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SMARTS CPA REVIEWBATCH 17 – OCTOBER 2019 3F Menorca Building, Roxas Street, General Santos CityMANAGEMENT ADVISORY SERVICES – 10: RELEVANT COSTING 1RELEVANT COSTING – is the process of making decision from at least two alternatives in a short-term period. It is also called DIFFERENTIAL COSTING and S...

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SMARTSCPA REVI EW BATCH 17 – OCTOBER 2019

3F Menorca Building, Roxas Street, General Santos City

MANAGEMENT ADVISORY SERVICES – 10: RELEVANT COSTING 1

RELEVANT COSTING– is the process of making decision from at least two alternatives in a short-term period. It is also called DIFFERENTIAL COSTING and SHORTTERM NON-ROUTINE DECISION. Types of Costs Used in Decision Making 1. Relevant Costs - future costs that are expected to be different between or among alternatives. 2. Differential Costs - increases (increments) or decreases (decrements) in total costs that result from selecting one alternative instead of another. 3. Avoidable Costs - [Relevant] costs that will be saved or those that will not be incurred if a certain decision is made. 4. Opportunity Costs - [Relevant] income sacrificed or forgone when a certain alternative is chosen over another alternative. 5. Out-of-Pocket Costs - [Relevant] costs that will require expenditure of cash or incurrence of a liability as a consequence of a management's decision. 6. Sunk Costs - [Irrelevant] costs that are incurred already and cannot be avoided regardless of what decision was made. 7. Committed Costs - [Irrelevant] costs and revenues that will remain the same regardless of the decision to be made. 8. Joint Costs [Irrelevant] costs that are incurred in simultaneously manufacturing two or more (joint) products that are difficult to identify individually as separate types of products until the products reach a certain processing age known as the split-off point. 9. Further Processing Costs - [Relevant] costs incurred beyond the split-off point. 10. Bottleneck Resources - any resource or operation where the capacity is less than the demand placed upon it. SHORT-TERM DECISION ALTERNATIVES 1. Make or buy (insource or outsource a component part) 2. Accept or reject a special order? 3. Drop or continue an organizational segment (e.g., division, department, or product line)? 4. Sell as is or process further? 5. Continue operations or temporarily shut down the operations?



6. Maximize or minimize bid price? 7. Optimization of scarce resources? 8. Sell now or later? 9. Replace or retain an old asset? 10. Scrap or rework a defective unit? 11. Determining the indifference point?

MAKE OR BUY

NATURE OF ALTERNATIVES MAKE OR BUY (a part or a product)

DESCRIPTION Should a part or product be manufactured (insourced) or bought Relevant cost to: (outsourced) Make from Purchase price outside supplier? Direct materials Pxx *Material handling cost xx Direct labor xx Variable OH xx Avoidable Fixed OH xx Rental income form released facility Contribution margin from a new product Total Relevant Cost Pxx *Material handling cost is included in the total cost of materials and total purchase price

DECISION GUIDELINES Choose the option that involves the lower cost. In most cases, fixed costs are Buy irrelevant. Pxx Consider opportunity costs, if any. xx

(xx) (xx) Pxx

STRAIGHT PROBLEM 1: MAKE OR BUY Golden Allen Corporation is studying whether to continue making or buying part 235YY. The following data are obtained for analysis: Unit purchase price offered by a reliable outside supplier Unit production costs: Direct materials Direct labor Variable overhead Fixed overhead (40% avoidable if the part is purchased outside) Unit variable administration, marketing and distribution expenses Unit fixed expenses Budgeted capacity in units Materials handling costs Rental equipment provided to sub-contractor Potential income from released facilities Rental income Additional contribution margin on new product Profit from special sales

P80 30 15 10 8 5

6 20,000 10% of cost P20,000 P250,000 292,000 120,000

Required: a. The savings per unit of the better alternative b. The indifference purchase price or the maximum amount the company should be willing to pay an outside supplier per unit? c. The unit purchase price to realize a savings of P5 from buying the part. d. The amount of rental income needed to generate a savings of P300,000 if the company had decided to purchase the part, and assuming the rental income is the best alternative use of the released facility?

SOLUTION GUIDE Relevant cost to: Purchase price Direct materials Material handling cost: Direct labor Variable OH Avoidable Fixed OH Rental income form released facility Contribution margin from a new product Total Relevant Cost

A Make

B Buy

Make

Buy ?

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Accept or Reject (accept if the special order provides incremental income)

Sales Less: Cost to Make and Sell Direct Materials Direct Labor Variable Manufacturing Overhead Variable Selling and Administrative (if required) Special Equipment and other requirements (if any) Lost Contribution Margin - if required to sacrifice regular sales due to lack of capacity Incremental Income

xx Xx xx xx xx xx xx xx

STRAIGHT PROBLEM 2: ACCEPT OR REJECT A SPECIAL ORDER – Incremental Profit Mike Corporation provided the following information with regard to its product M-Shoes: Regular unit sales price Regular unit production costs: Direct materials Direct labor Variable overhead Fixed overhead Regular unit marketing and distribution expenses Variable expenses Fixed expenses Maximum capacity Present capacity Special sales order by a one-time special customer Special unit sales price

P200 40 30 20 15 8 7 50,000 units 46,000 units 3,000 to 6,000 units P120

Required: a. Determine the effect to profit if a 3,000-unit special order is accepted in each of the independent cases below: 1. Unit variable expenses decreased to P5.50 2. Total fixed overhead increased by 10% b. Determine the effect to profit if the 6,000-unit special sales order is accepted in each of the independent cases below: 1. Excess order is bought from a competitor at the prevailing market price. 2. Excess order is outsourced from an independent supplier at P10 higher than the relevant costs of producing the part.

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CONTINUE OR DISCONTINUE OPERATING A BUSINESS SEGMENT – Segment Margin

NATURE OF ALTERNATIVES CONTINUE OR DROP a business segment

DESCRIPTION Should a business segment, which may be a product line, a department or a branch be continued or discontinued?

DECISION GUIDELINES Continue if avoidable revenue of the segment involved is greater than its avoidable costs; otherwise, consider shutting down the segment. Since allocated fixed cost is usually unavoidable, it is considered irrelevant.

STRAIGHT PROBLEM 3: Drop or continue product line/segment? When Mr. Ding L. Berry, president and chief executive of Berry, Inc., first saw the segmented income statement below, he flew into his usual rage: "When will we ever start showing a real profit? I'm starting immediate steps to eliminate those two unprofitable lines!"

Sales Variable expenses Contribution margin Traceable fixed expenses* Common expenses, allocated Operating income (loss)

Total P250,000 (119,000) 131,000 (98,200) (32,900) P(100)

U P100,000 (37,500) 63,000 (31,000) (18,000) P14,000

Product Lines V P75,000 (35,000) 40,000 (37,000) (10,500) P(7,500)

W P75,000 (47,000) 28,000 (30,200) (4,400) P(6,600)

*These traceable expenses could be eliminated if the product lines to which they are traced were discontinued. Required: a. Recommend which segments, if any, should be eliminated, and determine the effect to the overall profit of Berry Inc. b. If product V is eliminated and what will be the effect to the overall profit of Berry Inc.?

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c. If product V is eliminated and 30% of the allocated fixed can be avoided, what will be the effect to the overall profit of Berry Inc.?

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SELL AS IS OR PROCESS FURTHER – Incremental Profit

NATURE OF ALTERNATIVES SELL AS IS OR PROCESS a product

DESCRIPTION

DECISION GUIDELINES

Should a product, after undergoing the joint process, be sold at the split-off point or be processed further?

Process further if additional revenue from processing further is greater than further processing costs. Joint costs, since already incurred, are considered sunk costs and irrelevant.

Straight Problem 4: Sell now a product or process it further? Iaci Company makes two products from a common input. Joint processing costs up split-off point total $42,000 a year. The company allocates these costs to the products on the basis of their total sales values at the split-off point. Each may be sold at the split-off point or processed further. Data concerning these appear below: Product X Product Y Total Allocated joint processing costs P22,400 P19,600 P42,000 Sales value at split-off point 32,000 28,000 60,000 Costs of further processing 11,600 25,300 36,900 Sales value after further processing 40,800 54,200 95,000

to the joint product products

Required: a. What is the net monetary advantage (disadvantage) of split-off point? b. What is the net monetary advantage (disadvantage) of split-off point? c. What is the minimum amount the company should accept sold at the split-off point? d. What is the minimum amount the company should accept sold at the split-off point? e. The sunk cost in the decision to sell the product(s) further.

processing Product X beyond the processing Product Y beyond the for Product X if it is to be for Product Y if it is to be at split-off point or process

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SHUT-DOWN OR NOT NATURE OF ALTERNATIVES CONTINUE OPERATIONS OR TEMPORARILY SHUT DOWN THE OPERATIONS? 

– lesser loss DESCRIPTION

DECISION GUIDELINES

Product seasonality and industry cycle (slack season) may heavily restrain income and produce operating losses. In these cases, management may contemplate to temporarily stop its operations to avoid losses. Yet, if operations are temporarily shut down, the business will still lose because of the shutdown costs.

Either way, continue or shut down, the business will have a loss. The guideline is, which option will give a lesser amount of loss? If sales are greater than the shutdown point, better continue operating!

Straight Problem 5: Shut-down or continue operations? EFPA Amusement Park is considering temporarily closing its operations in the months of July and August due to slack business conditions. Also during this time, general reconditioning and repairs would be done in preparation for the fourth quarter peak services. The following data are gathered in relation to this proposal: Entrance fee per guest Unit variable costs per guest Regular number of monthly guests Estimated number of monthly guests in July and August

P150 60 40,000 4,000

Regular monthly fixed costs and expenses: Salaries Rent Promotions and advertising Other fixed costs and expenses Total Estimated

monthly

fixed

costs

and

expenses

P2,250,000 400,000 250,000 580,000 P3,480,000 in

July

and

August

If

the

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operations are shut down: Salaries Rent Promotions and advertising Other fixed costs and expenses Restart-up cost Cleaning and other shutdown month

operating

improvements

P750.000 P160,000 30% unavoidable base on contracts To be reduce by 60% P300,000 during the P500,000

Required: a. Shut down costs b. Shut down point c. Effect on profit if the business continues operating in July and August

MULTIPLE CHOICE QUESTIONS 1. To be useful in decision making, information should possess which of the following characteristics? Relevance Yes Yes Yes No

A. B. C. D. 2. Which A. A B. A C. A D. A

Accuracy No Yes Yes Yes

Timeliness Yes No Yes Yes

of the following best defines the concept of a relevant cost? past cost that is the same among alternatives. past cost that differs among alternatives. future cost that is the same among alternatives. future cost that differs among alternatives.

3. The following costs are relevant to the decision situation cited except: A. the cost of hiring a full-time staff attorney, in a decision to establish an in-house legal department or retain the services of a prominent law firm. B. the remodeling cost of existing office space, in a firm's decision to stay at its current location or move to a new building. C. the long-term salary costs demanded by Joe Torrez (a superstar) and Rip Moran (an average player) in baseball contract negotiations, in a decision that determines the amounts by which ticket prices must be raised. D. the cost to enhance an airline's Web site, in a decision to expand existing service to either Salt Lake City or Phoenix. 4. A joint A. any B. any C. any D. one

product is: product which consists of several parts. product produced by a firm with more than one product product involved in a make or buy decision. of several products produced from a common input.

line.

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5. Which of the following is a short-term decision in which opportunity costs are not relevant? A. Make-or-buy decision. B. Special-order decision. C. Drop-a-segment decision. D. None of the above. 6. An opportunity cost commonly associated with a special order is A. the contribution margin on lost sales. B. the variable costs of the order. C. additional fixed costs related to the increased output. D. any of the above. 7. Which of the following cost-classification schemes is most relevant to decision making? A. Fixed-variable. B. Joint-common C. Avoidable--unavoidable. D. Direct-common. 8. Which of the following is NOT relevant in deciding whether to process a joint product beyond its split-off point? A. The split-off value. B. The price after additional processing. C. The cost of further processing. D. The cost of operating the joint process. 9. Occidental is contemplating dropping a product because of ongoing losses. Costs that would be relevant in this situation would include variable manufacturing costs as well as: A. factory depreciation. B. avoidable fixed costs. C. unavoidable fixed costs. D. allocated corporate administrative costs. 10.

Which of the following is NOT relevant to a decision about whether to drop a segment? A. The contribution margin expected to be produced by the segment. B. The avoidable fixed costs direct to that segment. C. The complementary effects of dropping the segment. D. "None of the above" is the best answer because all of the above are relevant

For questions 11 to 13 Foster Company makes 20,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Unit product cost

P24.70 16.30 2.30 13.40 P56.70

An outside supplier has offered to sell the company all of these parts it needs for P51.80 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be P44,000 per year. If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided. However, P5.10 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the

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outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products. 11.

How much of the unit product cost of P56.70 is relevant in the decision of whether to make or buy the part? A. P51.60 C. P43.30 B. P48.40 D. P56.70

12.

What is the net total dollar advantage (disadvantage) of purchasing the part rather than making it? A. P(24,000) C. P142,000 B. P40,000 D. P96,000

13.

What is the maximum amount the company should be willing to pay an outside supplier per unit for the part if the supplier commits to supplying all 20,000 units required each year? A. P50.60 C. P53.80 B. P45.5 D. P58.90

14.

Factors in a decision problem that cannot be expressed in numerical terms are: A. B. C. D.

qualitative in nature. quantitative in nature. predictive in nature. sensitive in nature.

For questions 15 to 17 Joey Company produces a single product. The cost of producing and selling a single unit of this product at the company's normal activity level of 70,000 units per month is as follows: Direct materials P29.60 Direct labor 5.80 Variable manufacturing overhead 2.50 Fixed manufacturing overhead 17.20 Variable selling & administrative expense 1.80 Fixed selling & administrative expense 6.70 The normal selling price of the product is P72.90 per unit. An order has been received from an overseas customer for 2,000 units to be delivered this month at a special discounted price. This order would have no effect on the company's normal sales and would not change the total amount of the company's fixed costs. The variable selling and administrative expense would be P1.10 less per unit on this order than on normal sales. Direct labor is a variable cost in this company. 15.

Suppose there is ample idle capacity to produce the units required by the overseas customer and the special discounted price on the special order is P66.10 per unit. By how much would this special-order increase (decrease) the company's net operating income for the month? A. P55,000 C. PP67,800 B. P66,400 D. P52,800

16.

Suppose the company is already operating at capacity when the special order is received from the overseas customer. What would be the opportunity cost of each unit delivered to the overseas customer? A. P34.30 C. P33.20 B. P6.80 D. P27.50

17.

Suppose there is not enough idle capacity to produce all of the units for the overseas customer and accepting the special order would require cutting back on production of 1,300 units for regular customers. What would be the minimum acceptable price per unit for the special order? A. P66.10 C. P70.52

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B.

P60.18

D.

P60.89

For questions 18 to 20 Dowchow Company makes two products from a common input. Joint processing costs up to the split-off point total $38,400 a year. The company allocates these costs to the joint products on the basis of their total sales values at the split-off point. Each product may be sold at the split-off point or processed further. Data concerning these products appear below: Product X Product Y Total Allocated joint processing costs P20,800 P17,600 P38,400 Sales value at split-off point 26,000 22,000 48,000 Costs of further processing 22,600 20,400 43,000 Sales value after further processing 45,000 45,900 90,900 18.

What is the net monetary advantage (disadvantage) of processing Product X beyond the split-off point? A. P1,600 C. P22,400 B. P27,600 D. (P3,600)

19.

What is the net monetary advantage (disadvantage) of processing Product Y beyond the split-off point? A. P3,500 C. P29,900 B. P7,900 D. P25,500

20.

What is the minimum amount the company should accept for Product X if it is to be sold at the split-off point? A. P22,400 C. P20,800 B. P43,400 D. P45,000

Questions 21– 23 are based on the following information: Levy Corporation had been experiencing a slow-down in business activities in August and September and is considering temporarily shutting down its operations during those months. The accounting department has provided the following normal operating data for considerations: Unit sales price P150 U...