Chapter 13

Relevant Costs for Decision Making

Exercise 13-1 (15 minutes)
Case 1 Case 2
Item Relevant
Not
Relevant Relevant
Not
Relevant
a. Sales.............................. X X
b. Direct materials.............. X X
c. Direct labor.................... X X
d. Variable manufacturing
overhead..................... X X
e. Depreciation Model
1!! machine............. X X
f. oo" value Model
1!! machine............. X X
g. Disposal value Model
1!! machine............. X X
h. Mar"et valueModel
#!! machine (cost)... X X
i. $i%ed manufacturing
overhead..................... X X
&. Variable selling e%pense X X
". $i%ed selling e%pense.... X X
l. 'eneral administrative
overhead..................... X X
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Solutions Manual. -hapter 1# 1
Exercise 13-2 (#! minutes)
1. 2o. production and sale of the racing bi"es should not be discontinued.
/f the racing bi"es *ere discontinued. then the net operating income for
the compan3 as a *hole *ould decrease b3 411.!!! each 5uarter6
7ost contribution margin................................... 4(08.!!!)
$i%ed costs that can be avoided6
1dvertising. traceable.................................... 4 9.!!!
Salar3 of the product line manager................ 1!.!!! 19.!!!
Decrease in net operating income for the
compan3 as a *hole...................................... 4(11.!!!)
)he depreciation of the special e5uipment is a sun" cost and is not
relevant to the decision. )he common costs are allocated and *ill
continue regardless of *hether or not the racing bi"es are discontinued:
thus. the3 are not relevant to the decision.
1lternative Solution6
Current
Total
Total If
Racing
Bikes Are
Dropped
Difference:
Net
Operating
Income
Increase or
Decrease!
Sales.............................................. 4#!!.!!! 40;!.!!! 4(9!.!!!)
Variable e%penses......................... 10!.!!! <8.!!! ##.!!!
-ontribution margin....................... 1<!.!!! 15#.!!! (08.!!! )
$i%ed e%penses6
1dvertising. traceable................. #!.!!! 0;.!!! 9.!!!
Depreciation on special
e5uipment=............................... 0#.!!! 0#.!!! !
Salaries of product managers..... #5.!!! 05.!!! 1!.!!!
-ommon allocated costs............ 9!.!!! 9!.!!! !
)otal fi%ed e%penses...................... 1;<.!!! 1#0.!!! 19.!!!
2et operating income.................... 4 #0.!!! 4 01.!!! 4 (11.!!! )
=/ncludes pro+rated loss on the special e5uipment if it is disposed of.
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0 Managerial 1ccounting. 1#th >dition
Exercise 13-2 (continued)
0. )he segmented report can be improved b3 eliminating the allocation of
the common fi%ed e%penses. $ollo*ing the format introduced in -hapter
10 for a segmented income statement. a better report *ould be6
Total
Dirt
Bikes
"ountain
Bikes
Racing
Bikes
Sales..................................... 4#!!.!!! 4?!.!!! 415!.!!! 49!.!!!
Variable manufacturing and
selling e%penses................. 10!.!!! 08.!!! 9!.!!! ##.!!!
-ontribution margin............... 1<!.!!! 9#.!!! ?!.!!! 08.!!!
)raceable fi%ed e%penses6
1dvertising.......................... #!.!!! 1!.!!! 1;.!!! 9.!!!
Depreciation of special
e5uipment........................ 0#.!!! 9.!!! ?.!!! <.!!!
Salaries of the product line
managers......................... #5.!!! 10.!!! 1#.!!! 1!.!!!
)otal traceable fi%ed
e%penses............................ <<.!!! 0<.!!! #9.!!! 0;.!!!
@roduct line segment margin. ?0.!!! 4#5.!!! 4 5;.!!! 4 #.!!!
-ommon fi%ed e%penses....... 9!.!!!
2et operating income............ 4 #0.!!!
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Solutions Manual. -hapter 1# #
Exercise 13-3 (#! minutes)
1. #er $nit
Differential
Costs 1%&''' units
"ake Bu( "ake Bu(
-ost of purchasing......................... 4#5 4505.!!!
Direct materials.............................. 41; 401!.!!!
Direct labor.................................... 1! 15!.!!!
Variable manufacturing overhead. . # ;5.!!!
$i%ed manufacturing overhead.
traceable
1
.................................... 0 #!.!!!
$i%ed manufacturing overhead.
common......................................
)otal costs...................................... 40? 4#5 4;#5.!!! 4505.!!!
Difference in favor of continuing to
ma"e the carburetors.................. 49 4?!.!!!
Anl3 the supervisor3 salaries can be avoided if the carburetors are
purchased. )he remaining boo" value of the special e5uipment is a
sun" cost: hence. the 4; per unit depreciation e%pense is not
relevant to this decision.
ased on these data. the compan3 should re&ect the offer and should
continue to produce the carburetors internall3.
0. "ake Bu(
-ost of purchasing (part 1).............................. 4505.!!!
-ost of ma"ing (part 1).................................... 4;#5.!!!
Apportunit3 costsegment margin foregone
on a potential ne* product line..................... 15!.!!!
)otal cost......................................................... 45<5.!!! 4505.!!!
Difference in favor of purchasing from the
outside supplier............................................ 49!.!!!
)hus. the compan3 should accept the offer and purchase the
carburetors from the outside supplier.
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; Managerial 1ccounting. 1#th >dition
Exercise 13-4 (15 minutes)
Anl3 the incremental costs and benefits are relevant. /n particular. onl3 the
variable manufacturing overhead and the cost of the special tool are
relevant overhead costs in this situation. )he other manufacturing overhead
costs are fi%ed and are not affected b3 the decision.
#er $nit
Total
for 2'
Bracelets
/ncremental revenue............................... 419?.?5 4#.#??.!!
/ncremental costs6
Variable costs6
Direct materials................................. 4 <;.!! 1.9<!.!!
Direct labor........................................ ;5.!! ?!!.!!
Variable manufacturing overhead..... ;.!! <!.!!
Special filigree................................... 0.!! ;!.!!
)otal variable cost................................ 41#5.!! 0.8!!.!!
$i%ed costs6
@urchase of special tool.................... 05!.!!
)otal incremental cost............................ 0.?5!.!!
/ncremental net operating income.......... 4 ;;?.!!
>ven though the price for the special order is belo* the compan3Bs regular
price for such an item. the special order *ould add to the compan3Bs net
operating income and should be accepted. )his conclusion *ould not
necessaril3 follo* if the special order affected the regular selling price of
bracelets or if it re5uired the use of a constrained resource.
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Solutions Manual. -hapter 1# 5
Exercise 13-5 (#! minutes)
1. A B C
(1) -ontribution margin per unit.............................. 45; 41!< 49!
(0) Direct material cost per unit.............................. 40; 480 4#0
(#) Direct material cost per pound.......................... 4< 4< 4<
(;) @ounds of material re5uired per unit (0) C (#). . . # ? ;
(5) -ontribution margin per pound (1) C (;)............ 41< 410 415
0. )he compan3 should concentrate its available material on product 16
A B C
-ontribution margin per pound (above). . 4 1< 4 10 4 15
@ounds of material available................... D 5.!!! D 5.!!! D 5.!!!
)otal contribution margin......................... 4?!.!!! 49!.!!! 485.!!!
1lthough product 1 has the lo*est contribution margin per unit and the
second lo*est contribution margin ratio. it is preferred over the other t*o
products because it has the greatest amount of contribution margin per
pound of material. and material is the compan3Es constrained resource.
#. )he price arlo* -ompan3 *ould be *illing to pa3 per pound for
additional ra* materials depends on ho* the materials *ould be used. /f
there are unfilled orders for all of the products. arlo* *ould presumabl3
use the additional ra* materials to ma"e more of product 1. >ach pound
of ra* materials used in product 1 generates 41< of contribution margin
over and above the usual cost of ra* materials. )herefore. arlo*
should be *illing to pa3 up to 409 per pound (4< usual price plus 41<
contribution margin per pound) for the additional ra* material. but *ould
of course prefer to pa3 far less. )he upper limit of 409 per pound to
manufacture more product 1 signals to managers ho* valuable
additional ra* materials are to the compan3.
/f all of the orders for product 1 have been filled. arlo* -ompan3 *ould
then use additional ra* materials to manufacture product -. )he
compan3 should be *illing to pa3 up to 40# per pound (4< usual price
plus 415 contribution margin per pound) for the additional ra* materials
to manufacture more product -. and up to 40! per pound (4< usual price
plus 410 contribution margin per pound) to manufacture more product
if all of the orders for product - have been filled as *ell.
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9 Managerial 1ccounting. 1#th >dition
Exercise 13-6 (1! minutes)
A B C
Selling price after further processing. . . 40! 41# 4#0
Selling price at the split+off point.......... 19 < 05
/ncremental revenue per pound or
gallon................................................ 4 ; 4 5 4 8
)otal 5uarterl3 output in pounds or
gallons............................................... D 15.!!! D 0!.!!! D ;.!!!
)otal incremental revenue.................... 49!.!!! 41!!.!!! 40<.!!!
)otal incremental processing costs...... 9#.!!! <!.!!! #9.!!!
)otal incremental profit or loss............. 4(#.!!!) 4 0!.!!! 4(<.!!!)
)herefore. onl3 product should be processed further.
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Solutions Manual. -hapter 1# 8
Exercise 13-7 (0! minutes)
)he costs that can be avoided as a result of purchasing from the outside
are relevant in a ma"e+or+bu3 decision. )he anal3sis is6
#er $nit
Differential
Costs )'&''' $nits
"ake Bu( "ake Bu(
-ost of purchasing.................... 401.!! 49#!.!!!
-ost of ma"ing6
Direct materials...................... 4 #.9! 41!<.!!!
Direct labor............................. 1!.!! #!!.!!!
Variable overhead................... 0.;! 80.!!!
$i%ed overhead....................... #.!! = ?!.!!!
)otal cost................................... 41?.!! 401.!! 458!.!!! 49#!.!!!
)he remaining 49 of fi%ed overhead cost *ould not be relevant.
because it *ill continue regardless of *hether the compan3 ma"es
or bu3s the parts.
)he 4<!.!!! rental value of the space being used to produce part S+9 is an
opportunit3 cost of continuing to produce the part internall3. )hus. the
complete anal3sis is6
"ake Bu(
)otal cost. as above............................................ 458!.!!! 49#!.!!!
Fental value of the space (opportunit3 cost)...... <!.!!!
)otal cost. including opportunit3 cost.................. 495!.!!! 49#!.!!!
2et advantage in favor of bu3ing........................ 40!.!!!
@rofits *ould increase b3 40!.!!! if the outside supplierEs offer is accepted.
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< Managerial 1ccounting. 1#th >dition
Exercise 13- (0! minutes)
1. $i%ed cost per mile (45.!!!= C 5!.!!! miles)..... 4!.1!
Variable cost per mile......................................... !.!8
1verage cost per mile......................................... 4!.18
= /nsurance........................... 41.9!!
7icenses............................. 05!
)a%es................................. 15!
'arage rent........................ 1.0!!
Depreciation....................... 1.<!!
)otal................................... 45.!!!
)his ans*er assumes the resale value of the truc" does not decline
because of the *ear+and+tear that comes *ith use.
0. )he insurance. the licenses. and the variable costs (gasoline. oil. tires.
and repairs) *ould all be relevant to the decision because these costs
are avoidable b3 not using the truc". (,o*ever. the o*ner of the garage
might insist that the truc" be insured and licensed if it is left in the
garage. /n that case. the insurance and licensing costs *ould not be
relevant because the3 *ould be incurred regardless of the decision.)
)he ta%es *ould not be relevant because the3 must be paid regardless
of use: the garage rent *ould not be relevant because it must be paid to
par" the truc": and the depreciation *ould not be relevant because it is a
sun" cost. ,o*ever. an3 decrease in the resale value of the truc" due to
its use *ould be relevant.
#. Anl3 the variable costs of 4!.!8 *ould be relevant because the3 are the
onl3 costs that can be avoided b3 having the deliver3 done
commerciall3.
;. /n this case. onl3 the fi%ed costs associated *ith the second truc" *ould
be relevant. )he variable costs *ould not be relevant because the3
*ould not differ bet*een having one or t*o truc"s. (Students are
inclined to thin" that variable costs are al*a3s relevant in decision+
ma"ing. and to thin" that fi%ed costs are al*a3s irrelevant. )his
re5uirement helps to dispel that notion.)
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Solutions Manual. -hapter 1# ?
Exercise 13-! (#! minutes)
2o. the bilge pump product line should not be discontinued. )he
computations are6
-ontribution margin lost if the line is dropped....... G(;9!.!!!)
$i%ed costs that can be avoided6
1dvertising......................................................... G08!.!!!
Salar3 of the product line manager.................... #0.!!!
/nsurance on inventories.................................... <.!!! #1!.!!!
2et disadvantage of dropping the line.................. G (15!.!!! )
)he same solution can be obtained b3 preparing comparative income
statements6
*eep
#roduct
+ine
Drop
#roduct
+ine
Difference:
Net
Operating
Income
Increase or
Decrease!
Sales.................................................. G <5!.!!! G ! G (<5!.!!! )
Variable e%penses6
Variable manufacturing e%penses.... ##!.!!! ! ##!.!!!
Sales commissions.......................... ;0.!!! ! ;0.!!!
Shipping........................................... 1<.!!! ! 1<.!!!
)otal variable e%penses...................... #?!.!!! ! #?!.!!!
-ontribution margin............................ ;9!.!!! ! (;9!.!!! )
$i%ed e%penses6
1dvertising....................................... 08!.!!! ! 08!.!!!
Depreciation of e5uipment............... <!.!!! <!.!!! !
'eneral factor3 overhead................ 1!5.!!! 1!5.!!! !
Salar3 of product line manager........ #0.!!! ! #0.!!!
/nsurance on inventories.................. <.!!! ! <.!!!
@urchasing department.................... ;5.!!! ;5.!!! !
)otal fi%ed e%penses........................... 5;!.!!! 0#!.!!! #1!.!!!
2et operating loss.............................. G (<!.!!! ) G (0#!.!!! ) G (15!.!!! )
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1! Managerial 1ccounting. 1#th >dition
Exercise 13-1" (#! minutes)
1. )he relevant costs of a hunting trip *ould be6
)ravel e%pense (1!! miles H 4!.01 per mile) 401
Shotgun shells................................................ 0!
Ane bottle of *his"e3...................................... 15
)otal................................................................ 459
)his ans*er assumes that ill *ould not be drin"ing the bottle of
*his"e3 an3*a3. /t also assumes that the resale values of the camper.
pic"up truc". and boat are not affected b3 ta"ing one more hunting trip.
)he mone3 lost in the po"er game is not relevant because ill *ould
have pla3ed po"er even if he did not go hunting. ,e pla3s po"er ever3
*ee"end.
)he other costs are sun" at the point at *hich the decision is made to go
on another hunting trip.
0. /f ill gets luc"3 and bags another t*o duc"s. all of his costs are li"el3 to
be about the same as the3 *ere on his last trip. )herefore. it reall3
doesnEt cost him an3thing to shoot the last t*o duc"se%cept possibl3
the costs for e%tra shotgun shells. )he costs are reall3 incurred in order
to be able to hunt duc"s and *ould be the same *hether one. t*o.
three. or a doIen duc"s *ere actuall3 shot. 1ll of the costs. *ith the
possible e%ception of the costs of the shotgun shells. are basicall3 fi%ed
*ith respect to ho* man3 duc"s are actuall3 bagged during an3 one
hunting trip.
#. /n a decision of *hether to give up hunting entirel3. more of the costs
listed b3 John are relevant. /f ill did not hunt. he *ould not need to pa3
for6 gas. oil. and tires: shotgun shells: the hunting license: and the
*his"e3. /n addition. he *ould be able to sell his camper. e5uipment.
boat. and possibl3 pic"up truc". the proceeds of *hich *ould be
considered relevant in this decision. )he original costs of these items
are not relevant. but their resale values are relevant.
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Solutions Manual. -hapter 1# 11
Exercise 13-1" (continued)
)hese three re5uirements illustrate the slipper3 nature of costs. 1 cost
that is relevant in one situation can be irrelevant in the ne%t. 2one of the
costse%cept possibl3 the cost of the shotgun shellsare relevant
*hen *e compute the cost of bagging a particular duc": some of them
are relevant *hen *e compute the cost of a hunting trip: and more of
them are relevant *hen *e consider the possibilit3 of giving up hunting.
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10 Managerial 1ccounting. 1#th >dition
Exercise 13-11 (1! minutes)
Sales value if processed further
(8.!!! units D 410 per unit).................. 4<;.!!!
Sales value at the split+off point
(8.!!! units D 4? per unit).................... 9#.!!!
/ncremental revenue............................... 01.!!!
7ess cost of processing further............... ?.5!!
2et advantage of processing further....... 411.5!!
)he 49!.!!! cost incurred up to the split+off point is not relevant in a
decision of *hat to do after the split+off point.
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Solutions Manual. -hapter 1# 1#
Exercise 13-12 (15 minutes)
)he compan3 should accept orders first for @roduct -. second for @roduct
1. and third for @roduct . )he computations are6
#roduct
A
#roduct
B
#roduct
C
(1) Direct materials re5uired per unit....... 40; 415 4?
(0) -ost per pound................................... 4# 4# 4#
(#) @ounds re5uired per unit (1) C (0)...... < 5 #
(;) -ontribution margin per unit............... 4#0 41; 401
(5) -ontribution margin per pound of
materials used (;) C (#).................... 4;.!! 40.<! 48.!!
ecause @roduct - uses the least amount of material per unit of the three
products. and because it is the most profitable of the three in terms of its
use of materials. some students *ill immediatel3 assume that this is an
infallible relationship. )hat is. the3 *ill assume that the *a3 to spot the
most profitable product is to find the one using the least amount of the
constrained resource. )he *a3 to dispel this notion is to point out that
@roduct 1K uses more material (the constrained resource) than @roduct .
but 3et it is preferred over @roduct . T,e ke( factor is not ,o- muc, of a
constrained resource a product uses& .ut rat,er ,o- muc, contri.ution
margin t,e product generates per unit of t,e constrained resource/
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1; Managerial 1ccounting. 1#th >dition
Exercise 13-13 (15 minutes)
1. 1nnual profits *ill increase b3 4#?.!!!6
#er $nit
1%&'''
$nits
/ncremental sales.................................. 41;.!! 401!.!!!
/ncremental costs6
Direct materials................................... 5.1! 89.5!!
Direct labor......................................... #.<! 58.!!!
Variable manufacturing overhead....... 1.!! 15.!!!
Variable selling and administrative...... 1.5! 00.5!!
)otal incremental costs.......................... 11.;! 181.!!!
/ncremental profits................................. 4 0.9! 4 #?.!!!
)he fi%ed costs are not relevant to the decision because the3 *ill be
incurred regardless of *hether the special order is accepted or re&ected.
0. )he relevant cost is 41.5! (the variable selling and administrative
e%penses). 1ll other variable costs are sun" because the units have
alread3 been produced. )he fi%ed costs are not relevant because the3
*ill not change in total as a conse5uence of the price charged for the
left+over units.
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Solutions Manual. -hapter 1# 15
Exercise 13-14 (1! minutes)
-ontribution margin lost if the 7inens Department is dropped6
7ost from the 7inens Department............................................. 49!!.!!!
7ost from the ,ard*are Department (1!L D 40.1!!.!!!)........ 01!.!!!
)otal lost contribution margin....................................................... <1!.!!!
7ess fi%ed costs that can be avoided (4<!!.!!! M 4#;!.!!!)..... ;9!.!!!
Decrease in profits for the compan3 as a *hole......................... 4#5!.!!!
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19 Managerial 1ccounting. 1#th >dition
Exercise 13-15 (15 minutes)
)he target production level is ;!.!!! starters per period. as sho*n b3 the
relations bet*een per+unit and total fi%ed costs.
0Cost1
#er
Differential
Costs
$nit "ake Bu( 23planation
Direct materials...... 4#.1! 4#.1! -an be avoided b3 bu3ing
Direct labor............ 0.8! 0.8! -an be avoided b3 bu3ing
Variable
manufacturing
overhead............. !.9! !.9! -an be avoided b3 bu3ing
Supervision............ 1.5! 1.5! -an be avoided b3 bu3ing
Depreciation 1.!! Sun" -ost
Fent....................... !.#! 1llocated -ost
Autside purchase
price.................... 4<.;!
)otal cost................ 4?.0! 48.?! 4<.;!
)he compan3 should ma"e the starters. rather than continuing to bu3
from the outside supplier. Ma"ing the starters *ill result in a 4!.5! per
starter cost savings. or a total savings of 40!.!!! per period6
4!.5! per starter D ;!.!!! starters N 40!.!!!
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Solutions Manual. -hapter 1# 18
Exercise 13-16 (0! minutes)
1. $i%ed cost per mile (4#.0!!= C 1!.!!! miles). . . 4!.#0
Variable operating cost per mile....................... !.1;
1verage cost per mile....................................... 4!.;9
= Depreciation.............................. 41.9!!
/nsurance.................................. 1.0!!
'arage rent............................... #9!
1utomobile ta% and license....... ;!
)otal........................................... 4#.0!!
0. )he variable operating cost is relevant in this situation. )he depreciation
is not relevant because it is a sun" cost. ,o*ever. an3 decrease in the
resale value of the car due to its use is relevant. )he automobile ta% and
license costs *ould be incurred *hether Oristen decides to drive her
o*n car or rent a car for the trip during spring brea" and therefore are
irrelevant. /t is unli"el3 that her insurance costs *ould increase as a
result of the trip. so the3 are irrelevant as *ell. )he garage rent is
relevant onl3 if she could avoid pa3ing part of it if she drives her o*n car.
#. Phen figuring the incremental cost of the more e%pensive car. the
relevant costs include the purchase price of the ne* car (net of the
resale value of the old car) and the increases in the fi%ed costs of
insurance and automobile ta% and license. )he original purchase price of
the old car is a sun" cost and therefore is irrelevant. )he variable
operating cost *ould be the same and therefore is irrelevant. (Students
are inclined to thin" that variable costs are al*a3s relevant and fi%ed
costs are al*a3s irrelevant in decisions. )his re5uirement helps to dispel
that notion.)
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1< Managerial 1ccounting. 1#th >dition