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True/False Questions 1. Sunk costs are costs that have proven to be unproductive. Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Medium 2. All costs are avoidable in a decision except sunk costs and future costs that do not differ between the alternatives at hand. Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy 3. Consistency demands that a cost that is relevant in one decision be regarded as relevant in other decisions as well. Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Medium 4. A cost may be relevant for one decision making situation but irrelevant for another situation. Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy 5. A future cost that does not vary among alternatives under consideration is irrelevant. Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy 6. Opportunity costs represent economic benefits that are forgone as a result of pursuing some course of action. Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy 7. An existing asset should not be replaced until its original cost has been fully recovered. Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Medium

8. Fixed costs are irrelevant in decisions about whether a product line should be dropped. Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 2 Level: Easy 9. In a special order situation, any fixed cost associated with the order would be irrelevant. Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 4 Level: Medium 10. When a company has a production constraint, total contribution margin will be maximized by emphasizing the products with the highest contribution margin per unit of the constrained resource. Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 5 Level: Easy 11. Eliminating nonproductive time is particularly important in a bottleneck operation. Ans: True AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 5 Level: Medium 12. One way to increase the effective utilization of a bottleneck is to reduce the number of defective units. Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 5 Level: Easy 13. As a general guide, it is profitable to continue processing joint products after the splitoff point if their total revenues exceed the joint costs. Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 6 Level: Medium 14. Joint costs are irrelevant in the decision of whether to sell a joint product at the splitoff point or process it further and then sell it. Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 6 Level: Easy

15. A key advantage of using activity-based costing is that any cost that is assigned to a product is also a relevant cost in any decision involving that product. Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy

Multiple Choice Questions 16. Costs which can be eliminated in whole or in part if a particular business segment is discontinued are called: A) sunk costs. B) opportunity costs. C) avoidable costs. D) irrelevant costs. Ans: C AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy 17. Consider the following statements: I. II. III.

Assemble all costs associated with each alternative being considered. Eliminate those costs that are sunk. Eliminate those costs that differ between alternatives.

Which of the above statements does not represent a step in identifying the relevant costs in a decision problem? A) Only I B) Only II C) Only III D) Only I and III Ans: C AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy

18. Which of the following cash flows is relevant in a decision about accepting Alternative X or Alternative Y? A) a cash inflow for Alternative X that is not a cash inflow for Alternative Y. B) a cash inflow that is lost if Alternative X is accepted and is not lost if Alternative Y is accepted. C) a cash outflow that is avoided if Alternative X is accepted and is not avoided if Alternative Y is accepted. D) all of the above. Ans: D AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Medium 19. Which of the following best describes an opportunity cost: A) it is a relevant cost in decision making, but is not part of the traditional accounting records. B) it is not a relevant cost in decision making, but is part of the traditional accounting records. C) it is a relevant cost in decision making, and is part of the traditional accounting records. D) it is not a relevant cost in decision making, and is not part of the traditional accounting records. Ans: A AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Medium Source: CPA, adapted 20. Consider the following statements: I.

A division's net operating income, after deducting both traceable and allocated common corporate costs, is negative. II. The division's avoidable fixed costs exceed its contribution margin. III. The division's traceable fixed costs plus its allocated common corporate costs exceed its contribution margin. Which of the above statements give an economic reason for eliminating the division? A) Only I B) Only II C) Only III D) Only I and II Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 2 Level: Easy

21. The Jabba Company manufactures the “Snack Buster” which consists of a wooden snack chip bowl with an attached porcelain dip bowl. Which of the following would be relevant in Jabba's decision to make the dip bowls or buy them from an outside supplier? Fixed overhead cost The variable that can be eliminated if selling the bowls are purchased cost of the from the outside supplier Snack Buster A ) B) C) D )

Yes Yes No

Yes No Yes

No

No

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 3 Level: Medium 22. The acceptance of a special order will improve overall net operating income so long as the revenue from the special order exceeds: A) the contribution margin on the order. B) the incremental costs associated with the order. C) the variable costs associated with the order. D) the sunk costs associated with the order. Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 4 Level: Medium 23. Kinsi Corporation manufactures five different products. All five of these products must pass through a stamping machine in its fabrication department. This machine is Kinsi's constrained resource. Kinsi would make the most profit if it produces the product that: A) uses the lowest number of stamping machine hours. B) generates the highest contribution margin per unit. C) generates the highest contribution margin ratio. D) generates the highest contribution margin per stamping machine hour. Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 5 Level: Medium

24. In a sell or process further decision, consider the following costs: I. II. III.

A variable production cost incurred prior to split-off. A variable production cost incurred after split-off. An avoidable fixed production cost incurred after split-off.

Which of the above costs is (are) not relevant in a decision regarding whether the product should be processed further? A) Only I B) Only III C) Only I and II D) Only I and III Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 6 Level: Easy 25. Gandy Company has 5,000 obsolete desk lamps that are carried in inventory at a manufacturing cost of $50,000. If the lamps are reworked for $20,000, they could be sold for $35,000. Alternatively, the lamps could be sold for $8,000 for scrap. In a decision model analyzing these alternatives, the sunk cost would be: A) $8,000 B) $15,000 C) $20,000 D) $50,000 Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Easy Source: CPA, adapted

26. Hodge Inc. has some material that originally cost $74,600. The material has a scrap value of $57,400 as is, but if reworked at a cost of $1,500, it could be sold for $54,400. What would be the incremental effect on the company's overall profit of reworking and selling the material rather than selling it as is as scrap? A) -$79,100 B) -$21,700 C) -$4,500 D) $52,900 Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Medium Source: CIMA, adapted Solution: Incremental revenue from reworking ($54,400 − $1,500). Less incremental revenue from selling as scrap................ Net loss from reworking....................................................

$52,900 57,400 ($ 4,500)

27. Milford Corporation has in stock 16,100 kilograms of material R that it bought five years ago for $5.75 per kilogram. This raw material was purchased to use in a product line that has been discontinued. Material R can be sold as is for scrap for $3.91 per kilogram. An alternative would be to use material R in one of the company's current products, S88Y, which currently requires 2 kilograms of a raw material that is available for $7.60 per kilogram. Material R can be modified at a cost of $0.77 per kilogram so that it can be used as a substitute for this material in the production of product S88Y. However, after modification, 4 kilograms of material R is required for every unit of product S88Y that is produced. Milford Corporation has now received a request from a company that could use material R in its production process. Assuming that Milford Corporation could use all of its stock of material R to make product S88Y or the company could sell all of its stock of the material at the current scrap price of $3.91 per kilogram, what is the minimum acceptable selling price of material R to the company that could use material R in its own production process? A) $0.88 B) $3.03 C) $4.57 D) $3.91 Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Hard Source: CIMA, adapted

Solution: Product S88Y: Current cost (2 kg @ $7.60): $15.20 If material R were used, 4 kilograms would be needed. It currently costs $15.20 for Product S88Y; to maintain this same cost, material R would need to cost $3.03 per kilogram [($15.20 ÷ 4 kg) − $0.77]. The company should sell material R for $3.91 per kilogram. 28. Otool Inc. is considering using stocks of an old raw material in a special project. The special project would require all 240 kilograms of the raw material that are in stock and that originally cost the company $2,112 in total. If the company were to buy new supplies of this raw material on the open market, it would cost $9.25 per kilogram. However, the company has no other use for this raw material and would sell it at the discounted price of $8.35 per kilogram if it were not used in the special project. The sale of the raw material would involve delivery to the purchaser at a total cost of $71.00 for all 240 kilograms. What is the relevant cost of the 240 kilograms of the raw material when deciding whether to proceed with the special project? A) $1,933 B) $2,004 C) $2,220 D) $2,112 Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Hard Source: CIMA, adapted Solution: Opportunity cost of sales foregone if special project is undertaken ($8.35 × 240)............................................... Less: delivery cost.............................................................. Relevant cost of 240 kilograms of raw material................

$2,004 71 $1,933

29. Hamby Corporation is preparing a bid for a special order that would require 780 liters of material W34C. The company already has 640 liters of this raw material in stock that originally cost $8.30 per liter. Material W34C is used in the company's main product and is replenished on a periodic basis. The resale value of the existing stock of the material is $7.60 per liter. New stocks of the material can be readily purchased for $8.35 per liter. What is the relevant cost of the 780 liters of the raw material when deciding how much to bid on the special order? A) $6,481 B) $6,376 C) $6,513 D) $5,928 Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Hard Source: CIMA, adapted Solution: Relevant cost = $8.35 per liter × 780 liters = $6,513 30. Schickel Inc. regularly uses material B39U and currently has in stock 460 liters of the material for which it paid $3,128 several weeks ago. If this were to be sold as is on the open market as surplus material, it would fetch $5.95 per liter. New stocks of the material can be purchased on the open market for $6.45 per liter, but it must be purchased in lots of 1,000 liters. You have been asked to determine the relevant cost of 760 liters of the material to be used in a job for a customer. The relevant cost of the 760 liters of material B39U is: A) $4,902 B) $4,672 C) $4,522 D) $6,450 Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Hard Source: CIMA, adapted Solution: Relevant cost = $6.45 per liter × 760 liters = $4,902

31. Munafo Corporation is a specialty component manufacturer with idle capacity. Management would like to use its extra capacity to generate additional profits. A potential customer has offered to buy 6,500 units of component VGI. Each unit of VGI requires 1 unit of material I57 and 5 units of material M97. Data concerning these two materials follow: Current Original Market Disposal Units in Cost Per Price Value Material Stock Unit Per Unit Per Unit I57........ 2,400 $9.10 $9.40 $8.95 M97...... 33,960 $4.70 $4.70 $3.50 Material I57 is in use in many of the company's products and is routinely replenished. Material M97 is no longer used by the company in any of its normal products and existing stocks would not be replenished once they are used up. What would be the relevant cost of the materials, in total, for purposes of determining a minimum acceptable price for the order for product VGI? A) $174,850 B) $213,130 C) $213,850 D) $171,925 Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Hard Source: CIMA, adapted Solution: # Required Relevant Material per unit price I57................ 1× $9.40 = M97.............. 5× $3.50 = Total per unit relevant cost......................

Total $ 9.40 17.50 $26.90

Minimum acceptable price for 6,500 units of VGI = $26.90 per unit × 6,500 units = $174,850

32. Winder Corporation is a specialty component manufacturer with idle capacity. Management would like to use its extra capacity to generate additional profits. A potential customer has offered to buy 3,000 units of component QEA. Each unit of QEA requires 5 units of material F85 and 5 units of material E71. Data concerning these two materials follow: Original Current Disposal Units in Cost Per Market Price Value Per Material Stock Unit Per Unit Unit F85............. 740 $4.90 $4.75 $4.20 E71............. 13,680 $5.00 $4.70 $3.60 Material F85 is in use in many of the company's products and is routinely replenished. Material E71 is no longer used by the company in any of its normal products and existing stocks would not be replenished once they are used up. What would be the relevant cost of the materials, in total, for purposes of determining a minimum acceptable price for the order for product QEA? A) $126,702 B) $141,750 C) $126,295 D) $145,965 Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 1 Level: Hard Source: CIMA, adapted Solution:

Total needed (3,000 × 5) = F85............. 15,000

Inventory

# of units to purchase on market

Total cost

$4.75

$ 71,250

$4.70 13,680 $3.60 Minimum acceptable price for 3,000 units of QEA...........

6,204 49,248 $126,702

(3,000 × 5) = E71............. 15,000

15,000

Relevant price

(15,000 − 13,680) = 1,320

33. Rice Corporation currently operates two divisions which had operating results last year as follows:

Sales........................................................... Variable costs............................................. Contribution margin................................... Traceable fixed costs.................................. Allocated common corporate costs............ Net operating income (loss).......................

West Division $600,000 310,000 290,000 110,000 90,000 $ 90,000

Troy Division $300,000 200,000 100,000 70,000 45,000 ($ 15,000)

Since the Troy Division also sustained an operating loss in the prior year, Rice's president is considering the elimination of this division. Troy Division's traceable fixed costs could be avoided if the division were eliminated. The total common corporate costs would be unaffected by the decision. If the Troy Division had been eliminated at the beginning of last year, Rice Corporation's operating income for last year would have been: A) $15,000 higher B) $30,000 lower C) $45,000 lower D) $60,000 higher Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 2 Level: Medium Source: CPA, adapted Solution: Troy Division: Contribution margin........................................................... Less: traceable fixed costs................................................. Segment margin of Troy Division......................................

$100,000 70,000 $ 30,000

Rice Corporation’s operating income would have been $30,000 less without the segment margin contributed by the Troy Division.

34. Beaver Company (a multi-product firm) produces 5,000 units of Product X each year. Each unit of Product X sells for $8 and has a contribution margin of $5. If Product X is discontinued, $18,000 of fixed overhead would be eliminated. As a result of discontinuing Product X, the company's overall operating income would: A) decrease by $25,000 B) increase by $43,000 C) decrease by $7,000 D) increase by $7,000 Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making; Reporting LO: 2 Level: Medium Solution: Fixed overhead savings if Product X is eliminated........... Less: contribution margin lost if Product X is discontinued ($5 × 5,000)............................................... Decrease in overall operating income if Product X is eliminated.......................................................................

$18,000 25,000 ($ 7,000)

35. Milli Company plans to discontinue a division that generates a total contribution margin of $20,000 per year. Fixed overhead associated with this division is $50,000, of which $5,000 cannot be eliminated. The effect of this discontinuance on Milli's operating income would be an increase of: A) $5,000 B) $20,000 C) $25,000 D) $30,000 Ans: C AACSB: Analytic AICPA BB: Critica...