Accounting Ed 12.

Management Science – Relevant Costing Exercises

Make or Buy

1. ABC company manufactures a particular computer component. Currently, the costs per unit are as follows: direct materials,
P50; direct labor, P500; variable overhead, P250; fixed overhead, P400. XYZ has offered to sell 10,000 units of the
component for P1,100 per unit. If ABC accepts the proposal, P2,500,000 of the fixed overhead will be eliminated. Should
ABC make or buy the component? At what advantage?

ANSWER:
ABC Company should make or manufacture a particular computer component, because the net
advantage of making is 500,000

MAKE BUY
Purchase cost (10,000*1,100) P 11,000,000
Variable Manufacturing costs (10,000*800) P 8,000,000
Avoidable fixed overhead 2,500,000
Total relevant costs P 10,500,000 P 11,000,000
Less: cost to make 10,500,000
Net advantage of making P 500,000

*800(P50; direct labor, P500; variable overhead, P250)

2. GHI company manufactures part G for use in the production cycle. The cost per unit for 10,000 units for part G are as
follows: direct materials, P3; direct labor, P15; variable overhead, P6; fixed overhead, P8. TUV Company offered to sell
GHI 10,000 units of part G for P30 per unit. If GHI accepts TUV’s offer, the released facilities could be used to save
P45,000 in relevant costs. In addition, P5 per unit of fixed overhead applied to part G would be totally eliminated. What
alternative is more desirable and by what amount?

ANSWER:
Make Buy
Purchase price (10,000 units x P30) P300,000
Variable production costs (10,000 x P24) P240,000
Avoidable fixed overhead (10,000 x P5) 50,000
Savings from released facilities ( 45,000)
Net relevant costs P290,000 P255,000
Savings (P290,000 – P255,000) P 35,000

Buy, you’ll save P35,000

Accept or Reject a Special Order

1. Tagaytay open-air flea market is along the highway leading to Taal Vista Lodge. Arnel has a stall which specializes in
hand-crafted fruit baskets that sell for P60 each. Daily fixed costs are P15,000 and variable costs are P30 per basket. An
average of 750 baskets is sold each day. Arnel has a capacity of 800 baskets per day. By closing day time yesterday, a bus
load of teachers who attended a seminar at the Development Academy of the Philippines stopped by Arnel’s stall and
collectively offered P1,500 for 40 baskets.
Required: Decide whether Arnel should accept or reject the offer by computing the contribution
margin or loss.

ANSWER:
The special sales order should be accepted because it increases profit by P300

Sales P 1,500
Less: Variable Cost (30*40) 1,200
Contribution Margin P 300

2. Wagner company sells product A at a selling price of P21 per unit. Its cost per unit on the full capacity of 200,000 units are
as follow: direct materials, P4; direct labor, P5; overhead (2/3 of which is fixed), P6. A special order offering to buy 20,000
units were received from a foreign distributor. The only selling costs that would be incurred on this order would be P3 per
units for shipping. The company has sufficient existing capacity to manufacture the additional units.
Required: compute for the minimum selling price that Wagner should accept.

ANSWER:
 Direct Materials P4
Direct Labor 5
Variable overhead 2
Shipping cost 3
Minimum selling price P 14

Drop or Continue a Business Segment

1. Division A of a corporation is being evaluated for elimination. It has contribution to overhead of P400,000. It
receives an allocated overhead of P1 million, 10% of which cannot be eliminated.

Required: Compute by how much the elimination of Division A would affect pre-tax income of the corporation.

ANSWER:
Contribution margin P 400,000
Controllable fixed overhead (P1,000,000*90%) (900,000)
Segment Margin P (500,000)

Since the segment margin is negative, the division should be dropped to eliminate the negative segment margin and
increase in overall net income by P500,000.

2. A company’s partial income statement data are presented below:

S J P

Sales P200,000 P150,000 P125,000

Separate (product) fixed costs 60,000 35,000 40,000

Allocated fixed costs 35,000 40,000 25,000

Variable costs 95,000 75,000 50,000

The company lost its lease and must move to a smaller facility. As a result, total allocated fixed costs will be reduced by 40%.
However, one product must be discontinued.

Required: Identify the product that should be discontinued and compute the expected income after it is discontinued.

ANSWER:
S J P

Sales P200,000 P150,000 P125,000

Variable cost 95,000 75,000 50,000

Separate (product) fixed costs 35,000 40,000 25,000

Contribution Margin P45,000 P40,000 P35,000

Product P gives the lowest profit and shall be discontinued, only two products shall now be produced by the company.

the operating profit of the business shall be:

Contribution margin (P45,000 + P 40,000) P 85,000

Less: Allocated fixed costs [(P35,000 + P40,000 + P25,000) x 60%] 60,000
Operating income P 25,000

Optimization of Scarce Resources

 1. A company has a limited number of machine hours that it can use for manufacturing two products, A & B. Each
product has a selling price of P160 per unit. Product A has 40% contribution margin and product B has 70%
contribution margin. One unit of B takes twice as many machine hours to make as a unit of A.

Required: Identify which product should the limited number of machine hours be used, assuming that either product can be sold
in whatever quantity is produced.

ANSWER: A B
Unit contribution margin (P160 x 40%) P 64 P 112 (P160 x 70%)
Divide: No. of hours per unit 1 hr. 2 hrs.
Contribution margin per hour P 64 P 56
Rank of priority (1) (2)

Product A, having higher contribution margin per hour, should be produced instead of B.

2. Data regarding four different products manufactured by an organization are presented below. Direct materials and
direct labor are readily available from their respective resources. However, the manufacturer is limited to a maximum
of 3,000 machine hours per month.

Product A B C D

Selling price/unit P15 P18 P20 P25

Variable cost/unit 17 11 10 16

Units produced per machine hour 3 4 2 3

Required: Identify the most profitable product of the manufacturer.

ANSWER:

Product A B C D

Selling price/unit P15 P18 P20 P25

Less: Variable cost/unit 17 11 10 16

Contribution margin (2) 7 10 9

Multiplied by units produced P(6) P 28 P 20 P 27

The most profitable product is product be which has a contribution margin of P28.00

Retain or Replace an Old Asset

1. A company has an opportunity to acquire a new equipment to replace one of its existing equipment. The new equipment
would cost P900,000 and has a five-year useful life, with a zero terminal disposal price. Variable operating cost would be
P1 million per year. The present equipment has a book value of P500,000 and a remaining life of five years. Its disposal
price now is P50,000 but would be zero after five years. Variable operating costs would be P1,250,000 per year.

Required: Decide whether to replace or retain the old equipment considering the five years in total, but ignoring the time
value of money and income taxes.

ANSWER: RETAIN REPLACE

Purchase price P 900,000
Book value P 500,000
Useful life (remaining) 5 5
Terminal salvage value 0 0
Salvage value (now) 50,000
Variable operating costs 1,250,000 1,000,000
Annual savings in operating costs (P 1,250,000-P1,000,000) 250,000

Savings in 5 years (P250,000*5yrs) P 1,250,000

Salvage value of old equipment 50,000
 Total cash inflows 1,300,000
Purchase price (900,000)
Net advantage of replacing the old equipment P 400,000

Therefore A Company should replace the old equipment.

2. A company produces motherboard at a special economic zone in Bicol. It is now considering to shift to new automated
equipment instead of its present facility. Management was given the mandate to shift it. Its breakeven point will materially
be improved with a minimum of 10% reduction in volume. Below is the pertinent information:
Existing Automation
Sales in units 800,000 900,000
Selling price P 30 P 30
Variable cost per unit P 15 P 13
Fixed cost P 775,000 P 892,500

Required: Compute the basis of deciding whether the company should shift to automation or not.

ANSWER: Shift, since the break even volume will increase by 1% with the automation

EXISTING: AUTOMATION:

BEP = 775,000/(30-15) BEP= 892,500/(30-13)

= 51,667u =52,500u£

Sell as-is or Process Further

1. A company owns a large processing line which segregates coconuts into its components upon contract with breaker of the
machine. Presently, it sells the coconut meat, juice, shell and husk to various manufacturers. A feasibility study is being
made to process its components into “buko pies” for the meat, “buko juice” for the juice, flower pots for the shells and
fuel briquettes for the husk. At the segregation point, you gathered the following data per unit:

Meat Juice Shell Husk

Selling price P 4.00 P 2.00 P 1.00 P 1.00
Allocated joint cost .13 .06 .03 .03
Profit(loss) 3.87 1.94 .97 .97

The study shows that after further application of additional manufacturing process, the following is projected:

Meat Juice Shell Husk

Selling price P 12.00 P 4.00 P 2.00 P 2.00
Additional processing cost 3.8 2.90 1.95 1.95

Fixed cost of the plant amounts to P500,000. Interest rate is 12%.

Required: Identify which product/s should go through the additional manufacturing process.

ANSWER:
Meat Juice Shell Husk
Incremental sales P 8.00 P 2.00 P 1.00 P 1.00
Incremental cost 3.8 2.90 1.95 1.95
Incremental profit P 4.20 (P .90) (P .95) (P .95)

Coconut meat only because it will give incremental profit of P4.20

2. A company produces 3 products from a joint process costing P 100,000. The following information is available:
Selling price @ Cost/s to Process Sales price after
Product/s Unit/s Split -off Further processing further
A 10,000 P 35 P 60,000 P 40
 B 20,000 P 40 P 20,000 P 45
C 30,000 P 20 P 90,000 P 25

Required: Identify which product/s should go through the additional manufacturing process.

ANSWER:
A B C
Sales value after processing P400,000 P900,000 P750,000
Sales value at split-off point 350,000 800,000 600,000
Incremental revenue from further processing 50,000 100,000 150,000
Incremental cost of further processing 60,000 20,000 90,000
Profit (Loss) from further processing (P10,000) P80,000 P60,000

Products B and C Since, there will be a profit from further processing of P80,000 and P60,000 respectively.

Bid Price

1. A company manufactures engines for the military equipment on a cost-plus basis. The cost of a particular machine the
company manufactures is shown below:
Direct materials P 400,000
Direct labor 300,000
Overhead -
Supervisor’s salary 40,000
Fringe benefits on direct labor 30,000
Depreciation 24,000
Rent 22,000
Total P 816,000

Required: Compute the minimum bid price if the production of the engine was discontinued, the production capacity would
be idle and the supervisor will be laid off.

ANSWER:

Direct materials P 400,000

Direct Labor 300,000
Supervisor’s salary 40,000
Fringe benefits on direct labor 30,000
Incremental costs P 770,000

The costs of depreciation and rental are irrelevant costs since they are expected to be incurred regardless of whether
the bidding is won or not. The minimum bid price is the incremental costs of P770,000

2. A company has its own cafeteria with the following annual costs: food, P 400,000; labor, P 300,000; overhead, P440,000.
The overhead is 40% fixed. Of the fixed overhead, P100,000 is the salary of the cafeteria supervisor. The remainder of the
fixed overhead has been allocated from total company overhead.

Required: Determine the maximum cost that the company is willing to pay an outsider to operate the cafeteria assuming
that the cafeteria supervisor will remain and the company will continue to pay his salary.

ANSWER:
Food P 400,000
Labor 300,000
Variable overhead (440,000*60%) 264,000
Total Incremental cost P 964,000

Temporarily Shut Down Operations or Continue

1. A corporation has been experiencing a slowdown in business activities in August and September and is considering
temporarily shutting down its operations during those months. The accounting department has provided the following
normal operating data for consideration: unit sales price, P 150; unit variable production cost, P 60; unit variable marketing
cost, P10; monthly fixed overhead, P 500,000, monthly fixed expenses, P200,000; regular sales in units, 10,000 per month;
estimated sales in units in August and September, 5,000 per month.

If the company shuts down its operations, the following costs are expected to be incurred: security and safety, P 200,000 per
month; restart-up costs, P 100,000 per set-up, regular fixed overhead, 40% of total will remain; regular fixed expenses,
reduced by 30%.

Required: Compute the total shutdown costs, shutdown point in two months, and the advisable alternative (continuing or
discontinuing the operations) with its advantage amount.

ANSWER:
Unavoidable fixed overhead (P500,000*40%*2) P 400,000
Unavoidable fixed expenses (P200,000*70%*2) 280,000
Security and Safety (P200,000*2) 400,000
Restart up costs 100,000
Total shut down costs P 1,180,000

Fixed costs and expenses [(P500,000+P200,000)*2 months] P 1,400,000

Less: Shut down costs 1,080,000
Divide: Contribution Margin (P150-P60-P10) 80
Shutdown point in two months P 2,750

Contribution Margin (P5,000u*2 months*80) P 800,000

Less: Fixed costs and expenses 1,400,000
Loss on continuing the operations (600,000)
Less: Shut down costs 1,180,000
Net advantage of continuing the operations P 580,000

Scrap or Rework Defective Units

1. A company has 2,000 obsolete light fixtures that are carried in inventory at a manufacturing cost of P30,000. If the fixtures
are reworked for P10,000, they could be sold for P 18,000. Alternatively, the light fixtures could be sold for P 3,000 to a
jobber located in a distant city.

Required: Compute the opportunity cost in the decision to scrap or rework defective units.

ANSWER:
Sales from reworked units P18,000
Less: Additional cost of reworking (10,000)
Income from reworking 8,000
Less: Income from scrapping 3,000
Net advantage of reworking P 5,000

The alternative that gives the higher profitability shall be taken and in this case is the alternative of
reworking. And the alternative of scrapping should be set aside. This alternative would have possibly provide
P3,000 amount of income. The opportunity cost is P3,000.

2. A company has 7,000 obsolete toys carried in inventory at a manufacturing cost of P 6 per unit. If the toys are reworked for
P 2 per unit they could be sold for P 3 per unit. If the toys are scrapped, they could be sold for P1.85 per unit.

Required: Compute the total peso amount of the advantage of the desired alternative.

ANSWER:
Income from reworking units (7,000* P1) P 7,000
Income from scrapping (7,000*P1.85) (12,950)
Net advantage of scrapping P (5,950)

*P1 (P3.00 per unit-P2.00 per unit)

Indifference Point
1. A company owns and operates a chain of movie theaters. The theaters in the chain vary from low volume, small town to
high volume, Big City/Downtown theaters. Management is considering installing machines that will make popcorn on the
premises. This proposed feature would be properly advertised and is intended to increase patronage at the company’s
theaters. These machines are available in two different sizes with the following details:

Economy Popper Regular Popper

Annual capacity 50,000 boxes 120,000 boxes
Costs:
Annual machine rental P 80,000 P 110,000
Popcorn cost per box 1.30 1.30
Cost of each box .80 .80
Other variable costs/box 2.20 1.40

Required: Compute the level of output at which the two poppers would earn the same profit/loss.

ANSWER:
Economy Popper Regular Popper
Fixed costs P 80,000 P 110,000
Unit variable costs 4.30 3.50

P80,000+4.30X = P110,000+3.50X
4.30X-3.50X = P110,000-P80,000
0.80X = 30,000
X = 37,500u

At 37,500 units sold, the total cost and income of economy and regular popper is the same.

2. A company employs 45 personnel to market its cars. The average car sells for P 690,000 and a 6% commission is paid to
the sales person. It is considering changing the scheme to a commission arrangement that would pay each person a package
of P 30,000 plus a commission of 2% of the sales made by the person.

Required: Compute the indifference point where the total payments to sales personnel will be the same.

ANSWER:

We have:
Commission 1: 6% (P690,000x) = 41,400x
Commission 2: (P30,000 x 45 personnel) + 2% (P690,000x)
= P1,350,000 + 13,800x

At indifference point:
Commission 1 = Commission 2

By substitution:
41,400x = 1,350,000 + 13,800x
41,400x – 13,800x = 1,350,000
27,600x = 1,350,000
x = 1,350,000/27,600
x = 48.913043

Total Sales = P690,000x

= P690,000 (48.913043)
= P33,750,000

At the sales level of P33,750,000, the commission expense of the company will be the same regardless of the commission
payment models to be used.