MANAGEMENT ACCOUNTING (VOLUME II) - Solutions Manual
CHAPTER 19 RELEVANT COSTS FOR DECISION MAKING
I.
Questions
1. Quantitative Quantitative factors are those which which may more easily be reduced reduced in terms terms of peso pesoss such such as proje project cted ed costs costs of mater material ials, s, labor labor and and overh overhea ead. d. Qualitative factors are those whose measurement in pesos is difficult and imprecise; yet a qualitative factor may be easily given more weight than the measurable measurable cost savings. savings. It can be seen that the accountant’s accountant’s role in maing decisions deals with the quantitative factors. !. "ele "eleva vant nt cost costss are are e#pe e#pect cted ed futu future re cost costss that that will will diff differ er betw betwee een n alternatives. In view of the definition definition of relevant costs, historical costs are always irrelevant because they are not future costs. $hey may may be helpful in predicting relevant costs but they are always irrelevant costs per se. %. $he differ different ential ial costs costs in any given given situatio situation n is commo commonly nly defi defined ned as the change in total cost under each alternative. It is not relevant cost, but it is the algebraic difference between the relevant costs for the alternatives under consideration. &. 'nalysis( )uture costs( *ew $ruc -ess( +roceeds from disposal, net
Replace +1,!
Rebuild
1, + ,!
'dvantage of rebuilding
+/,0 +
$he original cost of the old truc is irrelevant but its disposal value is relevant. relevant. It is recommended recommended that the truc should be rebuilt rebuilt because it will involve lesser cash outlay. outla y.
II. Exercises Exercise 1 (Identi!in" #ele$ant Costs) 1%-1
C&a'ter 1% Relevant Costs for Decision Making
a. b. c. d. e. f. g. h. i. j. . l.
Case 1 Not Item Relevant Relevant 2ales revenue................................... 3 4irect materials............................... 3 4irect labor...................................... 3 5ariable manufacturing overhead.......................................... 3 6oo value 7 8odel 9 machine........................................... 3 4isposal value 7 8odel 9 machine........................................... 3 4epreciation 7 8odel 9 machine........................................... 3 8aret value 7 8odel )0 machine :cost................................. 3 )i#ed manufacturing overhead.......................................... 3 5ariable selling e#pense.................. 3 )i#ed selling e#pense...................... 3
Case 2 Not Relevant Relevant 3 3 3
3 3 3 3 3 3 3 3 3
Exercise (Identiication o #ele$ant Costs)
Requirement 1 )i#ed cost per mile :+%,0= > 1, miles.......................................................... +.%0 5ariable operating cost per mile............................................................................... ./ 'verage cost per mile............................................................................................... +.&% = 4epreciation............................................................................................................ +!, Insurance................................................................................................................. ?
Relevant Costs for Decision Making C&a'ter 1%
therefore irrelevant. It is unliely that her insurance costs would increase as a result of the trip, so they are irrelevant as well. $he garage rent is relevant only if she could avoid paying part of it if she drives her own car. Requirement 3 Ahen figuring the incremental cost of the more e#pensive car, the relevant costs would be the purchase price of the new car :net of the resale value of the old car and the increases in the fi#ed costs of insurance and automobile ta# and license. $he original purchase price of the old car is a sun cost and is therefore irrelevant. $he variable operating costs would be the same and therefore are irrelevant. :2tudents are inclined to thin that variable costs are always relevant and fi#ed costs are always irrelevant in decisions. $his requirement helps to dispel that notion. Exercise (Ma*e or +u! a Co,'onent)
Requirement 1
Bost of purchasing 4irect materials 4irect labor 5ariable manufacturing overhead )i#ed manufacturing overhead, traceable1
Per Unit Differential Costs 15,000 units Make Bu Make Bu +! +%,, + ? + , / 1,!, 1 10, !
%,
)i#ed manufacturing overhead, common +1
$otal costs
+! +!,00, +%,,
4ifference in favor of continuing to mae the parts +% +&0, 1 Cnly the supervisory salaries can be avoided if the parts are purchased. $he remaining boo value of the special equipment is a sun cost; hence, the +% per unit depreciation e#pense is not relevant to this decision. 6ased on these data, the company should reject the offer and should continue to produce the parts internally.
Requirement 2 Make Bu Bost of purchasing :part 1................................................................................................... +%,, 1%-
C&a'ter 1% Relevant Costs for Decision Making
Bost of maing :part 1........................................................................................................ +!,00, Cpportunity costDsegment margin forgone on a potential new product line................................................................................................ ?0, $otal cost............................................................................................................................... +%,!, +%,, 4ifference in favor of purchasi ng from the outside supplier.............................................................................................................................. +!, $hus, the company should accept the offer and purchase the parts from the outside supplier.
Exercise (E$aluatin" S'ecial Order)
Cnly the incremental costs and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are relevant overhead costs in this situation. $he other manufacturing overhead costs are fi#ed and are not affected by the decision. Per
!otal
Unit +%,&.0
10 "ra#elets +%&,0.
Incremental revenue Incremental costs( 5ariable costs( 4irect materials 1,&%. 1&,%. 4irect labor /?. /,?. 5ariable manufacturing overhead . . 2pecial filigree ?. ?. $otal variable cost +!,&!. !&,!. )i#ed costs( +urchase of special tool &,?0. $otal incremental cost !/./0. Incremental net operating income + ?.1&0. 9ven though the price for the special order is below the company’s regular price for such an item, the special order would add to the company’s net operating income and should be accepted. $his conclusion would not necessarily follow if the special order affected the regular selling price of bracelets or if it required the use of a constrained resource. Exercise . (Utili/ation o a Constrained #esource)
Requirement 1 $ 1%-
%
&
Relevant Costs for Decision Making C&a'ter 1%
:1 :! :% :&
Bontribution margin per unit................................................................................................ +1/ +%? +! 4irect labor cost per unit....................................................................................................... +1! +%! +1? 4irect labor rate per hour...................................................................................................... / / / 4irect laborEhours required per unit :! > :%....................................................................... 1.0 &. !. Bontribution margin per direct laborEhour :1 > :&............................................................. +1! + +1
Requirement 2 $he company should concentrate its labor time on producing product 3( $
%
&
Bontribution margin per direct laborEhour +1! F %, +%?,
4irect laborEhours available $otal contribution margin
+ F %, +!,
+1 F %, +%,
'lthough product 3 has the lowest contribution margin per unit and the second lowest contribution margin ratio, it has the highest contribution margin per direct laborEhour. 2ince labor time seems to be the company’s constraint, this measure should guide management in its production decisions. Requirement 3 $he amount Gaycee Bompany should be willing to pay in overtime wages for additional direct labor time depends on how the time would be used. If there are unfilled orders for all of the products, Gaycee would presumably use the additional time to mae more of product 3. 9ach hour of direct labor time generates +1! of contribution margin over and above the usual direct labor cost. $herefore, Gaycee should be willing to pay up to +! per hour :the +/ usual wage plus the contribution margin per hour of +1! for additional labor time, but would of course prefer to pay far less. $he upper limit of +! per direct labor hour signals to managers how valuable additional labor hours are to the company. If all the demand for product 3 has been satisfied, Gaycee Bompany would then use any additional direct laborEhours to manufacture product H. In that case, the company should be willing to pay up to +1/ per hour :the +/ usual wage plus the +1 contribution margin per hour for product H to manufacture more product H. -iewise, if all the demand for both products 3 and H has been satisfied, additional labor hours would be used to mae product . In that case, the company should be willing to pay up to +1 per hour to manufacture more 1%-.
C&a'ter 1% Relevant Costs for Decision Making
product . Exercise 0 (Sell or rocess 2urt&er)
2ales value after further processing 2ales value at splitEoff point Incremental revenue Bost of further processing Incremental profit :loss
Pro'u#t ( +/, 0, %, %0, +:0,
Pro'u#t B +10, , ?, &, !,
Pro'u#t C +0, ?, 10, 1!, %,
+roducts 6 and B should be processed further, but not +roduct '. III. Problems ro3le, 1 (Acce't or #e4ect an Order)
2elling price per unit -ess 5ariable costsJunit( 8aterials -abor )actory overhead :!0K Bontribution marginJunit 8ultiplied by number of units to be sold $otal contribution margin
Pro'u#t ( +1.!
Pro'u#t B +1.&
.0 .! .1 ./ +.& !1, units +/,&
. .!& .1& 1./ +.%! %, units +,?
+roduct 6 should be accepted because its total contribution margin is higher than that of +roduct '. ro3le, (Eli,inate or #etain a roduct Line)
Requirement 1 *o, production and sale of the round trampolines should not be discontinued. Bomputations to support this answer follow( Bontribution margin lost if the round trampolines are discontinued............................................. -ess fi#ed costs that can be avoided( 'dvertising 7 traceable.................................. -ine supervisors’ salaries............................... 4ecrease in net operating income for the company as a whole....................................... 1%-0
+:/, +&1, ?,
&, +:%%,
Relevant Costs for Decision Making C&a'ter 1%
$he depreciation of the special equipment represents a sun cost, and therefore it is not relevant to the decision. $he general factory overhead is allocated and will presumably continue regardless of whether or not the round trampolines are discontinued; thus, it is not relevant. Requirement 2 If management wants a clear picture of the profitability of the segments, the general factory overhead should not be allocated. It is a common cost and therefore should be deducted from the total productEline segment margin. ' more useful income statement format would be as follows(
!otal 2ales...................................... +1,, -ess variable e#penses.......... &1, Bontribution margin ............. 0, -ess fi#ed e#penses( 'dvertising 7 traceable..... !1?, 4epreciation of special equipment...................... 0, -ine supervisors’ salaries........................... 1, $otal traceable fi#ed e#penses............................ %%, +roductEline segment margin............................... !?, -ess common fi#ed e#penses............................ !, *et operating income :loss.................................. + ?,
Roun' +1&, ?, /,
!ram)oline Re#tan*ular +0, !, %,
+#ta*onal +%?, 10, !1,
&1,
11,
?0,
!,
&,
%0,
?,
,
?,
?,
10,
1?,
+ 1%,
+1&%,
+1&,
ro3le, (roduct Mix)
Requirement 1
2elling price per unit 5ariable cost per unit Bontribution margin J unit 4ivided by no. of hours required for each unit Bontribution per hour
( +% !0 +0 0 hrs. +1 1%-5
Pro'u#t ine B C +!0 +1 1 0 +10 + 0 1 hrs. +1.0
& hrs. +1.!0
D +/ & +& 1 hr. +&
C&a'ter 1% Relevant Costs for Decision Making
+roduct raning( 1. 4 !. 6
%. B
&. '
6ased on the above analysis, first priority should be given to +roduct 4. $he company should use &, out of the available ?, hrs. to produce &, units of product 4. $he remaining !, hrs. should be used to produce ,! units of +roduct 6. @ence, the best product combination is &, units of +roduct 4 and ,! units of +roduct 6. Requirement 2 If there were no maret limitations on any of the products, the company should use all the available ?, hours in producing ?, units of product 4 only.
$he difference in profit between the two alternatives is computed as follows( Bontribution margin of combination :1 +roduct 4 :&, # + &. +roduct 6 :,! # +10. $otal contribution margin of 4 and 6 -ess contribution margin of 4 only :?, # +& 4ifference, e#cess over profit in combination :1
+ 1?, 1%/, +10&, %/&, +!%,
ro3le, (Acce't or #e4ect a S'ecial Order)
Requirement 1 $he company should accept the special order of &, L +1 each because this selling price is still higher than the additional variable cost to be incurred. Ahether or not variable mareting e#penses will be incurred, the decision is still to accept the order. Supporting computations
:a 'ssume no additional variable mareting cost will be incurred. 1%-6
Relevant Costs for Decision Making C&a'ter 1%
2elling price per unit -ess variable manufacturing costs( 4irect materials 4irect labor 5ariable overhead Bontribution marginJunit 8ultiplied by number of units of order $otal increase in profit
+1. +0. %. .0
/.0 + 1.!0 &, units +0,
:b 'ssume additional variable mareting cost will be incurred. 2elling price per unit -ess variable costs :+/.0 M +.!0 Bontribution margin J unit 8ultiplied by number of units of order $otal increase in contribution margin
+1. . + 1. &, units +&,
Requirement 2 +/.0, the total variable manufacturing cost.
Requirement 3 4irect materials 4irect labor 5ariable factory overhead $otal cost of inventory under direct costing
+0. %. .0 +/.0
Requirement +resent contribution margin N1, units # :+10 E +O -ess proposed contribution margin N:+1& E + # 11, unitsO 4ecrease in contribution margin
+?, 00, + 0,
$he company should not reduce the selling price from +10 to +1& even if volume will go up because total contribution margin will decrease. ro3le, . (CV Anal!sis used or 7ecision Ma*in")
Requirement .a/ Units sol' )er mont &,
No of monts ? 1%-%
Pro"a"ilit !K
C&a'ter 1% Relevant Costs for Decision Making
0, ?,
10 %
0K %K 1K
Requirement ."/ Pro'u#tion 5,000 units +1?,
,000 units +1?,
1, E
1!0, E
10, E
$otal Bontribution margin
+1, + ?,
+1!0, + %0,
+10, + 1,
2ales :0, # +& -ess variable costs +roduction cost L +!0 +urchase cost L +&0
+!,
+!,
+!,
1, &0,
1!0, E
10, E
$otal Bontribution margin
+1&0, + 00,
+1!0, + 0,
+10, + 0,
2ales :?, # +& -ess variable costs +roduction cost L +!0 +urchase cost L +&0 $otal Bontribution margin
+!&,
+!&,
+!&,
1, , +1, + 0,
1!0, &0, +1, + ,
10, +10, + ,
2ales :&, # +& -ess variable costs +roduction cost L +!0 +urchase cost L +&0
-,000 units +1?,
Requirement .#/ ales +r'er Contri"ution Mar*in &, +%0, 0, 0, ?, , 'verage Bontribution 8argin ro3le, 0 (ricin")
1%-18
Pro"a"ilit .! .0 .%
4)e#te' 6alue + , %,0 !1, +?0,0
Relevant Costs for Decision Making C&a'ter 1%
Requirement (7
2ales -ess 5ariable cost Bontribution margin -ess )i#ed cost *et income :loss
2005 + 1, 1%, :+ %, &, :+ ,
+)eratin* Result at 8ull Ca)a#it + &/, ?!&, :+1&&, &, :+1/&,
200 + &, 0!, :+1!, &, :+1?,
$he company had been operating at a loss because the product had been selling with a negative contribution margin. @ence, the more units are sold, the higher the loss will be. Requirement B7 +?.1& Requirement C7 +&.! Requirement D7 +0?.0/ ro3le, 5 (Ma*e or +u!) Cost of Making
Cutside purchase 4irect materials 4irect labor 5ariable manufacturing overhead )i#ed manufacturing overhead= $otal cost
Cost of !u"ing +,
+10, %, 1, 10, +,
+,
= 1J% # +&0, P +10,
$herefore, the annual advantage to mae the parts is +!,. I5. Multiple C#oice Questions 1. !. %. &. 0. ?. .
B B 6 6 ' 6 B
11. 1!. 1%. 1&. 10. 1?. 1.
4 ' 4 ' 4 B '
!1. !!. !%. !&. !0. !?. !. 1%-11
4 ' 4 9 6 4 4
%1. %!. %%. %&. %0.
' 4 B ' B
C&a'ter 1% Relevant Costs for Decision Making
/. 6 . ' 1. 6
1/. 1. !.
B 6 B
!/. !. %.
B ' '
Supporting computations for nos$ 1% & 2'
1?. 2ales N:1, # K # :+0. # 1!KO -ess( 5ariable costs :+%, # K Bontribution margin -ess( )i#ed costs Cperating income
+0&, !, +!, 10, +1!,
1. 4irect materials 4irect labor Cverhead 2elling cost 8inimum selling price per unit
+ & 0 ! % +1&
1/. "elevant cost to mae :1, # +!& +urchase cost -ess( 2avings in manufacturing cost 'voidable fi#ed overhead *et purchase price 4ifference in favor of buyR alternative
+!&, +%, +&0, 0,
1. Increase in sales :?, # +% -ess( Increase in variable cost :?, # +!.0 *et increase in income !. 2ales :1, # +! -ess( 5ariable costs " :+1! # 1, 2 :+ / # 1, $ :+ & # 1,
R +!,
0, +!0, + %0,
+1/, 10, + %,
S +!,
( +!,
1!, /, &,
Bontribution margin
+ /,
+1!,
+1?,
2ales :+1? # 10,
R +!&,
S +!&,
( +!&,
!1.
1%-1
Relevant Costs for Decision Making C&a'ter 1%
-ess( 5ariable costs " :+1! # 10, 2 :+ / # 10, $ :+ & # 10,
1/, 1!, ?,
Bontribution margin -ess( )i#ed costs Cperating income
+ ?, &, + !,
+1!, /, + &,
!!. Cld operating income( Bontribution margin -ess( )i#ed cost
+1/, 1!, + ?,
+/, &, +&, !, +!,
*ew operating income 4ifference E decrease !%. 2ales -ess( 5ariable costs 4irect materials 4irect labor )actory overhead 8areting e#penses 'dministrative e#penses Bontribution margin -ess( )i#ed costs )actory overhead 8areting e#penses 'dministrative e#penses Increase in fi#ed costs +rofit !&. 2ales -ess( 5ariable costs 4irect materials 4irect labor )actory overhead 8areting e#penses
+1,!, +%, &, /, , 0,
+ 0, %, !, 1,
, + %,
11, + 1, +1,!,
+!0, %0, /, , 1%-1
C&a'ter 1% Relevant Costs for Decision Making
'dministrative e#penses Bontribution margin -ess( )i#ed costs )actory overhead 8areting e#penses 'dministrative e#penses 4ecrease in fi#ed costs :+!0, ÷ & +rofit
0,
+ 0, %, !, :?,!0
!0. 4irect materials :+! # 0, 4irect labor :+/ # 0, 5ariable overhead :+& # 0, $otal variable costs 'dd( 'voidable fi#ed overhead $otal !?. 'voidable fi#ed overhead 4irect materials 4irect labor 5ariable overhead $otal 8ultiplied by( *umber of units to be produced $otal relevant costs to mae the part
!. +urchase cost :+1.!0 # 1, 5ariable costs to mae 2avings of maing the blade !/. 2elling price per unit -ess( 5ariable costs of goods sold per unit :N+%!, E +/,O ÷ !, units Bontribution margin per unit 8ultiplied by units to be sold under 2pecial Crder Increase in operating income !. 6udgeted operating income( Bontribution margin :+!,, # %K -ess fi#ed costs 1%-1
/0, + %0,
%,0 + !0?,!0
+1, &, !, +, 1, +/, + & & 1? 1/ +&! !, +/&,
+1!,0 1, + !,0 +1 1! + 0 !, +1,
+?, &,
Relevant Costs for Decision Making C&a'ter 1%
*et operating income Cperating income under the proposal( 2ales +!,, -ess 5ariable costs :NK # +!,,O # /K 1,1!, Bontribution margin + //, -ess fi#ed costs 0!, Increase in budgeted operating profit
1%-1.
+!,
%?, +1?,
