Relevant Costs FOR Decision Making PDF

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MANAGEMENT ACCOUNTING (VOLUME II) Solutions Manual CHAPTER 19 RELEVANT COSTS FOR DECISION MAKING I. Questions 1. Quantitative factors are those which may more easily be reduced in terms of pesos such as projected costs of materials, labor and overhead. Qualitative factors are those whose measurement...

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MANAGEMENT ACCOUNTING (VOLUME II) - Solutions Manual

CHAPTER 19 RELEVANT COSTS FOR DECISION MAKING

I.

Questions 1. Quantitative factors are those which may more easily be reduced in terms of pesos such as projected costs of materials, labor and overhead. 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 cost savings. It can be seen that the accountant’s role in making decisions deals with the quantitative factors. 2. Relevant costs are expected future costs that will differ between alternatives. In view of the definition of relevant costs, historical costs are always irrelevant because they are not future costs. They may be helpful in predicting relevant costs but they are always irrelevant costs per se. 3. The differential costs in any given situation is commonly defined 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. 4. Analysis: Future costs: New Truck Less: Proceeds from disposal, net

Replace P10,200

Rebuild

1,000 P 9,200

Advantage of rebuilding

P8,500 P700

The original cost of the old truck is irrelevant but its disposal value is relevant. It is recommended that the truck should be rebuilt because it will involve lesser cash outlay.

II. Exercises

19-1

Chapter 19 Relevant Costs for Decision Making

Exercise 1 (Identifying Relevant Costs) Case 1

a. b. c. d. e. f. g. h. i. j. k. l.

Item Relevant Sales revenue................................... X Direct materials............................... X Direct labor...................................... X Variable manufacturing overhead.......................................... X Book value – Model E7000 machine........................................... Disposal value – Model E7000 machine........................................... Depreciation – Model E7000 machine........................................... Market value – Model F5000 machine (cost)................................. X Fixed manufacturing overhead.......................................... Variable selling expense.................. X Fixed selling expense...................... X General administrative overhead.......................................... X

Case 2

Not Relevant

Relevant

Not Relevant X

X X X X X

X X

X

X X

X

X X X X

Exercise 2 (Identification of Relevant Costs) Requirement 1 Fixed cost per mile (P3,500* ÷ 10,000 miles)........................................................ P0.35 Variable operating cost per mile.............................................................................. 0.08 Average cost per mile.............................................................................................. P0.43 * Depreciation........................................................................................................... P2,000 Insurance................................................................................................................ 960 Garage rent............................................................................................................. 480 Automobile tax and license.................................................................................... 60 Total........................................................................................................................ P3,500 Requirement 2 The variable operating costs would be relevant in this situation. The depreciation would not be relevant since it relates to a sunk cost. However, any decrease in the resale value of the car due to its use would be relevant. The automobile tax and license costs would be incurred whether Ingrid 19-2

Relevant Costs for Decision Making Chapter 19

decides to drive her own car or rent a car for the trip during summer break and are therefore irrelevant. It is unlikely that her insurance costs would increase as a result of the trip, so they are irrelevant as well. The garage rent is relevant only if she could avoid paying part of it if she drives her own car. Requirement 3 When figuring the incremental cost of the more expensive 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 fixed costs of insurance and automobile tax and license. The original purchase price of the old car is a sunk cost and is therefore irrelevant. The variable operating costs would be the same and therefore are irrelevant. (Students are inclined to think that variable costs are always relevant and fixed costs are always irrelevant in decisions. This requirement helps to dispel that notion.) Exercise 3 (Make or Buy a Component) Requirement 1

Cost of purchasing Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable 1

Per Unit Differential Costs 15,000 units Make Buy Make Buy P200 P3,000,000 P  60 P   900,000 80 1,200,000 10 150,000 20

300,000

Fixed manufacturing overhead, common 0 P170

Total costs

0 0 0 P200 P2,550,000 P3,000,000

Difference in favor of continuing to make the parts P30 P450,000 1 Only the supervisory salaries can be avoided if the parts are purchased. The remaining book value of the special equipment is a sunk cost; hence, the P3 per unit depreciation expense is not relevant to this decision. Based on these data, the company should reject the offer and should continue to produce the parts internally.

Requirement 2

19-3

Chapter 19 Relevant Costs for Decision Making Make Buy Cost of purchasing (part 1)................................................................................................... P3,000,000 Cost of making (part 1)........................................................................................................ P2,550,000 Opportunity cost—segment margin forgone on a potential new product line............................................................................................... 650,000 Total cost............................................................................................................................... P3,200,000 P3,000,000 Difference in favor of purchasing from the outside supplier.............................................................................................................................. P200,000 Thus, the company should accept the offer and purchase the parts from the outside supplier.

Exercise 4 (Evaluating Special Order) Only 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. The other manufacturing overhead costs are fixed and are not affected by the decision. Per Unit P3,499.50

Total 10 bracelets P34,995.00

Incremental revenue Incremental costs: Variable costs: Direct materials 1,430.00 14,300.00 Direct labor 860.00 8,600.00 Variable manufacturing overhead 70.00 700.00 Special filigree 60.00 600.00 Total variable cost P2,420.00 24,200.00 Fixed costs: Purchase of special tool 4,650.00 Total incremental cost 28.850.00 Incremental net operating income P 6.145.00 Even 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. This 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 5 (Utilization of a Constrained Resource) Requirement 1 19-4

Relevant Costs for Decision Making Chapter 19

(1) (2) (3) (4)

X Y Z Contribution margin per unit................................................................................................. P18 P36 P20 Direct labor cost per unit....................................................................................................... P12 P32 P16 Direct labor rate per hour...................................................................................................... 8 8 8 Direct labor-hours required per unit (2) ÷ (3)....................................................................... 1.5 4.0 2.0 Contribution margin per direct labor-hour (1) ÷ (4)............................................................. P12 P  9 P10

Requirement 2 The company should concentrate its labor time on producing product X: X

Y

Z

Contribution margin per direct labor-hour P12 × 3,000 P36,000

Direct labor-hours available Total contribution margin

P9 × 3,000 P27,000

P10 × 3,000 P30,000

Although product X has the lowest contribution margin per unit and the second lowest contribution margin ratio, it has the highest contribution margin per direct labor-hour. Since labor time seems to be the company’s constraint, this measure should guide management in its production decisions. Requirement 3 The amount Jaycee Company 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, Jaycee would presumably use the additional time to make more of product X. Each hour of direct labor time generates P12 of contribution margin over and above the usual direct labor cost. Therefore, Jaycee should be willing to pay up to P20 per hour (the P8 usual wage plus the contribution margin per hour of P12) for additional labor time, but would of course prefer to pay far less. The upper limit of P20 per direct labor hour signals to managers how valuable additional labor hours are to the company. If all the demand for product X has been satisfied, Jaycee Company would then use any additional direct labor-hours to manufacture product Z. In that case, the company should be willing to pay up to P18 per hour (the P8 usual wage plus the P10 contribution margin per hour for product Z) to manufacture more product Z. Likewise, if all the demand for both products X and Z has been satisfied, 19-5

Chapter 19 Relevant Costs for Decision Making

additional labor hours would be used to make product Y. In that case, the company should be willing to pay up to P17 per hour to manufacture more product Y. Exercise 6 (Sell or Process Further) Sales value after further processing Sales value at split-off point Incremental revenue Cost of further processing Incremental profit (loss)

Product A P80,000 50,000 30,000 35,000 P(5,000)

Product B P150,000 90,000 60,000 40,000 20,000

Product C P75,000 60,000 15,000 12,000 3,000

Products B and C should be processed further, but not Product A. III. Problems Problem 1 (Accept or Reject an Order) Selling price per unit Less Variable costs/unit: Materials Labor Factory overhead (25%) Contribution margin/unit Multiplied by number of units to be sold Total contribution margin

Product A P1.20

Product B P1.40

0.50 0.20 0.10 0.80 P0.40 21,000 units P8,400

0.70 0.24 0.14 1.08 P0.32 30,000 units P9,600

Product B should be accepted because its total contribution margin is higher than that of Product A. Problem 2 (Eliminate or Retain a Product Line) Requirement 1 No, production and sale of the round trampolines should not be discontinued. Computations to support this answer follow: Contribution margin lost if the round trampolines are discontinued............................................ Less fixed costs that can be avoided: Advertising – traceable.................................. Line supervisors’ salaries.............................. 19-6

P(80,000) P41,000 6,000

47,000

Relevant Costs for Decision Making Chapter 19

Decrease in net operating income for the company as a whole......................................

P(33,000)

The depreciation of the special equipment represents a sunk cost, and therefore it is not relevant to the decision. The 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 product-line segment margin. A more useful income statement format would be as follows: Total Sales...................................... P1,000,000 Less variable expenses......... 410,000 Contribution margin............. 590,000 Less fixed expenses: Advertising – traceable..... 216,000 Depreciation of special equipment...................... 95,000 Line supervisors’ salaries........................... 19,000 Total traceable fixed expenses............................ 330,000 Product-line segment margin............................... 260,000 Less common fixed expenses............................ 200,000 Net operating income (loss).................................. P 60,000

Trampoline Round Rectangular P140,000 P500,000 60,000 200,000 80,000 300,000

Octagonal P360,000 150,000 210,000

41,000

110,000

65,000

20,000

40,000

35,000

6,000

7,000

6,000

67,000

157,000

106,000

P 13,000

P143,000

P104,000

Problem 3 (Product Mix) Requirement 1 Selling price per unit Variable cost per unit Contribution margin / unit Divided by no. of hours required

A P30 25 P5

19-7

Product Line B C P25 P10 10 5 P15 P 5

D P8 4 P4

Chapter 19 Relevant Costs for Decision Making

for each unit Contribution per hour Product ranking: 1. D 2. B

5 hrs. P1 3. C

10 hrs. P1.5

4 hrs. P1.25

1 hr. P4

4. A

Based on the above analysis, first priority should be given to Product D. The company should use 4,000 out of the available 96,000 hrs. to produce 4,000 units of product D. The remaining 92,000 hrs. should be used to produce 9,200 units of Product B. Hence, the best product combination is 4,000 units of Product D and 9,200 units of Product B. Requirement 2 If there were no market limitations on any of the products, the company should use all the available 96,000 hours in producing 96,000 units of product D only.

The difference in profit between the two alternatives is computed as follows: Contribution margin of combination (1) Product D (4,000 x P 4.00) Product B (9,200 x P15.00) Total contribution margin of D and B Less contribution margin of D only (96,000 x P4) Difference, excess over profit in combination (1)

P 16,000 138,000 P154,000 384,000 P230,000

Problem 4 (Accept or Reject a Special Order) Requirement 1 The company should accept the special order of 4,000 @ P10 each because this selling price is still higher than the additional variable cost to be incurred. Whether or not variable marketing expenses will be incurred, the decision is still to accept the order. Supporting computations: 19-8

Relevant Costs for Decision Making Chapter 19

(a) Assume no additional variable marketing cost will be incurred. Selling price per unit Less variable manufacturing costs: Direct materials Direct labor Variable overhead Contribution margin/unit Multiplied by number of units of order Total increase in profit

P10.00 P5.00 3.00 0.75

8.75 P 1.25 4,000 units P5,000

(b) Assume additional variable marketing cost will be incurred. Selling price per unit Less variable costs (P8.75 + P0.25) Contribution margin / unit Multiplied by number of units of order Total increase in contribution margin

P10.00 9.00 P 1.00 4,000 units P4,000

Requirement 2 P8.75, the total variable manufacturing cost. Requirement 3 Direct materials Direct labor Variable factory overhead Total cost of inventory under direct costing

P5.00 3.00 0.75 P8.75

Requirement 4 Present contribution margin [10,000 units x (P15 - P9)] Less proposed contribution margin [(P14 - P9) x 11,000 units] Decrease in contribution margin

P60,000 55,000 P 5,000

The company should not reduce the selling price from P15 to P14 even if volume will go up because total contribution margin will decrease. Problem 5 (CVP Analysis used for Decision Making) Requirement (a) Units sold per month

No. of months 19-9

Probability

Chapter 19 Relevant Costs for Decision Making

4,000 5,000 6,000

6 15 9 30

20% 50% 30% 100%

Requirement (b) 4,000 units P160,000

Production 5,000 units P160,000

6,000 units P160,000

100,000 -

125,000 -

150,000 -

Total Contribution margin

P100,000 P 60,000

P125,000 P 35,000

P150,000 P 10,000

Sales (5,000 x P40) Less variable costs Production cost @ P25 Purchase cost @ P45

P200,000

P200,000

P200,000

100,000 45,000

125,000 -

150,000 -

Total Contribution margin

P145,000 P 55,000

P125,000 P 75,000

P150,000 P 50,000

Sales (6,000 x P40) Less variable costs Production cost @ P25 Purchase cost @ P45 Total Contribution margin

P240,000

P240,000

P240,000

100,000 90,000 P190,000 P 50,000

125,000 45,000 P170,000 P 70,000

150,000 0 P150,000 P 90,000

Sales (4,000 x P40) Less variable costs Production cost @ P25 Purchase cost @ P45

Requirement (c) Sales Order Contribution Margin 4,000 P35,000 5,000 75,000 6,000 70,000 Average Contribution Margin

19-10

Probability 0.20 0.50 0.30

Expected Value P 7,000 37,500 21,000 P65,500

Relevant Costs for Decision Making Chapter 19

Problem 6 (Pricing) Requirement A:

Sales Less Variable cost Contribution margin Less Fixed cost Net income (loss)

2005 P 100,000 130,000 (P 30,000) 40,000 (P 70,000)

Operating Result at Full Capacity P 480,000 624,000 (P144,000) 40,000 (P184,000)

2006 P 400,000 520,000 (P120,000) 40,000 (P160,000)

The company had been operating at a loss because the product had been selling with a negative contribution margin. Hence, the more units are sold, the higher the loss will be. Requirement B: P60.14 Requirement C: P74.29 Requirement D: P56.58 Problem 7 (Make or Buy) Cost of Making Outside purchase Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead* Total cost

Cost of Buying P90,000

P15,000 30,000 10,000 15,000 P70,000

P90,000

* 1/3 x P45,000 = P15,000

Therefore, the annual advantage to make the parts is P20,000. IV. Multiple Choice Questions 1. 2. 3. 4.

C C B B

11. 12. 13. 14.

D A D A

21. 22. 23. 24. 19-11

D A D E

31. 32. 33. 34.

A D C A

Chapter 19 Relevant Costs for Decision Making

5. 6. 7. 8. 9. 10.

A B C B A B

15. 16. 17. 18. 19. 20.

D C A C B C

25. 26. 27. 28. 29. 30.

B D D C A A