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com/doc/60189531/Chapter14-Decision-Making-Relevant-Costs-and-Benefits Pearson

1.

What is the validity of the following statements? (1) When deciding between alternative courses of action past costs should always be ignored. (2) When deciding between alternative courses of action all future costs should always be taken into account.

A B C D

Statement (1) (2) True True True False False True False False
Your Answer: C

Correct Answer: D Some future costs (for example, those that do not vary with the decision) can be ignored, whereas all past costs should be ignored as they cannot be affected by the decision. Thus both statements are false.

2.

Lynher Ltd has been offered a contract that requires the use of specialised equipment that it has owned for three years. The specialised equipment is no longer used by the company but can be rented to another company. The accountant of Lynher Ltd has provided the following data concerning the machine:

Net realisable value Acquisition cost Future rental income from machine Replacement cost

18,000 25,000 28,000 32,000

What is the relevant cost of the machine when considering the new contract? Your Answer: 32,000 Correct Answer: 28,000 The replacement cost is irrelevant as the machine is no longer used and the acquisition cost is a sunk cost (which is also irrelevant). The net realisable value is below the future rental value and so will not represent the opportunity foregone.

3.

The following data relates to 20 tonnes of chemical X105 that is currently in stock and can be used to fulfil a contract.

Purchase cost Replacement cost Net realisable value

2,800 3,200 3,000

The material is no longer used for production and so, unless it is used in this contract it will be converted into 15 tonnes of chemical X106 at a cost of 400. This chemical is widely used in the production process and such a quantity has a cost of 3,500. What is the relevant cost of chemical X105 when considering the viability of the contract? Your Answer: 3,100

4.

Yealm (Boat builders) Ltd has been asked to refit a boat for a customer. Skilled labour costing 8 per hour will be required for the refit. The workers will have to be taken off the production of canoes for resale for a total of 240 hours. The canoes are sold for 200 each and take 12 hours of skilled labour. The material cost of each canoe is 60. What is the relevant cost of labour when assessing the viability of the refit contract? Your Answer: 1920 Correct Answer: 2,800 The relevant cost of labour is: Opportunity cost [20 x (200 - 60)]

2,800

5.

Tamar Builders Ltd has been asked to build a conservatory for a customer. The conservatory will require 15 hours supervision time by a foreman who is paid 10 per hour. The foreman has spare capacity during normal working hours but it is estimated that 10 hours of the supervision will have to undertaken outside normal working hours and will be paid at 12 per hour. Semi-skilled workers will be required for the job for 150 hours in total. The current rate per hour is 7. The company has some spare capacity, at present, and so these workers have been undertaking jobs that are normally undertaken by unskilled workers. If the semi-skilled workers are required to build the conservatory, they will be taken off the unskilled jobs that will be done by unskilled workers who are normally paid 5 per hour. However, because the unskilled workers are already fully occupied, they will do the jobs outside normal working hours at an overtime rate of 6 per hour. What is the relevant cost of labour when assessing the viability of the conservatory contract?

Your Answer: 920 Correct Answer: 1,020 The relevant cost of labour is:

10 hours @12 per hour 150 hours @6 per hour 120 900 1020

6.

Consider the following types of cost: 1. 2. 3. 4. sunk costs committed costs opportunity costs outlay costs

Which of the above will always be irrelevant when considering a particular course of action? Your Answer: 1 only Correct Answer: 1 and 2 Sunk costs are past costs and committed costs are, in effect, past costs.

7.

Exmouth Marine Engineers Ltd owns a cruiser yacht that is in need of repair. The cruiser yacht was taken in lieu of payment for an unpaid bill for 3,400. The company is working to full capacity but is considering refurbishing the yacht for resale. Workers who are paid 10 per hour will carry out the refurbishment and it is estimated that 100 hours work is required. The normal labour charge for customers is 20 per hour. The company believes that the cruiser yacht could be sold for 3,100 in its current condition. Materials costing 500 would be required to carry out the refurbishment. These materials are currently in stock as they are frequently used by the business. What is the minimum resale price that the business would have to charge to justify the refurbishment? Your Answer: 5,600

8.

Dursley Ltd is a research company that has invested 70,000 to date in developing a new type of cream to arrest the effects of ageing on the skin. The research has not been entirely successful as there has been no interest in the new cream from healthcare companies. Recently, however, a cosmetics company has made enquiries about the cream and its potential as a sun blocker. Dursley Ltd believes that there is such potential for the cream, however, further research would have to be carried out. The company would have to extend the research contracts of two research chemists for a further year at a cost of 80,000. The research chemists are due to be made redundant at a total cost of 30,000. However, if the contract is extended the

redundancy cost will be 40,000 at the end of the contract. The further research that will have to be carried out will take up one quarter of the laboratory space available within the company. The company rents the laboratory at an annual cost of 60,000 per annum. What is the minimum price that Dursley Ltd could charge the cosmetics company to justify the additional research? Your Answer: 105,000 Correct Answer: 90,000 The minimum price is:

Cost of research chemists contract 80,000 Additional redundancy payments 10,000 90,000

9.

Staverton Manufacturers Ltd has the following materials in stock:

No. of units held Purchase cost per unit Net realisable value Replacement cost

Y50 100 7 6 8

Y60 150 12 5 4

The company has been asked to tender for a contract that requires 200 units of Y50 and 100 units of Y60. Y50 cannot be used for any other purpose within the business except the new contract. Y60 is in frequent use by the company. What is the relevant cost of the materials for the purpose of pricing the contract? Your Answer: 2,600 Correct Answer: 1,900 The relevant cost is:

Y50 100 units @ 6 each 100 units @ 8 each Y60 100 units @ 5 each

600 800 500 1,900

10.

Thornbury Ltd has the following chemicals in stock:

No. of litres held Purchase cost per unit Net realisable value Replacement cost

V20 180 8 10

V40 250 15 12 16

The company has been asked to tender for a contract that requires 300 litres of V20 and 200 litres of V40. V20 is very toxic and, if it is not used for this particular job, it will have to be disposed safely at a cost of 200. The company no longer uses V40. What is the relevant cost of the materials for the purpose of pricing the contract? Your Answer: 3,600 Correct Answer: 3,400 The relevant cost is:

V20

120 units @ 10 Disposal savings 200 units @ 12

1,200 (200) 2,400 3,400

V40