MANAGEMENT ACCOUNTING (VOLUME II) - Solutions Manual

19-1

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 accountants 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: Replace Rebuild
New Truck P10,200
Less: Proceeds from
disposal, net 1,000
P 9,200 P8,500
Advantage of rebuilding 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.



Chapter 19 Relevant Costs for Decision Making
19-2

II. Exercises

Exercise 1 (Identifying Relevant Costs)

Case 1 Case 2
Item Relevant
Not
Relevant Relevant
Not
Relevant
a. Sales revenue ................................ X X
b. Direct materials............................... X X
c. Direct labor ................................ X X
d. Variable manufacturing
overhead ......................................... X X
e. Book value Model E7000
machine........................................... X X
f. Disposal value Model
E7000 machine ............................... X X
g. Depreciation Model E7000
machine........................................... X X
h. Market value Model F5000
machine (cost)................................ X X
i. Fixed manufacturing
overhead ......................................... X X
j. Variable selling expense ................. X X
k. Fixed selling expense...................... X X
l. General administrative
overhead ......................................... 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
Relevant Costs for Decision Making Chapter 19
19-3
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
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


Per Unit
Differential
Costs 15,000 units
Make Buy Make Buy
Cost of purchasing ................................................................ P200 P3,000,000
Direct materials................................................................ P 60 P 900,000
Direct labor ................................................................ 80 1,200,000
Variable manufacturing overhead................................ 10 150,000
Fixed manufacturing overhead, traceable
1
................................ 20 300,000
Fixed manufacturing overhead, common................................ 0 0 0 0
Chapter 19 Relevant Costs for Decision Making
19-4
Total costs ................................................................ P170 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

Make Buy
Cost of purchasing (part 1) ................................................................ P3,000,000
Cost of making (part 1)................................................................ P2,550,000

Opportunity costsegment 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 Total
Unit 10 bracelets
Incremental revenue................................................................ P3,499.50 P34,995.00
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
Relevant Costs for Decision Making Chapter 19
19-5
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 companys regular
price for such an item, the special order would add to the companys 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

X Y Z
(1) Contribution margin per unit ................................................................ P18 P36 P20
(2) Direct labor cost per unit ................................................................ P12 P32 P16
(3) Direct labor rate per hour ................................................................ 8 8 8
(4) 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 P9 P10
Direct labor-hours available................................ 3,000 3,000 3,000
Total contribution margin ................................ P36,000 P27,000 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 companys
constraint, this measure should guide management in its production
decisions.

Requirement 3

Chapter 19 Relevant Costs for Decision Making
19-6
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,
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)

Product A Product B Product C
Sales value after further processing ................................ P80,000 P150,000 P75,000
Sales value at split-off point................................ 50,000 90,000 60,000
Incremental revenue................................ 30,000 60,000 15,000
Cost of further processing................................ 35,000 40,000 12,000
Incremental profit (loss)................................P(5,000) 20,000 3,000

Products B and C should be processed further, but not Product A.

III. Problems

Problem 1 (Accept or Reject an Order)

Product A Product B
Selling price per unit P1.20 P1.40
Less Variable costs/unit:
Relevant Costs for Decision Making Chapter 19
19-7
Materials 0.50 0.70
Labor 0.20 0.24
Factory overhead (25%) 0.10 0.14
0.80 1.08
Contribution margin/unit P0.40 P0.32
Multiplied by number of units to be sold 21,000 units 30,000 units
Total contribution margin P8,400 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............................................. P(80,000)
Less fixed costs that can be avoided:
Advertising traceable.................................. P41,000
Line supervisors salaries .............................. 6,000 47,000
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:

Trampoline
Total Round Rectangular Octagonal
Sales..................................... P1,000,000 P140,000 P500,000 P360,000
Less variable expenses......... 410,000 60,000 200,000 150,000
Chapter 19 Relevant Costs for Decision Making
19-8
Contribution margin............. 590,000 80,000 300,000 210,000
Less fixed expenses:
Advertising traceable..... 216,000 41,000 110,000 65,000
Depreciation of special
equipment .....................

95,000

20,000

40,000

35,000
Line supervisors
salaries ..........................

19,000

6,000

7,000

6,000
Total traceable fixed
expenses ...........................

330,000

67,000

157,000

106,000
Product-line segment
margin ..............................

260,000

P 13,000

P143,000

P104,000
Less common fixed
expenses ...........................

200,000

Net operating income
(loss)................................

P 60,000


Problem 3 (Product Mix)

Requirement 1
Product Line
A B C D
Selling price per unit P30 P25 P10 P8
Variable cost per unit 25 10 5 4
Contribution margin / unit P5 P15 P 5 P4
Divided by no. of hours required
for each unit

5 hrs.

10 hrs.

4 hrs.

1 hr.
Contribution per hour P1 P1.5 P1.25 P4

Product ranking:
1. D 2. B 3. C 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.
Relevant Costs for Decision Making Chapter 19
19-9






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) P 16,000
Product B (9,200 x P15.00) 138,000
Total contribution margin of D and B P154,000
Less contribution margin of D only
(96,000 x P4) 384,000
Difference, excess over profit in combination (1) 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:
(a) Assume no additional variable marketing cost will be incurred.
Selling price per unit P10.00
Less variable manufacturing costs:
Direct materials P5.00
Direct labor 3.00
Variable overhead 0.75 8.75
Contribution margin/unit P 1.25
Multiplied by number of units of order 4,000 units
Total increase in profit P5,000
(b) Assume additional variable marketing cost will be incurred.
Selling price per unit P10.00
Less variable costs (P8.75 + P0.25) 9.00
Contribution margin / unit P 1.00
Multiplied by number of units of order 4,000 units
Chapter 19 Relevant Costs for Decision Making
19-10
Total increase in contribution margin P4,000
Requirement 2

P8.75, the total variable manufacturing cost.


Requirement 3

Direct materials P5.00
Direct labor 3.00
Variable factory overhead 0.75
Total cost of inventory under direct costing P8.75

Requirement 4

Present contribution margin
[10,000 units x (P15 - P9)] P60,000
Less proposed contribution margin
[(P14 - P9) x 11,000 units] 55,000
Decrease in contribution margin 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 Probability
4,000 6 20%
5,000 15 50%
6,000 9 30%
30 100%

Requirement (b)
Production
4,000 units 5,000 units 6,000 units
Sales (4,000 x P40) P160,000 P160,000 P160,000
Less variable costs
Production cost @ P25 100,000 125,000 150,000
Relevant Costs for Decision Making Chapter 19
19-11
Purchase cost @ P45 - - -
Total P100,000 P125,000 P150,000
Contribution margin P 60,000 P 35,000 P 10,000





Sales (5,000 x P40) P200,000 P200,000 P200,000
Less variable costs
Production cost @ P25 100,000 125,000 150,000
Purchase cost @ P45 45,000 - -
Total P145,000 P125,000 P150,000
Contribution margin P 55,000 P 75,000 P 50,000

Sales (6,000 x P40) P240,000 P240,000 P240,000
Less variable costs
Production cost @ P25 100,000 125,000 150,000
Purchase cost @ P45 90,000 45,000 0
Total P190,000 P170,000 P150,000
Contribution margin P 50,000 P 70,000 P 90,000

Requirement (c)

Sales Order Contribution Margin Probability Expected Value
4,000 P35,000 0.20 P 7,000
5,000 75,000 0.50 37,500
6,000 70,000 0.30 21,000
Average Contribution Margin P65,500

Problem 6 (Pricing)

Requirement A:


2005


2006
Operating
Result at Full
Capacity
Sales P 100,000 P 400,000 P 480,000
Less Variable cost 130,000 520,000 624,000
Contribution margin (P 30,000) (P120,000) (P144,000)
Less Fixed cost 40,000 40,000 40,000
Net income (loss) (P 70,000) (P160,000) (P184,000)

Chapter 19 Relevant Costs for Decision Making
19-12
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 Cost of Buying
Outside purchase P90,000
Direct materials P15,000
Direct labor 30,000
Variable manufacturing overhead 10,000
Fixed manufacturing overhead* 15,000
Total cost 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. C 11. D 21. D 31. A
2. C 12. A 22. A 32. D
3. B 13. D 23. D 33. C
4. B 14. A 24. E 34. A
5. A 15. D 25. B 35. C
6. B 16. C 26. D
7. C 17. A 27. D
8. B 18. C 28. C
9. A 19. B 29. A
10. B 20. C 30. A

Supporting computations for nos. 16 - 29:

16. Sales [(100,000 x 90%) x (P5.00 x 120%)] P540,000
Relevant Costs for Decision Making Chapter 19
19-13
Less: Variable costs (P300,000 x 90%) 270,000
Contribution margin P270,000
Less: Fixed costs 150,000
Operating income P120,000


17. Direct materials P 4
Direct labor 5
Overhead 2
Selling cost 3
Minimum selling price per unit P14

18. Relevant cost to make (10,000 x P24) P240,000
Purchase cost P300,000
Less: Savings in manufacturing cost P45,000
Avoidable fixed overhead 50,000 95,000
Net purchase price P205,000
Difference in favor of buy alternative P 35,000

19. Increase in sales (60,000 x P3) P180,000
Less: Increase in variable cost (60,000 x P2.50) 150,000
Net increase in income P 30,000

20. R S T
Sales (10,000 x P20) P200,000 P200,000 P200,000
Less: Variable costs
R (P12 x 10,000) 120,000
S (P 8 x 10,000) 80,000
T (P 4 x 10,000) 40,000
Contribution margin P 80,000 P120,000 P160,000

21. R S T
Sales (P16 x 15,000) P240,000 P240,000 P240,000
Less: Variable costs
R (P12 x 15,000) 180,000
S (P 8 x 15,000) 120,000
T (P 4 x 15,000) 60,000
Contribution margin P 60,000 P120,000 P180,000
Less: Fixed costs 40,000 80,000 120,000
Operating income P 20,000 P 40,000 P 60,000
Chapter 19 Relevant Costs for Decision Making
19-14






22. Old operating income:
Contribution margin P80,000
Less: Fixed cost 40,000
P40,000
New operating income 20,000
Difference - decrease P20,000

23. Sales P1,200,000
Less: Variable costs
Direct materials P300,000
Direct labor 400,000
Factory overhead 80,000
Marketing expenses 70,000
Administrative expenses 50,000 900,000
Contribution margin P 300,000
Less: Fixed costs
Factory overhead P 50,000
Marketing expenses 30,000
Administrative expenses 20,000
Increase in fixed costs 10,000 110,000
Profit P 190,000

24. Sales P1,200,000
Less: Variable costs
Direct materials P275,000
Direct labor 375,000
Factory overhead 80,000
Marketing expenses 70,000
Administrative expenses 50,000 850,000
Contribution margin P 350,000
Less: Fixed costs
Factory overhead P 50,000
Marketing expenses 30,000
Administrative expenses 20,000
Relevant Costs for Decision Making Chapter 19
19-15
Decrease in fixed costs
(P25,000 4) (6,250) 93,750
Profit P 256,250



25. Direct materials (P2 x 5,000) P10,000
Direct labor (P8 x 5,000) 40,000
Variable overhead (P4 x 5,000) 20,000
Total variable costs P70,000
Add: Avoidable fixed overhead 10,000
Total P80,000

26. Avoidable fixed overhead P 4
Direct materials 4
Direct labor 16
Variable overhead 18
Total P42
Multiplied by: Number of units to be produced 20,000
Total relevant costs to make the part P840,000

27. Purchase cost (P1.25 x 10,000) P12,500
Variable costs to make 10,000
Savings of making the blade P 2,500

28. Selling price per unit P17
Less: Variable costs of goods sold per unit
([P320,000 - P80,000] 20,000 units) 12
Contribution margin per unit P 5
Multiplied by units to be sold under Special Order 2,000
Increase in operating income P10,000

29. Budgeted operating income:
Contribution margin (P2,000,000 x 30%) P600,000
Less fixed costs 400,000
Net operating income P200,000
Operating income under the proposal:
Sales P2,000,000
Less Variable costs
([70% x P2,000,000] x 80%) 1,120,000
Chapter 19 Relevant Costs for Decision Making
19-16
Contribution margin P 880,000
Less fixed costs 520,000 360,000
Increase in budgeted operating profit P160,000