DIFFERENTIAL COST ANALYSIS

Management Accounting Review

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A RELEVANT COST is a cost that only relates to a specific management decision, and which will change in the future as a
result of that decision. The relevant cost concept is extremely useful for eliminating extraneous information from a particular
decision-making process. Also, by eliminating irrelevant costs from a decision, management is prevented from focusing on
information that might otherwise incorrectly affect its decision.

Relevant costs and revenues are those costs and revenues that change as a direct result of a decision taken.

Relevant costs and revenues have the following features:

They are future costs and revenues – As it is not possible to change what has happened in the past, then relevant costs and
revenues must be future costs and revenues.

They are incremental – Relevant costs are incremental costs and it is the increase in costs and revenues that occurs as a direct
result of a decision taken that is relevant. Common costs can be ignored for the purposes of decision-making. In test
questions, look out for costs detailed as differential, specific or avoidable.

They are cash flows – In addition, future costs and revenues must be cash flows arising as a direct consequence of the
decision taken. Relevant costs do not include items which do not involve cash flows (e.g., depreciation and notional costs).

NON-RELEVANT COSTS

Costs which are not relevant to a decision are known as non-relevant costs and include: sunk costs; committed costs; non-
cash flow costs; general fixed overheads; and net book values.

Sunk costs are past costs or historical costs which are not directly relevant in decision-making, e.g., development costs or
market research costs.

Committed costs are future costs that cannot be avoided, whatever decision is taken.

Non-cash flow costs are costs which do not involve the flow of cash, e.g., depreciation and notional costs. A notional cost is
a cost that will not result in an outflow of cash either now or in the future, e.g., sometimes the head office of an organization
may charge a ‘notional’ rent to its branches. This cost will only appear in the accounts of the organization but will not result
in a ‘real’ cash expenditure.

General fixed overheads are usually not relevant to a decision. However, some fixed overheads may be relevant to a
decision, e.g., stepped fixed costs may be relevant if fixed costs increase as a direct result of a decision being taken.

Net book values are not relevant costs because like depreciation, they are determined by accounting conventions rather than
by future cash flows.

OPPORTUNITY COSTS

Opportunity cost is an important concept in decision-making. It represents the best alternative that is foregone in taking the
decision. The opportunity cost emphasizes that decision-making is concerned with alternatives and that a cost of taking one
decision is the profit or contribution forgone by not taking the next best alternative.

If resources to be used on projects are scarce (e.g. labor, materials, machines), then consideration must be given to profits or
contribution which could have been earned from alternative uses of the resources.

For example, the skilled labor which may be needed on a new project might have to be withdrawn from normal production.
This withdrawal would cause a loss in contribution which is obviously relevant to the project appraisal.

The cash flows of a single department or division cannot be looked at in isolation. It is always the effects on cash flows of the
whole organization which must be considered.

SHORT-TERM NON-ROUTINE CASES

a. Accept or reject a special order or a business proposal

Special order pricing is a technique used to calculate the lowest price of a product or service at which a special order may be
accepted and below which a special order should be rejected. Usually, a business receives special orders from customers at a
price lower than normal. In such cases, the business will not accept the special order if it can sell all its output at normal
price. However, when sales are low or when there is idle production capacity, special orders should be accepted if the
incremental revenue from special order is greater than incremental costs.

This method of pricing special orders, in which price is set below normal price but the sale still generates some contribution
per unit, is called contribution approach to special order pricing. The idea is that it is better to receive something above
variable costs, than receiving nothing at all.
Example

A company is producing, on the average, 10,000 units of product A per month despite having 30% more capacity. Costs per
unit of product A are as follows:

Direct Material ₱ 8.00

Direct Labor 5.00
Variable Factory Overhead 2.00
Variable Selling Expense 0.50
Fixed Factory Overhead 3.00
Fixed Office Expense 2.00
₱20.50

The company received a special order of 2,000 units of product A at ₱17 per unit from a new customer. Should the company
accept the special order, provided that the customer has agreed to pay the variable selling expenses in addition to the price of
the product?

Solution

The increment cost per unit for the special order is calculated as:

Direct Material ₱8
Direct Labor 5
Variable Factory Overhead 2
₱15

Since the incremental cost per unit is less that the price offered in the special order, the company should accept it. Accepting
special order will generate additional contribution of ₱2 unit and ₱4,000 in total.

b. Sell or process further a product line

A decision whether to sell a joint product at split-off point or to process it further and sell it in a more refined form is called a
sell-or-process-further decision. Joint products are two or more products which have been manufactured from the
same inputs and in a same production process (i.e., a joint process). The point at which joint products leave the joint process
is called split-off point.

Some of the joint products may be in final form ready for sale, while others may be processed further. In such cases,
managers have to decide whether to sell the unfinished goods at split-off point or to process them further. Such decision is
known as sell-or-process-further decision and it must be made so as to maximize the profits of the business.

A sell-or-process-further analysis can be carried out in three different ways:

• Incremental (or Differential) Approach calculates the difference between the additional revenues and the additional
costs of further processing. If the difference is positive, the product must be processed further, otherwise not.

• Opportunity Cost Approach calculates the difference between net revenue from further processed product and the
opportunity cost of not selling the product at split-off point. If the difference is positive, further processing will increase
profits.

• Total Project Approach (or the comparative statement approach) compares the profit statements of both options (i.e.,
selling or further processing) separately for each product. The option generating higher profit is chosen.

Example

Product A and B are produced in a joint process. At split-off point, Product A is complete whereas product B can be
processed further. The following additional information is available:

Product A B
Quantity in Units 5,000 10,000
Selling Price Per Unit:
At Split-Off ₱10 ₱2.50
If Processed Further ₱5
Costs After Split-Off ₱20,000

Perform sell-or-process-further analysis for product B.

Solution
Incremental Approach:
Incremental Revenue ₱25,000
Incremental Costs 20,000
Increase in Profits Due to Further Processing ₱5,000
Opportunity Cost Approach:
Sales in Case of Further Processing ₱50,000
Costs:
Additional Costs 20,000
Opportunity Cost of Not Selling at Split-Off 25,000
Gain on Further Processing ₱5,000

Total Project Approach:

Split-Off Point Further Processed
Revenue ₱25,000 ₱50,000
Costs 0 20,000
Net Revenue ₱25,000 ₱30,000
Gain from Further Processing ₱5,000

c. Make or buy a part, subassembly or product line

Make-or-Buy decision (also called the outsourcing decision) is a judgment made by management whether to make a
component internally or buy it from the market. While making the decision, both qualitative and quantitative factors must
be considered.

Examples of the qualitative factors in make-or-buy decision are: control over quality of the component, reliability of
suppliers, and impact of the decision on suppliers and customers, etc.

The quantitative factors are actually the incremental costs resulting from making or buying the component, e.g., incremental
production cost per unit, purchase cost per unit, production capacity available to manufacture the component, etc.

Example

The estimated costs of producing 6,000 units of a component are:

Per Unit Total

Direct Material ₱10 ₱ 60,000
Direct Labor 8 48,000
Applied Variable Factory Overhead 9 54,000
Applied Fixed Factory Overhead 12 72,000
₱1.50 per direct labor peso
₱39 ₱234,000

The same component can be purchased from market at a price of P29 per unit. If the component is purchased from market,
25% of the fixed factory overhead will be saved. Should the component be purchased from the market?

Solution

Per Unit Total

Make Buy Make Buy
Purchase Price ₱29 ₱174,000
Direct Material ₱10 ₱60,000
Direct Labor 8 48,000
Variable Overhead 9 54,000
Relevant Fixed Overhead 3 18,000
Total Relevant Costs ₱30 ₱29 ₱180,000 ₱174,000
Difference in Favor of Buying ₱1 ₱6,000

d. Continue operating or a close business segment

A decision whether or not to continue an old product line or department, or to start a new one is called an add-or-drop
decision. An add-or-drop decision must be based only on relevant information.

Relevant information includes the revenues and costs which are directly related to a product line or department. Examples
of relevant information are sales revenue, direct costs, variable overhead, and direct fixed overhead. Such decision must not
be based on irrelevant information such as allocated fixed overhead because allocated fixed overhead will not be eliminated
if the product line or department is dropped.

The following example illustrates an add-or-drop decision:

Example

A company has three products: Product A, Product B, and Product C. Income statements of the three product lines for the
latest month are given below:
 Product Line A B C
Sales ₱467,000 ₱314,000 ₱598,000
Variable Costs 241,000 169,000 321,000
Contribution Margin ₱226,000 ₱145,000 ₱277,000
Direct Fixed Costs 91,000 86,000 112,000
Allocated Fixed Costs 93,000 62,000 120,000
Net Income ₱ 42,000 − ₱3,000 ₱ 45,000

Use the incremental approach to determine if Product B should be dropped.

Solution

By dropping Product B, the company will lose the sale revenue from the product line. The company will also obtain gains in
the form of avoided costs. But it can avoid only the variable costs and direct fixed costs of product B and not the allocated
fixed costs. Hence:

If Product B is Dropped
Gains:
Variable Costs Avoided ₱169,000
Direct Fixed Costs Avoided 86,000 ₱255,000
Less: Sales Revenue Lost 314,000
Decrease in Net Income of the Company ₱ 59,000

e. Utilization of scare resources

Scarce resource utilization (or allocation) decision is a judgment regarding the best use of scarce resources so as to maximize
the total net income of a business. Scarcity of different resources puts constraints on the amount of product that can be
produced using those resources. For example, a business may have limited number of machine hours to utilize in
production. Scarce resource allocation decision is also called limiting factors decision.

When resources are abundant, products generating relatively higher contribution margin per unit are preferred because it
leads to highest net income. However, when resources are scarce, a decision in this way is unlikely to maximize the profit.
Instead, the allocation of a scarce resource to various products must be based on the contribution margin per unit of the
scarce resource from each product.

A simple scarce resource allocation decision involves the following steps:

1. Calculate the contribution margin per unit of the scarce resource from each product.
2. Rank the products in the order of decreasing contribution margin per unit of scarce resource.
3. Estimate the number of units of each product which can be sold.
4. Allocate scarce resource first to the product with highest contribution margin per unit of scarce resource, then to the
product with next highest contribution margin per unit of scarce resource.

A scarce resource decision can be better explained using an example.

Example

A company has 4,000 machine hours of plant capacity per month which are to be allocated to products A and B. The
following per unit figures relate to the products:

Product A B
Sale Price ₱300 ₱240
Costs:
Direct Material 100 70
Direct Labor 65 50
Variable Overhead 20 40
Fixed Overhead 15 30
Variable Operating Expenses 40 20
Total Costs ₱240 ₱210
Net Income ₱ 60 ₱ 30
Machine Hours Required 1.5 1.00

Assuming that the company can sell all its output, determine how many machine hours shall be allocated to each product.

Solution
Product A B
Sale Price ₱300 ₱240
− Variable Cost 225 180
CM Per Unit ₱ 75 ₱ 60
÷ Machine Hours Required 1.50 1.00
CM Per Machine Hour ₱50 ₱60

Since the company can sell all its output, the best decision is to allocate all machine hours (i.e., scarce resource) to product B.
 THE DECISION MAKING PROCESS (DSIDEC)

a. Defining the problem

b. Setting the criteria
c. Identifying the alternative courses
d. Determination of possible consequences of the alternatives
e. Evaluating the alternatives
f. Choosing the best alternative and making the decision

APPROACHES IN SOLVING DECISION MAKING PROBLEMS

1. Total Approach – The total revenues and costs are determined for each alternative and the results and compared to serve
as bases for making decisions.

2. Different Analysis – involves finding the most profitable alternative by analyzing the differential revenues and costs.

DEFINITION OF TERMS

• Relevant Revenues/Costs – future revenues/costs that are expected to be different under each alternative course of
action.

• Differential Costs – the increases (increments) or decreases (decrements) in total costs between two alternatives.

• Avoidable Costs – costs that will be saved or those that will not be incurred if a certain decision is liability.

• Out-of-Pocket-Costs – costs that require current or near future cash outlays or incurring of a liability for a decision at
hand.

• Postponable Costs – costs that may be deferred or shifted to a future date or period of time without adversely affecting
current operations.

• Opportunity Costs – the benefit lost by taking one action as opposed to another. The “other” action is the best
alternative available other than the one being contemplated.

• Imputed Costs – assumed or hypothetical costs representing the costs or value of a resource that is utilized for a specific
purpose.

• Sunk Costs – refer to the non-recoverable cost incurred in the past.

• Joint Costs – costs incurred in simultaneously processing or manufacturing two or more products which are difficult to
identify individually as separate types of products until a certain processing stage known as the point of separation or
split-off point.

Test 1. TRUE OR FALSE QUESTIONS.

________ 1. Incremental costs are relevant to the decision to further process a product beyond its current state.
________ 2. The opportunity cost of making a component part in a factory with excess capacity for which there
is no alternative use is equal to the contribution margin lost.
________ 3. The opportunity cost of making a component part in a factory with no excess capacity is the net
benefit forgone from the best alternative use of the capacity required.
________ 4. Costs relevant to a make-or-buy decision include variable manufacturing costs as well as
unavoidable fixed costs.
________ 5. The term incremental cost refers to the difference in total costs that results from selecting one
choice instead of another.
________ 6. Relevant or differential cost analysis considers all variable and fixed costs as they change with each
decision alternative.
________ 7. The relevance of a particular cost to a decision is determined by the potential effect on the decision,
accuracy and verifiability of the cost, riskiness of the decision, and the size of the cost.
________ 8. A decision-making concept, described as "the contribution to income that is forgone by not using a
limited resource for its best alternative use," is called marginal cost.
________ 9. The term that best refers to past costs that have been incurred and are not relevant to any future
decisions is full absorption costs.
________ 10. Relevant costs refer to anticipated future costs that will differ among various alternatives.
________ 11. Incremental fixed costs would be relevant in short-term decision making.
________ 12. Total unit costs are relevant for cost-volume-profit analysis.
________ 13. A company's approach to a make-or-buy decision involves an analysis of avoidable costs.
________ 14. The sum of the average fixed costs and the average variable costs for a given output is known as
average total cost.
________ 15. The change in total product resulting from the use of one unit more of the variable factor is known
as marginal product.
________ 16. In a joint manufacturing process, joint costs incurred prior to a decision as to whether to process
 the products after the split-off point should be viewed as relevant costs.
________ 17. Marginal revenue, by definition, is the change in total revenue associated with producing and
selling one more unit.
________ 18. Profits that are lost by moving an input from one use to another are referred to as cannibalization
income.
________ 19. Sunk costs are in and of themselves are not relevant to decision making.
________ 20. In a decision analysis situation, depreciation is not likely to contain a variable cost component.
________ 21. The disposal price of the old equipment is relevant to a manufacturing equipment replacement
decision.
________ 22. The replacement costs, out-of-pocket costs and differential costs are relevant to a decision to accept
or reject an order.
________ 23. When making a decision to increase the robotic automation equipment in an existing facility, a firm
takes into consideration the initial cost of the current facility.
________ 24. Incremental (differential) costs are additional costs that result when production, or some other
factor is increased.
________ 25. Some fixed cost may vary among the alternatives and would be relevant, but not all fixed cost are
relevant.
________ 26. Absorption costing includes all variable and fixed manufacturing cost, of which not all are relevant
to the decision whether to make-or-buy decision.
________ 27. Discretionary costs are costs that can be deferred to future periods without creating a significant
impact on the current period's results.
________ 28. An imputed cost is an opportunity cost. It is a benefit that is given up as a result of using the
company's resources elsewhere. It is a cost that is not stated and must be calculated in some way.
A common example of an imputed cost is the interest cost of equity capital.
________ 29. The cash inflow that the company would be able to gain from disposing of the old piece of
equipment is most relevant because this cash inflow will only occur if the decision is made to
dispose of the old piece of equipment.
________ 30. General office costs are not relevant.

Test 2. MULTIPLE CHOICE QUESTIONS.

1. The data available for the current year are given below:

Whole
company Division 1 Division 2
Variable manufacturing cost of goods sold ₱ 400,000 ₱220,000 ₱ 80,000
Unallocated costs (e.g., president's salary) 100,000
Fixed costs controllable by division managers
(e.g., advertising, engineering supervision costs) 90,000 50,000 40,000
Net revenue 1,000,000 600,000 400,000
Variable selling and administrative costs 130,000 70,000 60,000
Fixed controllable by others
(e.g., depreciation, insurance) 120,000 70,000 50,000

Using the information presented above, the net operating income contributed to the company by Division 1 was
A. ₱310,000. B. ₱380,000. C. ₱260,000. D. ₱190,000.

2. A manufacturer has been approached by a new customer who wants to place a one-time order for a component
similar to one that the manufacturer makes for another customer. Existing sales will not be affected by acceptance
of this order. The manufacturer has a policy of setting its targeted selling price at 60% over full manufacturing
cost. The manufacturing costs and the targeted selling price for the existing product are presented below:

Direct materials ₱ 2.30

Direct labor 3.60
Variable manufacturing overhead (applied at 75% of direct labor cost) 2.70
Fixed manufacturing overhead (applied at 150% of direct labor cost) 5.40
Total manufacturing cost ₱14.00
Markup (60% of full manufacturing cost) 8.40
Targeted selling price ₱22.40

The manufacturer has excess capacity to produce the quantity of the component desired by the new customer.
The direct materials used in the component for the new customer would cost the manufacturer ₱0.25 less than
the component currently being made. The variable selling expenses (packaging and shipping) would be the same,
or ₱0.90 per unit.

Under these circumstances, the minimum unit price at which the manufacturer would accept the special order is
one exceeding
A. ₱9.25. B. ₱8.35. C. ₱14.80. D. ₱14.

3. A printing company is considering replacing an old printing press. The old printing press has a book value of
₱24,000 and a trade-in value of ₱14,000. A new printing press would cost ₱85,000 after trade-in of the old press. It
is estimated that the new printing press would reduce operating costs by ₱20,000 per year. If the company decides
not to purchase the new press, the ₱85,000 could instead be used to retire debt that is currently costing ₱9,000 per
 year in interest.

Which of the given amounts is an example of a sunk cost?

A. The estimated reduction in operating costs C. The book value of the old printing press
B. The interest on the existing debt D. The trade-in value of the old printing press

4. 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. Additional cost of making X, given the cost of making Y, and additional revenue from Y.
B. Additional cost of making Y, given the cost of making X, and additional revenue from Y.
C. Total cost of making X and the revenue from sale of X and Y.
D. Total cost of making Y and the revenue from sale of Y.

5. Shanghai Company produces Product A and sells it for ₱18. The following cost data apply:

Type of Cost Per Unit

Direct materials (3 pounds x ₱1.50) ₱ 4.50
Direct labor 6.45
Variable overhead 1.35
Fixed overhead 1.50
Variable selling expense 1.10
Fixed selling expense 2.20
₱17.10

Shanghai has thought of marketing a new Product B with the same cost structure as Product A, except that the
price will be ₱15.60. Shanghai Company currently has the plant capacity necessary for this expansion. Because of
the cost structure, Shanghai Company will find the production and sale of Product B in the short run to be
A. Profitable to produce and sell Product B in the short run at the price of ₱15.60.
B. Not profitable unless the price can be raised to ₱17.10.
C. Not profitable at any price.
D. Not profitable at ₱15.60 because the fixed selling expense and fixed manufacturing overhead will not be
covered by the price.

6. Bangkok Company's controller developed the following direct-costing income statement for year 1:

Per Unit
Sales (150,000 units at ₱30) ₱4,500,000 ₱30
Variable costs:
Direct materials ₱1,050,000 ₱ 7
Direct labor 1,500,000 10
Manufacturing overhead 300,000 2
Selling and marketing 300,000 2
3,150,000 ₱21
Contribution margin ₱1,350,000 ₱ 9
Fixed costs:
Manufacturing overhead ₱600,000 ₱ 4
Selling and marketing 300,000 2
900,000 ₱ 6
Net income ₱ 450,000 ₱ 3

Bangkok Company based its next year's budget on the assumption that fixed costs, unit sales, and the sales price
would remain as they were in year 1, but with net income being reduced to ₱300,000. By July of year 2, the
controller was able to predict that unit sales would increase over year 1 levels by 10%. Based on the year 2
budget and the new information, the predicted year 2 net income would be
A. ₱585,000. B. ₱420,000. C. ₱330,000. D. ₱300,000.

7. The ABC Company manufactures components for use in producing one of its finished products. When 12,000
units are produced, the full cost per unit is ₱35, separated as follows:

Direct materials ₱ 5
Direct labor 15
Variable overhead 10
Fixed overhead 5

The XYZ Company has offered to sell 12,000 components to ABC for ₱37 each. If ABC accepts the offer, some of
the facilities currently being used to manufacture the components can be rented as warehouse space for ₱40,000.
However, ₱3 of the fixed overhead currently applied to each component would have to be covered by ABC's other
products. What is the differential cost to the ABC Company of purchasing the components from the XYZ
Company?
A. ₱20,000 B. ₱8,000 C. ₱24,000 D. ₱44,000

8. Persia Company has just completed a hydro-electric plant at a cost of ₱21,000,000. The plant will provide the
 company's Super needs for the next 20 years. Persia will use only 60% of the Super output annually. At this level
of capacity, Persia's annual operating costs will amount to ₱1,800,000, of which 80% are fixed.

Mesopotamia Company currently purchases its Super from MP Electric at an annual cost of ₱1,200,000. Persia
could supply this Super, thus increasing output of the plant to 90% of capacity. This would reduce the estimated
life of the plant to 14 years.

If Persia decides to supply Super to Mesopotamia, it wants to be compensated for the decrease in the life of the
plant and the appropriate variable costs. Persia 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
Persia would charge Mesopotamia would be
A. Some other amount than those given. C. ₱630,000.
B. ₱450,000. D. ₱990,000.

9. Bhurma Manufacturing uses ten units of Part Number KJ37 each month in the production of radar equipment.
The unit cost to manufacture 1 unit of KJ37 is presented below:

Direct materials ₱ 1,000

Materials handling (20% of direct material cost) 200
Direct labor 8,000
Manufacturing overhead (150% of direct labor) 12,000
Total manufacturing cost ₱21,200

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. This is a separate charge in addition to
manufacturing overhead. Bhurma's annual manufacturing overhead budget is one-third variable and two-thirds
fixed. Scott Supply, one of Bhurma's reliable vendors, has offered to supply Part Number KJ37 at a unit price of
₱15,000.

If Bhurma purchases the KJ37 units from Scott, the capacity Bhurma used to manufacture these parts would be
idle. Should Bhurma decide to purchase the parts from Scott, the unit cost of KJ37 would
A. Increase by ₱4,800. C. Decrease by ₱3,200.
B. Decrease by ₱6,200. D. Change by some other amounts.

10. Management accountants are frequently asked to analyze various decision situations including the following:

1. Alternative uses of plant space, to be considered in a make/buy decision.

2. Joint production costs incurred, to be considered in a sell-at-split versus a process-further decision.
3. Research and development costs incurred in prior months, to be considered in a product-introduction
decision.
4. The cost of a special device that is necessary if a special order is accepted.
5. The cost of obsolete inventory acquired several years ago, to be considered in a keep-versus-disposal
decision.

The costs described in situations 1 and 4 are

A. Relevant costs. C. Prime costs.
B. Discretionary costs. D. Sunk costs.

11. Tokyo, Inc. produces X-547 in a joint manufacturing process. The company is studying whether to sell X-547 at the
split-off point or upgrade the product to become Xylene. The following information has been gathered:
1. Selling price per pound of X-547.
2. Variable manufacturing costs of the upgrade process.
3. Avoidable fixed costs of the upgrade process.
4. Selling price per pound of Xylene.
5. Joint manufacturing costs to produce X-547.

Which of these items should be reviewed when making the upgrade decision?
A. 1, 2, 3, 4, and 5 C. 1, 2, 3, and 4
B. 1, 2, 4, and 5 D. 1, 2, and 4

12. Kuala Lumpur Company is a manufacturer of industrial components. One of their products that is used as a
subcomponent in auto manufacturing is KB-96. This product has the following financial structure per unit:

Selling price ₱150

Direct materials ₱ 20
Direct labor 15
Variable manufacturing overhead 12
Fixed manufacturing overhead 30
Shipping and handling 3
Fixed selling and administrative 10
Total costs ₱ 90
 During the next year, KB-96 sales are expected to be 10,000 units. All of the costs will remain the same, except that
fixed manufacturing overhead will increase by 20% and direct materials will increase by 10%. The selling price
per unit for next year will be ₱160. Based on this data, the contribution margin from KB-96 for next year will be
A. ₱1,080,000. B. ₱1,110,000. C. ₱750,000. D. ₱620,000.

13. Laos Corporation produces chemicals used in the cleaning industry. During the previous month, Laos incurred
₱300,000 of joint costs in producing 60,000 units of AM-12 and 40,000 units of BM-36. Laos uses the units-of-
production method to allocate joint costs. Currently, AM-12 is sold at split-off for ₱3.50 per unit. Flank
Corporation has approached Laos to purchase all of the production of AM-12 after further processing. The
further processing will cost Laos ₱90,000.

Concerning AM-12, which of the following alternatives is most advantageous?

A. Laos should process further and sell to Flank if the total selling price per unit after further processing is
greater than ₱3, which covers the joint costs.
B. Laos should process further and sell to Flank if the total selling price per unit after further processing is
greater than ₱5.25, which maintains the same gross profit percentage.
C. Laos should process further and sell to Flank if the total selling price per unit after further processing is
greater than ₱5.
D. Laos should continue to sell at split-off unless Flank offers at least ₱4.50 per unit after further processing,
which covers Laos's total costs.

14. Laos Corporation produces chemicals used in the cleaning industry. During the previous month, Laos incurred
₱300,000 of joint costs in producing 60,000 units of AM-12 and 40,000 units of BM-36. Laos uses the units-of-
production method to allocate joint costs. Currently, AM-12 is sold at split-off for ₱3.50 per unit. Flank
Corporation has approached Laos to purchase all of the production of AM-12 after further processing. The further
processing will cost Laos ₱90,000.
Assume that Laos Corporation agreed to sell AM-12 to Flank Corporation for ₱5.50 per unit after further
processing. During the first month of production, Laos sold 50,000 units with 10,000 units remaining in
inventory at the end of the month. With respect to AM-12, which of the following statements is correct?
A. The operating profit last month was ₱125,000, and the inventory value is ₱30,000.
B. The operating profit last month was ₱200,000, and the inventory value is ₱30,000.
C. The operating profit last month was ₱50,000, and the inventory value is ₱45,000.
D. The operating profit last month was ₱50,000, and the inventory value is ₱15,000.

15. Hawaii Manufacturing Company produces two products for which the following data have been tabulated. Fixed
manufacturing cost is applied at a rate of ₱1 per machine hour.

Per Unit XY-7 BD-4

Selling price ₱4.00 ₱3.00
Variable manufacturing cost 2.00 1.50
Fixed manufacturing cost 0.75 0.20
Variable selling cost 1.00 1.00

The sales manager has had a ₱160,000 increase in the budget allotment for advertising and wants to apply the
money to the most profitable product. The products are not substitutes for one another in the eyes of the
company's customers.

Suppose Hawaii has only 100,000 machine hours that can be made available to produce additional units of XY-7
and BD-4. If the potential increase in sales units for either product resulting from advertising is far in excess of
this production capacity, which product should be advertised and what is the estimated increase in contribution
margin earned?
A. Product XY-7 should be produced, yielding a contribution margin of ₱133,333.
B. Product BD-4 should be produced, yielding a contribution margin of ₱250,000.
C. Product XY-7 should be produced, yielding a contribution margin of ₱75,000.
D. Product BD-4 should be produced, yielding a contribution margin of ₱187,500.

16. Montana Industries has been producing two bearings, components B12 and B18, for use in production.

B12 B18
Machine hours required per unit 2.5 3.0
Standard cost per unit:
Direct material ₱ 2.25 ₱ 3.75
Direct labor 4.00 4.50
Manufacturing overhead:
Variable (See Note 1) 2.00 2.25
Fixed (See Note 2) 3.75 4.50
₱12.00 ₱15.00

Montana's annual requirement for these components is 8,000 units of B12 and 11,000 units of B18. Recently,
Montana'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 Montana the annual supply of the bearings at prices of ₱11.25 for B12 and ₱13.50 for B18. Montana 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).

Note 1. Variable manufacturing overhead is applied on the basis of direct labor hours.

Note 2. Fixed manufacturing overhead is applied on the basis of machine hours.

Montana will maximize its net benefits by

A. Purchasing 4,800 units of B12 and manufacturing the remaining bearings.
B. Purchasing 4,000 units of B18 and manufacturing the remaining bearings.
C. Purchasing 11,000 units of B18 and manufacturing 8,000 units of B12.
D. Purchasing 8,000 units of B12 and manufacturing 11,000 units of B18.

17. When a decision is made in an organization, it is selected from a group of alternative courses of action. The loss
associated with choosing the alternative that does not maximize the benefit is the
A. Net realizable value. C. Opportunity cost.
B. Incremental cost. D. Expected value.

18. Canadian Coat Company estimates that 60,000 special zippers will be used in the manufacture of men's jackets
during the next year. Greece Zipper Company has quoted a price of ₱0.60 per zipper. Canadian would prefer to
purchase 5,000 units per month, but Greece is unable to guarantee this delivery schedule. In order to ensure
availability of these zippers, Canadian is considering the purchase of all 60,000 units at the beginning of the year.
Assuming Canadian can invest cash at 8%, the company's opportunity cost of purchasing the 60,000 units at the
beginning of the year is
A. ₱2,640. B. ₱1,320. C. ₱1,440. D. ₱1,500.

19. Boracay Company manufactures plugs used in its manufacturing cycle at a cost of ₱36 per unit that includes ₱8 of
fixed overhead. Boracay needs 30,000 of these plugs annually, and El Nido Company has offered to sell these units
to Boracay at ₱33 per unit. If Boracay decides to purchase the plugs, ₱60,000 of the annual fixed overhead applied
will be eliminated, and the company may be able to rent the facility previously used for manufacturing the plugs.

If Boracay Company purchases the plugs but does not rent the unused facility, the company would
A. Save ₱2 per unit. C. Save ₱3 per unit.
B. Lose ₱6 per unit. D. Lose ₱3 per unit.

20. Boracay Company manufactures plugs used in its manufacturing cycle at a cost of ₱36 per unit that includes ₱8 of
fixed overhead. Boracay needs 30,000 of these plugs annually, and El Nido Company has offered to sell these units
to Boracay at ₱33 per unit. If Boracay decides to purchase the plugs, ₱60,000 of the annual fixed overhead applied
will be eliminated, and the company may be able to rent the facility previously used for manufacturing the plugs.

If the plugs are purchased and the facility rented, Boracay Company wishes to realize ₱100,000 in savings annually.
To achieve this goal, the minimum annual rent on the facility must be
A. ₱40,000. B. ₱10,000. C. ₱190,000. D. ₱70,000.

21. Macau Corporation has its own cafeteria with the following annual costs:

Food ₱100,000
Labor 75,000
Overhead 110,000
Total ₱285,000

The overhead is 40% fixed. Of the fixed overhead, ₱25,000 is the salary of the cafeteria supervisor. The remainder
of the fixed overhead has been allocated from total company overhead. Assuming the cafeteria supervisor will
remain and the Macau will continue to pay his/her salary, the maximum cost Macau will be willing to pay an
outside firm to service the cafeteria is
A. ₱219,000. B. ₱285,000. C. ₱241,000. D. ₱175,000.

22. ABD Realty manages five apartment complexes in a three-state area. Summary income statements for each
apartment complex are shown as follows.

ABD Realty Summary Income Statements

One Two Three Four Five

Rental income ₱1,000,000 ₱1,210,000 ₱2,347,000 ₱1,878,000 ₱1,065,000
Expenses 800,000 1,300,000 2,600,000 2,400,000 1,300,000
Profit ₱ 200,000 (₱ 90,000) (₱ 253,000) (₱ 522,000) (₱ 235,000)

Included in the expenses is ₱1,200,000 of corporate overhead allocated to the apartment complexes based on rental
income. The apartment complex/es that ABD should consider selling is/are
A. Apartment complexes Four and Five.
B. Apartment complexes Three, Four, and Five.
C. Apartment complexes Two, Three, Four, and Five.
 D. Apartment complex Four.

23. Super Systems, Inc. manufactures jet engines for the United States armed forces on a cost-plus basis. The cost of a
particular jet engine the company manufactures is shown as follows:

Direct materials ₱200,000

Direct labor 150,000
Overhead:
Supervisor's salary 20,000
Fringe benefits on direct labor 15,000
Depreciation 12,000
Rent 11,000
Total cost ₱408,000

If production of this engine were discontinued, the production capacity would be idle and the supervisor would be
laid off. When asked to bid on the next contract for this engine, the minimum unit price that Super Systems should
bid is
A. ₱408,000. B. ₱365,000. C. ₱397,000. D. ₱385,000.

24. Management accountants are frequently asked to analyze various decision situations, including the following:

I. The cost of a special device that is necessary if a special order is accepted.

II. The cost proposed annually for the plant service for the grounds at corporate headquarters.
III. Joint production costs incurred, to be considered in a sell-at-split versus a process-further decision.
IV. The costs associated with alternative uses of plant space, to be considered in a make/buy decision.
V. The cost of obsolete inventory acquired several years ago, to be considered in a keep-versus-disposal
decision.

The costs described in situations I and IV are

A. Prime costs. C. Sunk costs.
B. Discretionary costs. D. Relevant costs.

25. Condensed monthly operating income data for Ohio, Inc. for May follows:

Urban Store Suburban Store Total

Sales ₱80,000 ₱120,000 ₱200,000
Variable costs 32,000 84,000 116,000
Contribution margin ₱48,000 ₱ 36,000 ₱ 84,000
Direct fixed costs 20,000 40,000 60,000
Store segment margin ₱28,000 (₱4,000) ₱ 24,000
Common fixed cost 4,000 6,000 10,000
Operating income ₱24,000 (₱10,000) ₱ 14,000

Additional information regarding Ohio's operations follows:

• One-fourth of each store's direct fixed costs would continue if either store were closed.
• Ohio allocates common fixed costs to each store on the basis of sales pesos.
• Management estimates that closing the Suburban Store would result in a 10% decrease in the Urban Store's
sales, while closing the Urban Store would not affect the Suburban Store's sales.
• The operating results for May are representative of all months.

A decision by Ohio to close the Suburban Store would result in a monthly increase (decrease) in Ohio's operating
income of
A. (₱1,200). B. (₱10,800). C. (₱6,000). D. ₱4,000.

26. West Virginia Industries is trying to decide which of the following two options to pursue. Either option will take
effect on January 1st of the next year.

Option One - Acquire a New Finishing Machine

The cost of the machine is ₱1,000,000 and will have a useful life of five years. Net pre-tax cash flows arising from
savings in labor costs will amount to ₱100,000 per year for five years. Depreciation expense will be calculated using
the straight-line method for both financial and tax reporting purposes. As an incentive to purchase, West
Virginia will receive a trade-in allowance of ₱50,000 on their current fully depreciated finishing machine.

Option Two - Outsource the Finishing Work

West Virginia can outsource the work to LM, Inc. at a cost of ₱200,000 per year for five years. If they outsource,
West Virginia will scrap their current fully depreciated finishing machine.

West Virginia's effective income tax rate is 40%. The weighted average cost of capital is 10%. When comparing
the two options, the ₱50,000 trade-in allowance would be considered
A. Relevant because it is an increase in cash outflows.
 B. Relevant because it is a decrease in cash outflow.
C. Irrelevant because it does not affect cash.
D. Irrelevant because it does not affect taxes.

27. Trump Manufacturing occasionally has capacity problems in its metal shaping division, where the chief cost driver
is machine hours. In evaluating the attractiveness of its individual products for decision-making purposes,
which measurement tool should the firm select?

1. If machine hours do not constrain the number of units produced

2. If machine hours constrain the number of units to be produced

A. 1) Contribution margin 2) Contribution margin per machine hour

B. 1) Gross profit 2) Contribution margin
C. 1) Contribution margin per machine hour 2) Contribution margin
D. 1) Contribution margin 2) Contribution margin ratio

28. The loss of a key customer has temporarily caused Caledonia Machining to have some excess manufacturing
capacity. Caledonia is considering the acceptance of a special order, one that involves Caledonia's most popular
product. Consider the following types of costs:

I. Variable costs of the product

II. Fixed costs of the product
III. Direct fixed costs associated with the order
IV. Opportunity cost of the temporarily idle capacity

Which of the following combinations of cost types should be considered in the special order acceptance
decision?
A. I and II B. II and III C. I and IV D. I, III, and IV

29. Following are the operating results of the two segments of Paris Corporation:

Segment A Segment B Total

Sales ₱10,000 ₱15,000 ₱25,000
Variable cost of goods sold 4,000 8,500 12,500
Fixed costs of goods sold 1,500 2,500 4,000
Gross margin ₱ 4,500 ₱ 4,000 ₱ 8,500
Variable selling and administrative 2,000 3,000 5,000
Fixed selling and administrative 1,500 1,500 3,000
Operating income (loss) ₱ 1,000 (₱ 500) ₱ 500

Variable costs of goods sold are directly related to the operating segments. Fixed costs of goods sold are allocated
to each segment based on the number of employees. Fixed selling and administrative expenses are allocated
equally. If Segment B is eliminated, ₱1,500 of fixed costs of goods sold would be eliminated. Assuming Segment B
is closed, the effect on operating income would be a/n
A. Increase of ₱2,000. C. Decrease of ₱2,000.
B. Increase of ₱500. D. Decrease of ₱2,500.

30. Ireland Products has just developed a new product with a manufacturing cost of ₱30. The marketing director has
identified three marketing approaches for this new product.

Approach X Set a selling price of ₱36 and have the firm's sales staff sell the product at a 10% commission with no
advertising program. Estimated annual sales would be 10,000 units.

Approach Y Set a selling price of ₱38, have the firm's sales staff sell the product at a 10% commission, and back
them up with a ₱30,000 advertising program. Estimated annual sales would be 12,000 units.

Approach Z Rely on wholesalers to handle the product. Ireland would sell the new product to the wholesalers at
₱32 per unit and incur no selling expenses. Estimated annual sales would be 14,000 units.

Rank the three alternatives in order of net profit, from highest net profit to lowest.
A. Z, X, Y B. Z, Y, X C. Y, Z, X D. X, Y, Z

31. Gotham Manufacturing is analyzing the market potential for its specialty turbines. Gotham developed its
pricing and cost structures for their specialty turbines over various relevant ranges. The pricing and cost data for
each relevant range are presented below:

Units produced and sold: 1-5 6 - 10 11 - 15 16 - 20

Total fixed costs ₱200,000 ₱400,000 ₱600,000 ₱800,000
Unit variable cost 50,000 50,000 45,000 45,000
Unit selling price 100,000 100,000 100,000 100,000

Which of the following production/sales levels would produce the highest operating income for Gotham?
 A. 17 units B. 14 units C. 10 units D. 8 units

32. Los Angeles, Inc., a bearings manufacturer, has the capacity to produce 7,000 bearings per month. The company
is planning to replace a portion of its labor intensive production process with a highly automated process, which
would increase Los Angeles's fixed manufacturing costs by ₱30,000 per month and reduce its variable costs by ₱5
per unit.

Los Angeles's Income Statement for an average month is as follows:

Sales (5,000 units at ₱20 per unit) ₱100,000

Variable manufacturing costs ₱50,000
Variable selling costs 15,000 65,000
Contribution margin ₱ 35,000
Fixed manufacturing costs ₱16,000
Fixed selling costs 4,000 20,000
Operating income ₱ 15,000

If Los Angeles installs the automated process, the company's monthly operating income would be
A. ₱10,000. B. ₱40,000. C. ₱30,000. D. ₱5,000.

33. Boston Corporation makes two types of motors for use in various products. Operating data and unit cost
information for its products are presented below:

Product A Product B
Annual unit capacity 10,000 20,000
Annual unit demand 10,000 20,000
Selling price ₱100 ₱80
Variable manufacturing cost 53 45
Fixed manufacturing cost 10 10
Variable selling & administrative 10 11
Fixed selling & administrative 5 4
Fixed other administrative 2 0
Unit operating profit ₱20 ₱10
Machine hours per unit 2.0 1.5

Boston has 40,000 productive machine hours available. What is the maximum total contribution margin that
Boston can generate in the coming year?
A. ₱689,992 B. ₱980,000 C. ₱665,000 D. ₱850,000

34. Two months ago, Holland Corporation purchased 4,500 pounds of Pollie at a cost of ₱15,300. The market for this
product has become very strong, with the price jumping to ₱4.05 per pound. Because of the demand, Holland can
buy or sell Pollie at this price. Holland recently received a special order inquiry that would require the use of 4,200
pounds of Pollie. In deciding whether to accept the order, management must evaluate a number of decision
factors. Without regard to income taxes, which of the following combination of factors correctly depicts relevant
and irrelevant decision factors, respectively?

1. Relevant DecisionFactor 2. Irrelevant Decision Factor

A. 1) 4,500 pounds of Pollie 2) Remaining 300 pounds of Pollie
B. 1) Purchase price of ₱3.40 per pound 2) Market price of ₱4.05 per pound
C. 1) Market price of ₱4.05 per pound. 2) Purchase price of ₱3.40 per pound
D. 1) Remaining 300 pounds of Pollie 2) Market price of ₱4.05 per pound

35. New York, Inc. manufactures several different products, including a premium lawn fertilizer and weed killer that
is popular in hot, dry climates. New York is currently operating at less than full capacity because of market
saturation for lawn fertilizer. Sales and cost data for a 40-pound bag of New York lawn fertilizer is as follows:

Selling price ₱18.50

Production cost:
Materials and labor ₱12.25
Variable overhead 3.75
Allocated fixed overhead 4.00 20.00
Income (Loss) per bag (₱ 1.50)

On the basis of this information, which of the following alternatives should be recommended to New York
management?
A. Drop this product from its product line.
B. Increase output and spread fixed overhead over a larger volume base.
C. Continue to produce and market this product.
D. Select a different cost driver to allocate its overhead.
36. In differential cost analysis, which of the following best fits the description of a sunk cost?
A. Cost of a large crane used to move materials
B. Cost of the forklift driver to move the material to the manufacturing floor
C. Direct materials required in the manufacture of a table
D. Purchasing department costs incurred in acquiring material

37. San Fo Company has decided to discontinue a product produced on a machine purchased four years ago at a
cost of ₱70,000. The machine has a current book value of ₱30,000. Due to technologically-improved machinery
now available in the marketplace, the existing machine has no current salvage value. The company is reviewing
the various aspects involved in the production of a new product. The engineering staff advised that the existing
machine can be used to produce the new product. Other costs involved in the production of the new product
will be materials of ₱20,000 and labor priced at ₱5,000. Ignoring income taxes, the costs relevant to the decision to
produce or not to produce the new product would be
A. ₱30,000. B. ₱95,000. C. ₱25,000. D. ₱55,000.

38. Fitzpatrick Corporation uses a joint manufacturing process in the production of two products, Gummo and Xylo.
Each batch in the joint manufacturing process yields 5,000 pounds of an intermediate material, Valdene, at a cost
of ₱20,000. Each batch of Gummo uses 60% of the Valdene and incurs ₱10,000 of separate costs. The resulting
3,000 pounds of Gummo sells for ₱10 per pound. The remaining Valdene is used in the production of Xylo
which incurs ₱12,000 of separable costs per batch. Each batch of Xylo yields 2,000 pounds and sells for ₱12 per
pound. Fitzpatrick uses the net realizable value method to allocate the joint material costs. The company is
debating whether or not to process Xylo further into a new product, Zinten, which would incur an additional
₱4,000 in costs and sell for ₱15 per pound. If Zinten is produced, income would increase by
A. ₱5,760 per batch produced. C. ₱14,000 per batch produced.
B. ₱2,000 per batch produced. D. ₱26,000 per batch produced.

39. Casper Company plans to sell 12,000 units of product XT and 8,000 units of product RP. Casper has a capacity of
12,000 productive machine hours. The unit cost structure and machine hours required for each product is as
follows.
Unit Costs XT RP
Materials ₱37 ₱24
Direct labor 12 13
Variable overhead 6 3
Fixed overhead 37 38
Machine hours required 1.0 1.5

Casper can purchase 12,000 units of XT at ₱60 and/or 8,000 units of RP at ₱45. Based on the above, which of the
following actions should be recommended to Casper's management?
A. Produce XT internally and purchase RP. C. Purchase both XT and RP.
B. Produce RP internally and purchase XT. D. Produce both XT and RP.

40. Super-S, Inc. produces a component that is popular in many refrigeration systems. Data on three of the five
different models of this component are as follows:

Model
A B C
Volume needed (units) 5,000 6,000 3,000
Manufacturing costs:
Variable direct costs ₱10 ₱24 ₱20
Variable overhead 5 10 15
Fixed overhead 11 20 17
Total manufacturing costs ₱26 ₱54 ₱52
Cost if purchased ₱21 ₱42 ₱39

Super-S applies variable overhead on the basis of machine hours at the rate of ₱2.50 per hour. Models A and B
are manufactured in the Freezer Department, which has a capacity of 28,000 machine processing hours. Which of
the following options should be recommended by Super-S's management?
A. Purchase all three products in the quantities required.
B. The Freezer Department's manufacturing plan should include 5,000 units of Model A and 4,500 units of
Model B.
C. The Freezer Department's manufacturing plan should include 2,000 units of Model A and 6,000 units of
Model B.
D. Manufacture all three products in the quantities required.

Test 3. PRACTICE EXERCISES.

Problem 1

Faith Company is selling 80,000 units of a product at ₱10 per unit. The variable cost is ₱6 per unit, and the annual fixed cost
is ₱120,000. A discount house has offered to buy 10,000 additional units of the product which would slightly be modified,
but the medications would not affect production cost. The discount house will pay ₱7 per unit.
Requirements:

1. If the two markets can be distinguished, should the order be accepted (assuming capacity exists and has no other use)?
2. The manager feels that the two markets might not be distinguished and that the lower price would cause regular sales to
fall by 5,000 units. Should Faith accept the discount house offer?
3. If the discount house offer is raised to ₱9 per unit and competition resulting from the special sale causes the regular price
to drop to ₱9.50 to maintain the same regular sales volume, should Faith accept the discount house offer?

Problem 2

Graduation Box Company manufactures jewelry cases. The firm is currently operating at 80% of its capacity of 7,500 direct
labor hours per month. The sales manager has been looking for special orders to increase the use of capacity. Rings
Company has offered to buy 10,000 cases at ₱7.50 per case provided the delivery is within two months. Per case cost data for
the other are presented as follows:

Materials ₱2.50
Direct labor (1/2 hour at ₱6) 3.00
Manufacturing overhead 2.00
Total unit cost ₱7.50

Variable manufacturing overhead is ₱1.50 per direct labor hour and the company allocates fixed manufacturing overhead to
units of product based on their direct labor time. Without the order, Graduation Box has enough business to operate at 6,000
direct labor hours (80% of 7,500) in each of the next two months. The normal selling price of the jewelry case is ₱10.50. Rings
would put its own label on the case. The production manager is concerned about the labor time that making 10,000 cases
would require. She cannot schedule more than 7,500 hours per month because Nix Box has a policy about overtime. Thus,
the company would have to reduce some regular-price sales of the jewelry case if it accepts the order. Rings Company
would not take fewer than 10,000 cases.

Requirements:

1. Determine whether Graduation box should accept the order.

2. Determine the price per case for the order that would make Graduation Box indifferent between accepting and rejecting
the order (the price that would give Graduation Box the same profit under both alternatives).

Problem 3

Honor Company is currently manufacturing part Z911, producing 40,000 units actually. The part is used in the production
of several products made by Honor. The cost per unit for Z911 is as follows:

Direct materials ₱ 9.00

Direct labor 3.00
Variable overhead 2.50
Fixed overhead 4.00
Total ₱18.50

Of the total fixed overhead assigned to Z911, ₱88,000 is direct fixed overhead (the lease of production machinery and salary
of a production line supervisor-neither of which will be needed if the line is dropped). The remaining fixed overhead is
common fixed overhead. An outside supplier has offered to sell the part to Honor for ₱16. There is no alternative use for the
facilities currently used to produce the part.

Requirements:

1. Should Honor Company make or buy part Z911?

2. What is the most Honor would be willing to pay an outside supplier?
3. If Honor bought the part, by how much would income increase or decrease?
4. Now suppose that all of the fixed overhead is common,
a. Should Honor Company make or buy part Z911?
b. What is the most Honor would be willing to pay an outside supplier?
c. If Honor bought the part, by how much would income increase or decrease?

Problem 4

Family Dentistry Services operates in a large metropolitan area. Currently, Family has its own dental laboratory to produce
porcelain and the gold crowns. The unit costs to produce the crows are as follows:

Porcelain Gold
Direct materials ₱ 80 ₱165
Direct labor 27 27
Variable overhead 8 8
Fixed overhead 22 22
Total ₱137 ₱222
Fixed overhead is detailed as follows:

Salary (Supervisor) ₱26,000

Depreciation 5,000
Rent (Lab facility) 32,000

A local dental laboratory has offered to supply Family all the crowns it needs. Its price is ₱130 for porcelain crowns and ₱200
for gold crowns; however, the offer is conditional on supplying both types of crowns-it will not supply just one type for the
price indicated. If the offer is accepted, the equipment used by Family’s laboratory would be scrapped (it is old and has no
market value), and the lab facility would be closed. Family uses 3,000 porcelain crowns and 800 gold crowns per year.

Requirements:

1. Should Family continue to make its own crowns, or should they be purchased from the external supplier? What is the
peso effect of purchasing?
2. What qualitative factors should Family consider in making this decision?
3. Suppose that the lab facility is owned rather than rented and that the ₱32,000 is depreciation rather than rent. What
effect does this have on the analysis in number 1?
4. Refer to the original data. Assume that the volume of crowns used is 4,000 porcelain and 600 gold. Should Family make
or buy the crowns? Explain the outcome.

Problem 5

Dignity Company sells CPA2k17, a special model of calculator, at a price of ₱800 per unit. Dignity’s costs per unit are:

Materials ₱240
Labor 80
Variable factory overhead 120
Fixed factory overhead 160

A special order for 1,000 units was received from IS, a well-known school in the country. Additional shipping costs on the
sale are ₱72 per unit.

Requirements:

1. If Dignity has excess capacity, what is the minimum price per unit that should be set for the IS order?
2. If Dignity is operating at full capacity, what is the minimum price per unit?

Problem 6

Compassion Company normally produces and sells 30,000 units of Product A each month. Product A is a small electrical
relay used in the automotive industry as a component part in various products. The selling prices is ₱22 per unit, variable
costs are ₱14 per unit, fixed manufacturing overhead costs total ₱150,000 per month, and fixed selling costs total ₱30,000 per
month.

Employment-contract strikes in the companies that purchase the bulk of Product A units have caused Compassion
Company’s sales to temporarily drop to only 8,000 units per month. Compassion Company estimates that the strikes will
last for about two months, after which time, sales of Product A should return to normal. Due to the current low level of
sales, however, Compassion Company is thinking about closing down its own plant during the two months that the strikes
overhead costs can be reduced by ₱45,000 per month and that fixed selling costs can be reduced by 10%. Start-up costs at the
end of the shut-down period would total ₱8,000. Since Compassion Company uses just-in-time (JIT) production methods, no
inventories are on hand.

Requirements:

1. Assuming that the strikes continue for two months, would you recommend that Compassion Company close its own
plant?
2. At what level of sales (in units) for the two-month period should Compassion Company be indifferent between closing
the plant and keeping it open?

Problem 7

A merchandising company has two departments, H and M. A recent monthly income statement for the company follows:

Total Department H Department M

Sales ₱4,000,000 ₱3,000,000 ₱1,000,000
Less: Variable cost and expenses 1,300,000 900,000 400,000
Contribution margin ₱2,700,000 ₱2,100,000 ₱ 600,000
Less: Fixed cost and expenses 2,200,000 1,400,000 800,000
Net operating income/(loss) ₱ 500,000 ₱ 700,000 (₱200,000)
A study indicates that ₱340,000 of the fixed expenses being charged to Department M are sunk costs or allocated costs that
will continue even if M is dropped. In addition, the elimination of Department M will result to a 10% increase in the sales of
Department H. If Department M is dropped, what will be the effect of the net operating income of the company as a whole?

Problem 8

Safety Van Lines is considering the acquisition of two new trucks. Because of improved mileage, these vehicles are expected
to have a lower operating cost per mile than the trucks the company plans to replace. Management is studying whether the
firm would be better-off keeping the older vehicles or going ahead with the replacement, and has identified the following
decision factors to evaluate:

1. Cost and book value of the old trucks

2. Moving revenues, which are not expected to change with the acquisition
3. Operating costs of the new and old vehicles
4. New truck purchase price and related depreciation charges
5. Proceeds from sale of the old vehicles
6. The 8% return on alternative investments that Safety will forego by tying up cash in the new trucks
7. Drivers' wages and fringe benefits

Requirements:

Classify the seven decision factors listed into the following categories: (Note: Factors may be used more than once.)

1. Relevant costs.
2. Opportunity costs.
3. Sunk costs.
4. Factors to be considered in the decision.

Problem 9

Blessing Corporation manufactures two products: X and Y. The company has 4,000 hours of machine time available and can
sell no more than 950 units of product X. Other pertinent data follow:

Product X Product Y
Selling price ₱8.00 ₱11.00
Variable cost 3.00 5.00
Fixed cost 3.50 6.25
Machine time per unit 2 hours 3 hours

How many units of product X and Y would maximize the profit?

Problem 10

Success Corporation manufactures faucets. Several weeks ago, the firm received a special-order inquiry from Yale, Inc. Yale
desires to market a faucet similar to Success's model no. 55 and has offered to purchase 3,000 units. The following data are
available:

• Cost data for Success's model no. 55 faucet: direct materials, ₱45; direct labor, ₱30 (2 hours at ₱15 per hour); and
manufacturing overhead, ₱70 (2 hours at ₱35 per hour).
• The normal selling price of model no. 55 is ₱180; however, Yale has offered Success only ₱115 because of the large
quantity it is willing to purchase.
• Yale requires a design modification that will allow a ₱4 reduction in direct material cost.
• Success's production supervisor notes that the company will incur ₱8,700 in additional set-up costs and will have to
purchase a ₱3,300 special device to manufacture these units. The device will be discarded once the special order is
completed.
• Total manufacturing overhead costs are applied to production at the rate of ₱35 per labor hour. This figure is based, in
part, on budgeted yearly fixed overhead of ₱624,000 and planned production activity of 24,000 labor hours.
• Success will allocate ₱5,000 of existing fixed administrative costs to the order as "… part of the cost of doing business."

Requirements:

1. One of Success's staff accountants wants to reject the special order because "financially, it's a loser." Do you agree with
this conclusion if Success currently has excess capacity? Show calculations to support your answer.
2. If Success currently has no excess capacity, should the order be rejected from a financial perspective? Briefly explain.
3. Assume that Success currently has no excess capacity. Would outsourcing be an option that Success could consider if
management truly wanted to do business with Yale? Briefly discuss, citing several key considerations for Success in
your answer.
 Case 1: Make or Buy

Jam Foods Corp is known for selling a great tasting yet very affordable siomai in Manila. Information on
selling price and related costs of one complete order is shown below. Fixed cost is computed using the normal
operations of 3,000 orders (4pcs per order).

Selling price per order P 25.00

Variable cost per order
Direct materials P 4.00
Direct Labor 4.00
Variable Overhead 2.00
Fixed cost allocated to products per order
Supervisory salaries P 3.00
Other fixed cost 3.00

1. If Erwin has offered to supply siomai for P3 per piece, on normal operations, should Jam make or buy
siomai?

Suppose that Erwin has offered to supply siomai for P3 per piece and that P2.50 of the total fixed costs
could be eliminated.
2. Should Jam make or buy siomai?
3. Determine the indifference point.
4. If Jam plans to sell 1,800 orders, should the company make or buy siomai?

Case 2: Accept or Reject

Jam Foods Corp is known for producing and selling a great tasting yet very affordable siomai.
Information on selling price and cost per unit at a normal capacity of 20,000 pieces is as follows:

Selling Price P 6.25

Less, Variable Cost 2.50
Contribution Margin P 3.75
Less, Fixed Cost 1.50
Net Profit P 2.25

Ruby House of Dumplings offers to buy 5,000 pieces at P3.65. Also, an extra shipping cost of P0.15 per
unit will be incurred if the company will accept the special order.

5. If the business is presently very slow, should Jam accept or reject the order?
6. If Jam has more businesses than it can handle, should the special order be accepted?
7. If present production is 16,500 pieces, should the Jam accept or reject the special order?

Case #3: Drop/Eliminate or Retain

Jam Foods Corp has three product lines. Results of the 4th quarter are presented below:

Shrimp Pork Beef Total

Units sold 800 4,000 4,200 9,000
Revenue P20,000.00 P100,000.00 P105,000.00 P225,000.00
Variable departmental
costs 12,000.00 40,000.00 42,000.00 94,000.00
Direct fixed costs 5,000.00 15,000.00 15,000.00 35,000.00
Allocated fixed costs 8,000.00 12,000.00 12,000.00 32,000.00
Net Income (Loss) (P5,000.00) P33,000.00 P36,000.00 P64,000.00

Demands of individual products are not affected by changes in other product lines.

8. Will Jam retain or drop Shrimp Siomai?

9. What will be the net income or loss of Jam if Shrimp is dropped?
 Problem #4: Shut down or Continue Operation

ABC Company is contemplating to temporarily stop operating for the next four months since demand
declines below the breakeven point. The company has a normal operating fixed cost of P50,000 per month and if
they shut down, they could eliminate P20,000 fixed cost per month. However, they would incur additional costs
for insurance and security guards for the entire shut down period of P25,000. They estimated that the restarting
cost will be P20,000. At present, they have a selling price of P50 per unit and a variable cost of P30. For the next
four months, they will be forced to reduce their selling price to 80%. Based on these facts, determine the
following:

1. Shut down costs ____________________________

2. Shut down savings ____________________________
3. Shut down point ____________________________
4. If the monthly sales will temporarily drop to only 1,000 units, what will you recommend? To shut down
or continue operations?

Problem #5: Sell as is or Process Further

Vicky 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 Vicky decides to process B beyond the split-off point, the change

in operating income will be ______________.

Problem #6: Profit maximization – by utilizing limited or scarce resources:

Smith Manufacturing has 6,000 labor hours available for producing X and Y. Consider the
following information:
Product Product
X Y
Selling price per unit P10.00 P20.00
Variable cost per unit 5.00 14.00
Contribution margin per unit P5.00 P6.00

Required labor time per unit

2 3
(hours)

Problem #7: Replace or Retain Equipment?