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 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:
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.

19-1

Chapter 19 Relevant Costs for Decision Making

II. Exercises
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

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
19-2

Relevant Costs for Decision Making Chapter 19

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, traceable1 .......................................................................
20
300,000
Fixed manufacturing overhead, common .........................................................................
0
0
0
0
Total costs .......................................................................................................................
P170
P200 P2,550,000 P3,000,000
Difference in favor of continuing to make
19-3

P30

P450,000

Chapter 19 Relevant Costs for Decision Making

1

the parts......................................................................................................................
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
Total variable cost ............................................................................................
P2,420.00
24,200.00
Fixed costs:
Purchase of special tool.................................................................................
4,650.00
Total incremental cost ..........................................................................................
28.850.00
19-4

Relevant Costs for Decision Making Chapter 19

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

(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
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
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
19-5

Chapter 19 Relevant Costs for Decision Making

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)

Selling price per unit

Less Variable costs/unit:
Materials
Labor
Factory overhead (25%)
Contribution margin/unit
Multiplied by number of units to be sold
19-6

Product A
P1.20

Product B
P1.40

0.50
0.20
0.10
0.80
P0.40
21,000 units

0.70
0.24
0.14
1.08
P0.32
30,000 units

Relevant Costs for Decision Making Chapter 19

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............................................
Less fixed costs that can be avoided:
Advertising traceable .................................
Line supervisors salaries ..............................
Decrease in net operating income for the
company as a whole......................................

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

47,000
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
19-7

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

Chapter 19 Relevant Costs for Decision Making

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

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

Product Line
B
C
P25
P10
10
5
P15
P 5

A
P30
25
P5
5 hrs.
P1

3. C

10 hrs.
P1.5

4 hrs.
P1.25

D
P8
4
P4
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.

19-8

Relevant Costs for Decision Making Chapter 19

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:
(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

Requirement 2
19-9

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

Chapter 19 Relevant Costs for Decision Making

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
4,000
5,000
6,000

No. of months
6
15
9
30

Probability
20%
50%
30%
100%

Requirement (b)

Sales (4,000 x P40)

Less variable costs
Production cost @ P25
Purchase cost @ P45
Total

4,000 units
P160,000

Production
5,000 units
P160,000

6,000 units
P160,000

100,000
P100,000

125,000
P125,000

150,000
P150,000

19-10

Relevant Costs for Decision Making Chapter 19

Contribution margin

P 60,000

P 35,000

P 10,000

Sales (5,000 x P40)

Less variable costs
Production cost @ P25
Purchase cost @ P45
Total
Contribution margin

P200,000

P200,000

P200,000

100,000
45,000
P145,000
P 55,000

125,000
P125,000
P 75,000

150,000
P150,000
P 50,000

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 (6,000 x P40)

Less variable costs
Production cost @ P25
Purchase cost @ P45
Total
Contribution margin
Requirement (c)

Sales Order
Contribution Margin
4,000
P35,000
5,000
75,000
6,000
70,000
Average Contribution Margin

Probability
0.20
0.50
0.30

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

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)

19-11

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

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

Chapter 19 Relevant Costs for Decision Making

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

C
C
B
B
A
B
C
B
A
B

11.
12.
13.
14.
15.
16.
17.
18.
19.
20.

D
A
D
A
D
C
A
C
B
C

21.
22.
23.
24.
25.
26.
27.
28.
29.
30.

D
A
D
E
B
D
D
C
A
A

31.
32.
33.
34.
35.

A
D
C
A
C

Supporting computations for nos. 16 - 29:

16. Sales [(100,000 x 90%) x (P5.00 x 120%)]
19-12

P540,000

Relevant Costs for Decision Making Chapter 19

Less: Variable costs (P300,000 x 90%)

Contribution margin
Less: Fixed costs
Operating income

270,000
P270,000
150,000
P120,000

17. Direct materials

Direct labor
Overhead
Selling cost
Minimum selling price per unit

P 4
5
2
3
P14

18. Relevant cost to make (10,000 x P24)

Purchase cost
Less: Savings in manufacturing cost
Avoidable fixed overhead
Net purchase price
Difference in favor of buy alternative

P240,000
P300,000
P45,000
50,000

19. Increase in sales (60,000 x P3)

Less: Increase in variable cost (60,000 x P2.50)
Net increase in income
20.
Sales (10,000 x P20)
Less: Variable costs
R (P12 x 10,000)
S (P 8 x 10,000)
T (P 4 x 10,000)
Contribution margin
21.
Sales (P16 x 15,000)
Less: Variable costs
R (P12 x 15,000)
S (P 8 x 15,000)
T (P 4 x 15,000)
Contribution margin
Less: Fixed costs

R
P200,000

95,000
P205,000
P 35,000
P180,000
150,000
P 30,000

S
P200,000

T
P200,000

120,000
80,000
P 80,000

P120,000

40,000
P160,000

R
P240,000

S
P240,000

T
P240,000

180,000
120,000
P 60,000
40,000
19-13

P120,000
80,000

60,000
P180,000
120,000

Chapter 19 Relevant Costs for Decision Making

Operating income

P 20,000

P 40,000

22. Old operating income:

Contribution margin
Less: Fixed cost

P 60,000

P80,000
40,000
P40,000
20,000
P20,000

New operating income

Difference - decrease
23. Sales
Less: Variable costs
Direct materials
Direct labor
Factory overhead
Marketing expenses
Administrative expenses
Contribution margin
Less: Fixed costs
Factory overhead
Marketing expenses
Administrative expenses
Increase in fixed costs
Profit
24. Sales
Less: Variable costs
Direct materials
Direct labor
Factory overhead
Marketing expenses
Administrative expenses
Contribution margin
Less: Fixed costs
Factory overhead
19-14

P1,200,000
P300,000
400,000
80,000
70,000
50,000

P 50,000
30,000
20,000
10,000

900,000
P 300,000

110,000
P 190,000
P1,200,000

P275,000
375,000
80,000
70,000
50,000

P 50,000

850,000
P 350,000

Relevant Costs for Decision Making Chapter 19

Marketing expenses
Administrative expenses
Decrease in fixed costs
(P25,000 4)

30,000
20,000
(6,250)

Profit

25. Direct materials

(P2 x 5,000)
Direct labor
(P8 x 5,000)
Variable overhead
(P4 x 5,000)
Total variable costs
Add: Avoidable fixed overhead
Total
26. Avoidable fixed overhead
Direct materials
Direct labor
Variable overhead
Total
Multiplied by: Number of units to be produced
Total relevant costs to make the part
27. Purchase cost (P1.25 x 10,000)
Variable costs to make
Savings of making the blade
28. Selling price per unit
Less: Variable costs of goods sold per unit
([P320,000 - P80,000] 20,000 units)
Contribution margin per unit
Multiplied by units to be sold under Special Order
Increase in operating income
29. Budgeted operating income:
Contribution margin (P2,000,000 x 30%)
Less fixed costs
Net operating income
Operating income under the proposal:
19-15

93,750
P 256,250

P10,000
40,000
20,000
P70,000
10,000
P80,000
P 4
4
16
18
P42
20,000
P840,000
P12,500
10,000
P 2,500
P17
12
P 5
2,000
P10,000

P600,000
400,000
P200,000

Chapter 19 Relevant Costs for Decision Making

Sales
P2,000,000
Less Variable costs
([70% x P2,000,000] x 80%) 1,120,000
Contribution margin
P 880,000
Less fixed costs
520,000
Increase in budgeted operating profit

19-16

360,000
P160,000