Read) | ROPE = the: Revdom Schookog Rocommlance.s Penney texte Feri Yis-04: RELEVANT COSTING DECISION MAKING - is the process of choosing from at least two alternatives. For business entities, ‘management must choose in favor of the option that is most beneficial to the company 1m order to achieve corporate objectives of maximizing profit. ‘SHORT-TERM DECISION ALTERNATIVES . Accept or reject a special order Sell or process further a product tine ‘Make or buy a part or a product line Continue or shutdown a business segment Choosing the best product combination Selecting a change in prof factors TYPICAL DECISION MAKING PROCESS + Defining the problem. ‘Specifying the objective and criteria, Identifying the alternative courses of action, Evaluating the possible consequences of the alternatives. Collecting the data needed to make decision. Choosing the best alternative and making the decision. Evaluating the results of the decision, FACTORS CONSIDERED IN DECISION MAKING Qualitative Factors Factors in a decision problem that cannot be expressed effectively in numerical terms. Quantitative Factors Factors that can easily be expressed in terms of money or other numerical unit of measure. APPROACHES IN PROBLEM-SOLVING INVOLVING DECISION MAKING Total approach Total revenues and costs are determined for each alternative, and the results are compared to serve as a basis for the decision to make. Differential approach Only the differences or changes in costs and revenues are considered. ‘TYPES OF COSTS AND TERMINOLOGIES USED IN SHORT-TERM DECISION MAKING RELEVANT COSTS: Future costs that are expected to be different among alternatives; it is usually regarded as the avordable costs of a particular decision. DIFFERENTIAL COSTS —_ Increases (increments) or decreases (decrements) in total costs that result from selecting one alternative instead of another. [Relevant] AVOIDABLE COSTS Costs that will be saved or those that will not be incurred if a certain decision is made. (Relevant) SUNK COSTS Costs that are incurred already and cannot be avoided regardless of what decision is made. {Irrelevant} Out-of Pocket COSTS Costs that will require expenditure of cash or incurrence of @ liability as a ‘consequence of a management decision. (Usually relevant] OPPORTUNITY COSTS —_Income sacrificed or foregone when a certain alternative is ch alternative. [Relevant] ‘¢ is chosen over another JOINT COSTS Costs incurred in simultaneously manufacturing two or more (Joint) produ that are dct to identity inidually as separate ype a oot, Products Products reach a certain processing stage known as the spliff pomne [Irrelevant] FURTHER PROCESSING Costs incurred beyond the split-off point as se; Furr proceed other Rees arated joint products are to be ‘SPLIT OFF POINT A point in the manufacturing process where some or all of joint products can be recognized as distinct and separate products, TTLENECK Any resource or operation where thi ity i BOTTLENEGH me 'e capacity is less than the demand piacedSI HORT TERM DECISION MAKING GUIDELINES Basic rule: choose the action that will yield the BEST PROFIT POSITION, Highest reve Lowest costs J a part/product (Outsourcing Decision) ‘ACCEPT or a special order [30 CONTINUE or SHUTDOWN | a business segment PROCESS FURTHER @ product BEST PRODUCT COMBINATION (Optimization of Scarce Resources) 6. CHANGE IN PROFIT FACTORS (Cost-Volume-Profit Analysis under MS-02) 4. TOTAL ANALYSIS vs. Leyte Company has a single product called Palo. The company currently sells 8,000 units of Palo at hues, pleas, DESCRIPTION Should a part or product be manufactured (in-sourced) or bought (outsourced) from outside supplier? E Should @ special order that requires a price lower than the regular selling price be accepted? uld a business segment, which | may be a product line, a department or a branch” be continued or discontinued? ‘Should product, al undergoing the joint process, be sold at the split-off point or be processed further? Which ~ product(s) should be produced and sold when there is a given limited resources or bottleneck operation? | Should any of the profit factors such as selling price, unit sales, variable cost, fixed cost and sales mix be manipulated to increase irrelevant. DIFFERENTIAL ANALYSIS Best profit position DECISION GUIDELINES Choose the option that has the lower cost, In most cases, fixed costs are irrelevant. Consider opportunity costs, if any. bs = ‘Accept the order when the additional revenue from the special order exceeds additional cost, provided the regular market, will not be affected. In most cases, fixed costs are irrelevan continu n avoidable revenue of the segment involved is greater than its avoidable costs; otherwise, consider Since usually shutting down allocated fixed unavoidable, it the segment. cost is is Process further from processing further than further processing costs. Joint costs, since already incurred at the split-off point, are considered sunk id irre is greater [Identify and measure the constramt ‘on the limited resource(s). Rank the product(s) according to the highest contribution margin per unit of limited resources. identify the factor to change and the amount of contemplated change. Change the profit factor if it will cause an improvement on the over-all profit position. _| P40 per unit. The compaiy’s costs at this level of activity are given below: REQUIRED: a 2. Leyte Company Determine the ef Variable Costs: Direct materials Direct labor Variable Overhead Variable Selling Expense Fixed Costs! Fixed Overhead Fixed Selling Expense ‘What is Leyte Company's present profit? 4e.e0e could increase its sales’ by 25% ffect on company profit using ‘A) Total analysis Ploage iw fief B) Differential analysis 10 00 in felt P10 8 5 2 P 50,000, 30,000 if tt spends P 20,000 for advertisements,5: MAKE OR BUY Roar Company uses 20 units of Part ‘Miming’ per month in the production of its main product. The ‘manufacturing costs per unit of Part ‘Miming’ are as follows: Materials P 1,000 Handling Cost * 100 Direct Labor 5,000 Factory Overhead (40% fixed) _10,000 TOTAL ° P16,100 * Handling cost is applied at 10% of cost of direct materials and/or any purchased parts. Katy Company, a well-known producer of Part ‘Miming,’ has offered to supply the part for Roar Company at P 12,000 per unit. If Roar Company accepts Katy’s offer, the resulting idle facility may be used to produce another product, Product ‘Meow, which is expected to earn P 20,000 per month. REQUIRED: ‘Should Roar Company make Part "Miming’ or buy it from Katy Company? MAKE. MAKE OR BUY BMW Motors is trying to decide whether the company should continue to produce an engine ‘component or buy it from Saraw-Philippines at P 100 each. Demand for the coming year is 200 units. The costs of producing these 200 units are as follows: Direct materials P 10,000 Direct labor 4,000 Variable Factory Overhead 2,000 Fixed Factory Overhead 5,000 TOTAL 21,000 IF BMW makes the components, the unit costs of direct materials will increase by 20%. If BMW buys the components, 30% of the fixed costs will be avoided. Moreover, the facility now used to make the components can be rented out to another firm for P 2,500. REQUIRED: ‘Should BMW make or buy the components? ACCEPT OR REJECT (SPECIAL ORDER DECISION) ‘Antonia 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 50,000 units per month is as follows: ‘Manufacturing costs: Direct materials P 32.50 per unit Direct labor 7.20 per unit Variable manufacturing overhead 1.30 per unit Fixed manufacturing overhead P 1,045,000 per month Selling and administrative costs: Vanable P 1.90 per unit Fixed P 365,000 per month The normal selling price of the product is P 75.00 per unit. ‘An order has been received from a customer for 3,000 units at a special discounted price of P 65.60 per unit. This order would have no effect on normal sales and would not change the total hxed cote The variable selling and administrative expense would be P 0.30 less per unit on this order than on normal sales. REQUIRE! ‘Should Antonia accept or reject the special order? SPECIAL ORDER PRICING ‘Conrada Company sells I-Phone 7 at a price of P 28,000 per unit. The costs per unit are: Direct materials P-8,000 Direct labor 6,000 Variable overhead 4,000 Fixed overhead 2,000 TOTAL 0,000 AA special order for 1,000 units was received from Marcia Bona, 4 based in Cavite. Additional shipping costs for this sale are P 2,000 per unit Anon” ell Phone dealer REQUIRED: ‘What is the minimum selling price per unit for the special order if: A) Conrada is operating at full capacity? 8B) Conrada has excess capacity?6. SHUTTING DOWN OPERATIONS. The most recent monthly income statement for G Ching Sales 1,200,000 #"800,000 2,000,000 Less: Variable expenses 10,000) (300,000) (1,200,000) Contribution margin P360,000°— Pan0,000 400,00 Less: Traceable fined expenses (210,000) (449,000) (390,000) Segment margin P'150,000 260,000 P-410,000 Less: Common fixed expenses (180,000) (120,000) (300,000) Profit (loss) (P 30,000) P 140,000 P 110,000 Georgia Stores considers eliminating China Branch, China Branch were eliminated, then its. traceable fixed expenses could be avoiited, The total common fixed expenses, are merely allocated and would be unaffected. A). What will be the profit (loss) if China Branch 4s eliminated? a. P 260,000 ye (40,000) b. P 140,000 ‘d,(P 70,000) 8) Assume that if China Branch is closed, one-fifth (20%) of its traceable fixed expense would continue unchanged. Also, closing of China Branch would result ina 20% decrease in sales of US Branch, What will be the overall decrease in profit? a, P.352,000 & P136,000 . FF. 280,000 d. No decrease; profit will merease 7. PRODUCT ELIMINATION (SHUTDOWN) POINT Christy Company expects that sales will drop below the current level of 5,000 units per month, An income statement prepared for the monthly sales of 5,000 units show the following: Sales (5,000 @ P 2) P 15,000 Less Vanable costs (5,000 @ P2)P 10,000 Fixed costs __5,000.____ 15,000, Profit = Nil- 1f plant operations are suspended, a shutitown cost (i.e., plant maintenance and taxes) of P 2,000 per month will remain as incurred, | Sime there 1s no timmedate possibility of profit under present conditions, the problem of the company Is Just how to minimize the loss. REQUIRED: - 1. What is the shutdown point in units? =v 2. Should the company continue or shut down operations if the company expects demand to be: A) 4,000 units? 8) 2,000 units? SOLUTION GUIDE to item 7: is [aghae (A)4,000 nts | (8) 2,000 units) 3,000 units | Contribution Margin “Fixed Costs |} (5,000) (5,900) (5,000) Profit (loss) 7 E 2k 8. SELL OR PROCESS FURTHER Oval Company produces four products for a joint cost of P 10,000, The firm could sell the products at the split-off point for the following amounts: 15,000, 41,000_ 2,000, 0 At present, the products are processed beyond the split-off point and they are sold as follows: Products Sales ___ Additional Processing Cost ™ ~~ -40,000 P 28,000 1 30,000 16,000 L 20,000 14,000 o 2,500 3,000 REQUIRED: eR hich product(s) should the firm sell at spit-off pont? 4 2. Ifthe company takes the most profitable action, then what Wall be wts profit? M69 + if Page 4 of 5 pages vee 3,90 Tow 25m] ss i 2 Geng)9 Fe. T?. 8. 9. 10. BEST PRODUCT COMBINATION Kapos Co. produces three products: A, 8 and C. One machine is used to produce the produicts. ‘The contribution margins, sales demands, and time on the machine (in hours) are as follows: tribution Margin Hours.on Machine Market Limit Unit Cont A "100 units P20 10 per unit B 80 units Pig 5 per unit C 150 units P25 10 per unit There are 2,400 hours available on the machine during the week. Total fixed cost is P 5,000, REQUIRED: 1. What is the best product combination that maximizes the weekly contribution? ‘a. A, 100; B, 80; C, 150 cA, 90; B, 0; C, 150 Jr A, 50; B, 80; C, 150 d. A, 100; 8, 80; C, 100 2. How much is the profit associated with the best product combination? PL iqd max. SOLUTION GUIDE to item 9: Product A | Product B 20 WRAP-UP EXERCISES (TRUE OR FALSE; MULTIPLE-CHOICE) Which of the following costs is generally considered irrelevant in decision making process? a. Direct materials ¢, Variable factory overhead b. Direct labor id Fixed factory overhead The salary you would otherwise earn by working rather than attending the CPA review is a good example of a. sunk cost £2. An opportunity cost b. An out-of-pocket cost ‘d. An incremental cost ; ‘An opportunity cost is usually: 4. Relevant, but is not part of traditional accounting records. b. Not relevant, but is part of traditional accounting records. €. Relevant, and is part of traditional accounting records. d. Not relevant, and is not part of traditional accounting records. What is the opportunity cost of making a component part in a factory with excess capacity for which there is no alternative use? 2. The total manufacturing cost of the component 0. The variable cost of the component : . The fixed cost of the component & Zero. If there is excess capacity, the minimum acceptable price for a special order must cover ’2. Usual fixed manufacturing costs b. Variable and usual fixed manufacturing costs Variable manufacturing costs associated with the special order ‘d. Variable manufacturing costs plus contribution margin foregone on If the margin that will be lost by dropping a product line is more than the tinea sew by avoided, then the line should be dropped. ee If there are shutdown costs, a company’s shutdown point is alwa = Which is usually considered irrelevant sell or process further decision moninge ere Pe & Joint costs ¢. Sales value at the split-off point 'b. Further processing costs d. Sales value after further processin ‘A company that has a limited number of labor hours and abundant machine ty "I the product that has the highest lours should produce first 2. Demand in units b. Contribution margin per unit. Contribution margin per labor hour ‘d. Contribution margin per machine hour le of sunk costs in Isic The role of sunk costs in decsion making can be summed up in which ofthe following sayings? b. Bygones are bygones * ©. Apenny saved is a penny earned d. | The love of money is the root of all evil