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Exam 9: Relevant Costs: the Key to Decision Making

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The split-off point is the stage in production of joint products at which the different end products are identified.

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One of the dangers of allocating common fixed costs to a product line is that such allocations can make the line appear less profitable than it really is.

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Reference: 09-09 Bingham Company manufactures and sells Product J. Results for last year's manufacture and sale of Product J are as follows: $\begin{array} { | l | l | l | } \hline \text { Sales: } 10,000 \text { units at } \$ 160 \text { each } & & \$ 1,600,000 \\\hline \text { Less costs: } & & \\\hline \text { Variable production costs } & 960,000 & \\\hline \text { Sales commissions: } 15 \% \text { of sales } & 240,000 & \\\hline \text { Salaries of line supervisors } & 195,000 & \\\hline \text { Traceable fixed advertising expense } & 180,000 & \\\hline \text { Fixed general factory overhead (allocated to } & & \\\hline \text { products on the basis of square feet occupied) } & 170,000 & \\\hline \text { Total costs } & & 1,745,000 \\\hline \text { Net loss } & & \$ ( 145,000 ) \\\hline\end{array}$ Bingham Company anticipates no change in the operating results for Product J in the foreseeable future if the product is produced. Bingham is re-examining all of its products and is trying to decide whether to discontinue the manufacture and sale of Product J. The company's total fixed factory overhead cost would not be affected by this decision. -Assume that discontinuing Product J would result in a $30,000 increase in the contribution margin of other product lines. If Bingham chooses to discontinue Product J, then the change in net income next year due to this action will be a:

An avoidable cost is a cost that can be eliminated (in whole or in part)as a result of choosing one alternative over another.

Existing fixed manufacturing overhead costs are not relevant in deciding whether to accept a special order.

Pitkin Company produces a part used in the manufacture of one of its products. The unit product cost of the part is $33, computed as follows: $\begin{array} { | l | r | } \hline \text { Direct materials } & \$ 12 \\\hline \text { Direct labour } & 8 \\\hline \text { Variable manufacturing overhead } & 3 \\\hline \text { Fixed manufacturing overhead } &10\\\hline \text { Unit product cost } & \underline { 33 } \\\hline\end{array}$ An outside supplier has offered to provide the annual requirement of 10,000 of the parts for only $27 each. The company estimates that 30% of the fixed manufacturing overhead costs above will continue if the parts are purchased from the outside supplier. Assume that direct labour is an avoidable cost in this decision. Based on these data, the per unit dollar advantage or disadvantage of purchasing the parts from the outside supplier would be:

Reference: 09-09 Bingham Company manufactures and sells Product J. Results for last year's manufacture and sale of Product J are as follows: $\begin{array} { | l | l | l | } \hline \text { Sales: } 10,000 \text { units at } \$ 160 \text { each } && \$ 1,600,000 \\\hline \text { Less costs: } & & \\\hline \text { Variable production costs } & 960,000 & \\\hline \text { Sales commissions: } 15 \% \text { of sales } & 240,000 & \\\hline \text { Salaries of line supervisors } & 195,000 & \\\hline \text { Traceable fixed advertising expense } & 180,000 & \\\hline \text { Fixed general factory overhead (allocated to } & & \\\hline \text { products on the basis of square feet occupied) } & 170,000 & \\\hline \text { Total costs } & & 1,745,000 \\\hline \text { Net loss } & & \$ ( 145,000 ) \\\hline\end{array}$ Bingham Company anticipates no change in the operating results for Product J in the foreseeable future if the product is produced. Bingham is re-examining all of its products and is trying to decide whether to discontinue the manufacture and sale of Product J. The company's total fixed factory overhead cost would not be affected by this decision. -Assume that discontinuing the manufacture and sale of Product J will not affect the sale of other products. If the company discontinues Product J, the change in annual net income due to this decision will be a:

Reference: 09-06 Clemson Company reported the following results last year for the manufacture and sale of one of its products known as a Tam. $\begin{array} { | l | c | } \hline \text { Sales } ( 6,500 \text { Tams at } \$ 130 \text { each } ) & \$ 845,000 \\\hline \text { Variable cost of sales } & 390,000 \\\hline \text { Variable distribution costs } & 65,000 \\\hline \text { Fixed advertising expense } & 275,000 \\\hline \text { Salary of product line manager } & 25,000 \\\hline \text { Fixed manufacturing overhead } & 145,000 \\\hline \text { Net loss } & ( \$ 55,000 \\\hline\end{array}$ Clemson Company is trying to determine whether or not to discontinue the manufacture and sale of Tams. The operating results reported above for last year are expected to continue in the foreseeable future if the product is not dropped. The fixed manufacturing overhead represents the costs of production facilities and equipment that the Tam product shares with other products produced by Clemson. If the Tam product were dropped, there would be no change in the fixed manufacturing costs of the company. -Assume that discontinuing the Tam product would result in a $120,000 increase in the contribution margin of other product lines. How many Tams would have to be sold next year for the company to be as well off as if it just dropped the line and enjoyed the increase in contribution margin from other products?

Reference: 09-04 Varone Company makes a single product called a Hom. The company has the capacity to produce 40,000 Homs per year. Per unit costs to produce and sell one Hom at that activity level are as follows: $\begin{array} { | l | c | } \hline \text { Direct materials } & \$ 20 \\\hline \text { Direct labour } & 10 \\\hline \text { Variable manufacturing overhead } & 5 \\\hline \text { Fixed manufacturing overhead } & 7 \\\hline \text { Variable selling expense } & 8 \\\hline \text { Fixed selling expense } & 2 \\\hline\end{array}$ The regular selling price for one Hom is $60. A special order has been received at Varone from the Fairview Company to purchase 8,000 Homs next year at 15% off the regular selling price. If this special order were accepted, the variable selling expense would be reduced by 25%. However, Varone would have to purchase a specialized machine to engrave the Fairview name on each Hom in the special order. This machine would cost $12,000 and it would have no use after the special order was filled. The total fixed costs, both manufacturing and selling, are constant within the relevant range of 30,000 to 40,000 Homs per year. Assume direct labour is a variable cost. -If Varone can expect to sell 32,000 Homs next year through regular channels and the special order is accepted at 15% off the regular selling price, the effect on net operating income next year due to accepting this order would be a:

Reference: 09-02 Tolar Company has 400 obsolete desk calculators that are carried in inventory at a total cost of $26,800. If these calculators are upgraded at a total cost of $10,000, they can be sold for a total of $30,000. As an alternative, the calculators can be sold in their present condition for $11,200. -The sunk cost in this situation is?

Managers should pay little attention to bottleneck operations since they have limited capacity for producing output.

Reference: 09-13 Brown Company makes four products in a single facility. These products have the following unit product costs: $\begin{array}{|l|c|c|c|c|}\hline&\text { Product }\\\hline &A&B&C&D\\\hline \text { Direct materials } & \$ 15.60 & \$ 19.50 & \$ 12.50 & \$ 15.20 \\\hline \text { Direct labour } & 17.60 & 21.00 & 15.40 & 9.40 \\\hline \begin{array}{l}\text { Variable manufacturing } \\\text { overhead }\end{array} & 4.40 & 5.60 & 8.10 & 5.10 \\\hline \begin{array}{l}\text { Fixed manufacturing } \\\text { overhead }\end{array} & 27.50 & 14.40 & 14.50 & 16.50 \\\hline \text { Unit product cost } & \underline{\underline{\$ 65.10}} & \$ 60.50 & \$ 50.50 & \$ 46.20 \\\hline\end{array}$ $\text { Additional data concerning these products are listed below. }$ $\begin{array}{|l|l|l|l|l|}\hline&\text { Product }\\\hline &A&B&C&D\\\hline \text { Grinding minutes per unit } & 2.00 & 1.10 & 0.70 & 0.30 \\\hline \text { Selling price per unit } & \$ 78.70 & \$ 71.10 & \$ 67.90 & \$ 62.60 \\\hline \begin{array}{l}\text { Variable selling cost per } \\\text { unit }\end{array} & \$ 2.60 & \$ 3.10 & \$ 2.80 & \$ 3.50 \\\hline \text { Monthly demand in units } & 3,000 & 2,000 & 2,000 & 4,000 \\\hline\end{array}$ The grinding machines are potentially the constraint in the production facility. A total of 10,500 minutes are available per month on these machines. Direct labour is a variable cost in this company. -Which product makes the MOST profitable use of the grinding machines

Reference: 09-14 Crane Company makes four products in a single facility. Data concerning these products appear below: $\begin{array} { | l | l | l | l | l | } \hline & \text { Product } &\\\hline & A & B & C & D \\\hline \text { Selling price per unit } & \$ 35.30 & \$ 30.20 & \$ 20.80 & \$ 26.00 \\\hline \text { Variable manuf. cost per unit } & \$ 16.50 & \$ 15.80 & \$ 7.90 & \$ 8.50 \\\hline \text { Variable selling cost per unit } & \$ 3.80 & \$ 1.60 & \$ 1.90 & \$ 3.30 \\\hline \text { Milling machine minutes per unit } & 3.30 & 1.70 & 2.10 & 2.50 \\\hline \text { Monthly demand in units } & 4,000 & 1,000 & 3,000 & 1,000 \\\hline\end{array}$ The milling machines are potentially the constraint in the production facility. A total of 22,600 minutes are available per month on these machines. -Which product makes the MOST profitable use of the milling machines

Opportunity costs are recorded in the accounts of an organization.

Variable costs are always relevant costs.

6 $\begin{array} { | l | r | } \hline \text { Cost to Cardinal to make the part: } & \\\hline \text { Direct materials } & \$ 4 \\\hline \text { Direct labour } & 16 \\\hline \text { Variable manufacturing overhead } & 8 \\\hline \text { Fixed manufacturing overhead } & 10 \\\hline & \$ 38 \\\hline \text { Cost to buy the part from } & \\\hline \text { the Oriole Company } & \$ 36 \\\hline\end{array}$ Oriole Company has offered to sell this part to Cardinal company for $36 each. If Cardinal buys the part from Oriole instead of making it, Cardinal would not have any use for the released capacity. In addition, 60% of the fixed manufacturing overhead costs will continue regardless of what decision is made. Assume that direct labour is an avoidable cost in this decision. In deciding whether to make or buy the part, the total relevant costs to make the part are:

Which of the following best describes relevant cost

Reference: 09-14 Crane Company makes four products in a single facility. Data concerning these products appear below: $\begin{array} { | l | l | l | l | l | } \hline & \text { Product } & \\\hline & A & B & C & D \\\hline \text { Selling price per unit } & \$ 35.30 & \$ 30.20 & \$ 20.80 & \$ 26.00 \\\hline \text { Variable manuf. cost per unit } & \$ 16.50 & \$ 15.80 & \$ 7.90 & \$ 8.50 \\\hline \text { Variable selling cost per unit } & \$ 3.80 & \$ 1.60 & \$ 1.90 & \$ 3.30 \\\hline \text { Milling machine minutes per unit } & 3.30 & 1.70 & 2.10 & 2.50 \\\hline \text { Monthly demand in units } & 4,000 & 1,000 & 3,000 & 1,000 \\\hline\end{array}$ The milling machines are potentially the constraint in the production facility. A total of 22,600 minutes are available per month on these machines. -Up to how much should the company be willing to pay for one additional hour of milling machine time if the company has made the best use of the existing milling machine capacity

Reference: 09-03 Immanuel Company has just obtained a request for a special order of 6,000 jigs to be shipped at the end of the month at a selling price of $7 each. The company has a production capacity of 90,000 jigs per month with total fixed production costs of $144,000. At present, the company is selling 80,000 jigs per month through regular channels at a selling price of $11 each. For these regular sales, the cost for one jig is: $\begin{array} { | l | c | } \hline \text { Variable production cost } & \$ 4.60 \\\hline \text { Fixed production cost } & 1.80 \\\hline \text { Variable selling expense } & 1.00 \\\hline\end{array}$ If the special order is accepted, Immanuel will not incur any selling expense; however, it will incur shipping costs of $0.30 per unit. -At what selling price per unit should Immanuel be indifferent between accepting or rejecting the special offer?

Gata Co. plans to discontinue a department that has a $48,000 contribution margin and $96,000 of fixed costs. Of these fixed costs, $42,000 cannot be avoided. What would be the effect of this discontinuance on Gata's overall net operating income?