unavoidable costs is similar to the distinction between a. variable costs and fi%ed costs. c. step-variable costs and fi%ed costs. b. variable costs and mi%ed costs. d. discretionary costs and committed costs. . If a cost is irrelevant to a decision, the cost could not be a. a sunk cost. b. a future cost. c. a variable cost. d. an incremental cost. 5. In a make or buy decision, the opportunity cost of capacity could a. be considered to decrease the price of units purchased from suppliers. b. be considered to decrease the cost of units manufactured by the company. c. be considered to increase the price of units purchased from suppliers. d. not be considered since opportunity costs are not part of the accounting records. B. !hich of the following costs are relevant to a make-or-buy decision? a. original cost of the production e"uipment b. annual depreciation of the e"uipment c. the amount that would be received if the production e"uipment were sold d. the cost of direct materials purchased last month and used to manufacture the component ). !hich of the following is & relevant in a make-or-buy decision about a part the entity uses in some of its products? a. &he reliability of the outside supplier. b. &he alternative uses of owned e"uipment used to make the part. c. &he outside supplier2s per-unit variable cost to make the part. d. &he number of units of the part needed each period. (7. !hen only differential manufacturing costs are taken into account for special-order pricing, an essential assumption is that a. Manufacturing fi%ed and variable costs are linear. b. 0elling and administrative fi%ed and variable costs are linear. c. Acceptance of the order will not affect regular sales. d. Acceptance of the order will not cause unit selling and administrative variable costs to increase . ((. If a firm is at full capacity, the minimum special order price must cover a. variable costs associated with the special order b. variable and fi%ed manufacturing costs associated with the special order c. variable and incremental fi%ed costs associated with the special order d. variable costs and incremental fi%ed costs associated with the special order plus foregone contribution margin on regular units not produced (=. 9inoy Company temporarily has e%cess production capacity, the idle plant facilities can be used to manufacture a low-margin item. &he low-margin item should be produced if it can be sold for more than its a. +ariable costs plus opportunity cost of idle facilities. b. Indirect costs plus any opportunity cost of idle facilities. c. 'i%ed costs. d. +ariable costs. (>. An opportunity cost commonly associated with a special order is a. &he contribution margin on lost sales. b. &he variable costs of the order. c. Additional fi%ed costs related to the increased output. d. Any of the above. (8. !hich of the following costs is & relevant to a special order decision? a. the direct labor costs to manufacture the special order units b. the variable manufacturing overhead incurred to manufacture the special-order units c. the portion of the cost of leasing the factory that is allocated to the special order d. All of the above costs are relevant. (*. A manager is attempting to determine whether a segment of the business should be eliminated. &he focus of attention for this decision should be on a. the net income shown on the segments income statement. b. sales minus total e%penses of the segment. c. sales minus total direct e%penses of the segment. d. sales minus total variable e%penses and avoidable fi%ed e%penses of the segment. (. Chow Inc. has its own cafeteria with the following annual costs 'ood 9 877,777 $abor >77,777 verhead 887,777 Capital 9(,(87,777 &he overhead is 87E fi%ed. f the fi%ed overhead, 9(77,777 is the salary of the cafeteria supervisor. &he remainder of the fi%ed overhead has been allocated from total company overhead. Assuming the cafeteria supervisor will remain and that Chow will continue to pay said salary, the ma%imum cost Chow will be willing A(5nd 6 7778
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to pay an outsider firm to service the cafeteria is a. 9(,(87,777 b. 9(,787,777
c.
9577,777
d. 9)8,777
(5. $isted below are a company2s monthly unit costs to manufacture and market a particular product. Fnit Costs +ariable Cost 'i%ed Costs Direct materials G=.77 Direct labor =.87 Indirect Manufacturing (.7 G(.77 Marketing =.*7 (.*7 &he company must decide to continue making the product or buy it from an outside supplier. &he supplier has offered to make the product at the same level of "uality that the company can make it. 'i%ed marketing costs would be unaffected, but variable marketing costs would be reduced by >7E if the company were to accept the proposal. !hat is the ma%imum amount per unit that the company can pay the supplier without decreasing its operating income? a. GB.*7 b. G.5* c. G5.5* d. G*.=* (B. 9icnic Items, Inc. manufactures coolers of (7,777 units that contain a freeable ice bag. 'or an annual volume of (7,777 units, fi%ed manufacturing costs of 9*77,777 are incurred. +ariable costs per unit amount are direct materials 6 9B7H direct labor 6 9(*, and variable factory overhead 6 9=7 3ags Corp. offered to supply the assembled ice bag for 987 with a minimum order of *,777 units. If 9icnic accepts the offer, it will be able to reduce variable labor and overhead by *7E. &he direct materials for the freeable bag will cost 9icnic 9=7 if it will produce it. Considering 3ags Corp. offer, 9icnic should a. 3uy the freeable ice bag due to 9(*7,777 advantage. b. 9roduce the freeable ice bag due to 9=*,777 advantage. c. 9roduce the freeable ice bag due to 9*7,777 advantage. d. 3uy the freeable bag due to 9*7,777 advantage. (). 0avage Industries is a multi-product company that currently manufactures >7,777 units of 9art 08= each month for use in production. &he facilities now being used to produce 9art 08= have fi%ed monthly cost of 9(*7,777 and a capacity to produce B8,777 units per month. If 0avage were to buy 9art 08= from an outside supplier, the facilities would be idle, but its fi%ed costs would continue at 87E of their present amount. &he variable production costs of 9art 08= are 9(( per unit. If 0avage Industries is able to obtain 9art 08= from an outside supplier at a unit purchase price of 9(=.B5*, the monthly usage at which it will be indifferent between purchasing and making 9art 08= is a. >7,777 units. b. >=,777 units. c. B7,777 d. 8B,777 =7. Jreat ;lectronics is operating at 57E capacity. &he plant manager is considering making component *7( now being purchased for 9((7 each, a price that is pro:ected to increase in the near future. &he plant has the e"uipment and labor force re"uired to manufacture the component. &he design engineer estimates that each component re"uires 987 of direct materials and 9>7 of direct labor. &he plant overhead is =77E of direct labor peso cost, and 87E of the overhead is fi%ed cost. A decision to manufacture component *7( will result in a gain or loss for each component of a. 9=B b. 9( c. 9=7 d. 98 =(. 9art 3K is a component that Motors and ;ngines Co. uses in the assembly of motors. &he cost to produce one 3K is presented below4 Direct materials 9 8,777 Materials handling =7E of direct materials B77 Direct labor >=,777 verhead (*7E of direct labor 8B,777 &otal manufacturing costs 9B8,B77 Materials handling which is not included in manufacturing overhead, represents the direct variable costs of the receiving department that are applied to direct materials and purchased components on the basis of their cost. &he company2s annual overhead budget is one-third variable and two-thirds fi%ed. 9re-casts Co., offers to supply 3K at a unit price of 97,777. 0hould the company buy or manufacture? a. 3uy, due to advantage of 9=8,B77 per product. b. Manufacture, due to advantage of 95,=77 per unit. c. 3uy, due to advantage of 9(=,B77 per unit. d. Manufacture, due to advantage of 9(),=77 per unit. ==. &yler Company currently sells (,777 units of product M for G( each. +ariable costs are G7.87 and avoidable fi%ed costs are G877. A discount store has offered G7.B7 per unit for 877 units of product M. &he managers believe that if they accept the special order, they will lose some sales at the regular price. Determine the number of units they could lose before the order become unprofitable. a. =5 units. b. *77 units. c. 77 units. d. 5*7 units =>. &he 3lue 9late Co. is operating at *7E capacity producing (77,777 units of ceramic plates a year. !ith the economic boom that the country is e%pected to have in the coming year, the company plans to utilie 5*E capacity. 9art of the manufacturing process is hand-painting which has a variable cost of material at 98.*7 and A(5nd 6 7778
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labor at 9*.*7 per plate. &his painting process has variable overhead at 9(.77 which is 87E of total variable factory overhead. &otal factory overhead is 9*77 per (77 plates. o increase in fi%ed factory overhead is e%pected even with the substantial increase in production. An offer to sub-contract the incremental hand painting :ob was given at 9(7.*7 per plate but the company will have to lease an e"uipment at 9(7,777 annual rental. &he plates sell for 9*7.77 per plate a piece at the contribution margin rate of 8*E. 0hould 3lue 9late Company sub-contract? !hy? a. o, because the company will lose 9(>*,777. b. Les, because the company will save 9*,777. c. Les, because the company will earn 9(*,777 more. d. o, because there is no benefit for the company. =8. 9i%ie Co. produces Component 8(5 for use in one of its electronic gadgets. ormal annual production for the item is (77,777 units. &he cost per unit lot of the part are as follows4 Direct material 9*=7 Direct labor =77 Manufacturing overhead +ariable =87 'i%ed >=7 &otal manufacturing costs per (77 units 9(,=B7 3obbie Inc. has offered to sell 9i%ie all (77,777 units it will need during the coming year for 9(,=77 per (77 units. If 9i%ie accepts the offer from 3obbie, the facilities used to manufacture Component 8(5 could be used in the production of Component B=5*. &his change would save 9i%ie 9(B7,777 in relevant costs. In addition, a 9=77,777 cost item included in fi%ed overhead is specifically related to 9art 8(5 and would be eliminated. 9i%ie should a. 3uy Component 8(5 because of 9>77,777 savings. b. 3uy Component 8(5 because of 9(87,777 savings. c. Continue producing Component 8(5 because of 987,777 savings. d. Continue producing Component 8(5 because of 97,777 savings. =*. Chow 'oods operates a cafeteria for its employees. &he operations of the cafeteria re"uires fi%ed costs of 9857,777 per month and variable costs of 87E of sales. Cafeteria sales are currently averaging 9(,=77,777 per month. &he company has the opportunity to replace the cafeteria with vending machines. Jross customer spending at the vending machines is estimated to be 87E greater than the current sale because the vending machines are available at all hours. 3y replacing the cafeteria with vending machines, the company would receive (E of the gross customer spending and avoid cafeteria costs. A decision to replace the cafeteria with vending machines will result in a monthly increase decrease in operating income of a. 9(B=,777 b. 9=*B,B77 c. 9*BB,777 d. 9(B,B77 =. A3C Company receives a one-time special order for *,777 units of leen. Acceptance of this order will not affect the regular sales of B7,777 units. &he cost to manufacture one unit of this particular product is4 +ariable costs per unit 'i%ed costs per year Direct materials G(.*7 Direct labor =.*7 verhead 7.B7 G(77,777 0elling and administrative >.77 *7,777 +ariable selling costs for each of these *,777 units will be G(.77. !hat is the differential cost to A3C Company of accepting this special order? a. G>),777 b. G>8,777 c. G>7,=*7 d. G=),777 =5. 9# Company e%pects to incur the following costs at the planned production level of (7,777 units4 Direct materials 9(77,777 Direct labor (=7,777 +ariable overhead 7,777 'i%ed overhead >7,777 &he selling price is 9*7 per unit. &he company currently operates at full capacity of (7,777 units. Capacity can be increased to (>,777 units by operating overtime. +ariable costs increase by 9(8 per unit for overtime production. 'i%ed overhead costs remain unchanged when overtime operations occur. 9# Company has received a special order from a wholesaler who has offered to buy =,777 units at 98* each. . !hat is the incremental cost associated with this special order? a. 9B8,777 b. 9>(,777 c. 9=,777 d. 98=,777 =B. &agaytay pen-Air 'lea Market is along the highway leading to &aal +ista $odge. Arnel has a stall which specialies in hand-crafted fruit baskets that sell for 97 each. Daily fi%ed costs are 9(*,777 and variable costs are 9>7 per basket. An average of 5*7 baskets are sold each day. Arnel has a capacity of B77 baskets per day. 3y closing time, yesterday, a bus load of teachers who attended a seminar at the Development Academy of the 9hilippines stopped by Arnel2s stall. Collectively, they offered Arnel 9(,*77 for 87 baskets. Arnel should have a. #e:ected the offer since he could have lost 9*77. b. #e:ected the offer since he could have lost 9)77. c. Accepted the offer since he could have 9>77 contribution margin. A(5nd 6 7778
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d. Accepted the offer since he could have 9577 contribution margin.
=). 0ta. ;lena Company manufactures men2s caps. &he pro:ected income statement for the year before any special order is as follows4 Amount 9er Fnit 0ales 9 877,777 9 =7 Cost of goods sold >=7,777 ( Jross margin 9 B7,777 9 8 0elling e%penses >7,777 > perating income 9 *7,777 9 ( 'i%ed costs included in above pro:ected income statement are 9B7,777 in cost of goods sold and 9),777 in selling e%penses. A special order offering to buy =,777 caps for 9(5 each was made to 0ta. ;lena. o additional selling e%penses will be incurred if the special order is accepted. 0ta. ;lena has the capacity to manufacture =,777 more caps. As a result of the special order, the operating income would increase by a. 9>8,777 b. 9=8,777 c. 9(7,777 d. 97 >7. Data covering M3 Corporation2s two product lines are as follows4 9roduct N!O 9roduct N@O 0ales 9>,777 9=*,=77 Income before income ta% (*,)> B,>BB 0ales price per unit >7.77 (8.77 +ariable cost per unit B.*7 (*.77 &he total unit sold of N!O was (,=77 and that of N@O was (,B77 units. If 9roduct N@O is discontinued and this results in a 877 units decrease in sales of 9roduct N!O, the total effect on income will be a. 9(>,77 decrease. b. 9,B77 decrease. c. 9B,77 decrease. d. 9*,777 decrease. >(. akinnat Corporation2s utlet o. * reported the following results of operations for the period :ust ended4 0ales 9=,*77,777 $ess4 +ariable e%penses (,777,777 Contribution margin 9(,*77,777 $ess4 'i%ed e%penses 0alaries P wages 9 5*7,777 Insurance on inventories *7,777 Depreciation on e"uipment >=*,777 Advertising *77,777 (,=*,777 et income loss 9(=*,777 &he management is contemplating on dropping outlet o. * due to the unfavorable operational results. If this would happen, one employee will have to be retained with an annual salary of 9(*7,777. &he e"uipment has no resale value. utlet o. * should a. ot be dropped due to foregone overall income of 9>*7,777. b. 3e dropped due to foregone overall income of 9>=*,777. c. ot be dropped due to foregone overall income of 9=*,777. d. 3e dropped due to overall operational loss of 9=*,777. >=. &he &able &op Model Corp. produces three products. N&ic,O N&ac.O, and N&oc.O &he owner desires to reduce production load to only one product line due to prolonged absence of the production manager. Depreciation e%pense amounts to 977,777 annually. ther fi%ed operating e%penses amount to 97,777 per year. &he sales and variable cost data of the three products are 7772s omitted &ic &ac &oc 0ales 9,77 9*,>77 9(7,B77 +ariable costs >,)77 (,577 B,)77 !hich product must be retained and what is the opportunity cost of selecting such product line? a. #etain product N&acOH opportunity cost is 98. million. b. #etain product N&acOH opportunity cost is 9>.(8 million. c. #etain product N&icOH opportunity cost is 98.78 million. d. #etain product N&ocOH opportunity cost is 98.B8 million . >>. A company produces and sells three products4 9roducts C Q 9 0ales G=77,777 G(*7,777 G(=*,777 0eparable product fi%ed costs 7,777 >*,777 87,777 Allocated fi%ed costs >*,777 87,777 =*,777 +ariable costs )*,777 5*,777 *7,777 &he company lost its lease and must move to a smaller facility. As a result, total allocated fi%ed costs will be reduced by 87E.
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facility. 3ecause the companys ob:ective is to ma%imie profits, what is its e%pected net profit after the appropriate product has been discontinued? a. G(7,777 b. G(*,777 c. G=7,777 d. G=*,777 uestions >8 and >* are based on the following information. 8. If 7,777. c. G))7,777. d. GB77,777 >*. &he ma%imum amount uigley would be willing to pay
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