THEORY b. An opportunity cost. d. A sunk cost.

1. In the development of accounting data for decision-making,

relevant costs are 16 The manner of determining whether favorable results of an
A. Historical costs which are the best available basis for estimating alternative are sufficient to justify the cost of taking that alternative
future costs. a. Cost behavior analysis c. Cost control analysis
B. Future costs which will differ under each alternative course of b. Cost benefit analysis d. Cost center analysis
action.
C. Budgetary costs authorized for the administrative year. 17. When there is one scarce resource, the product that should be
D. Standard costs developed by time and motion experts. produced first is the product with
a. the highest contribution margin per unit of the scarce resource
2. The term relevant cost applies to all of the following decision b. the highest sales price per unit of scarce resource
situations except the c. the highest demand
A. Acceptance of special product order. d. the highest contribution margin per unit
B. Manufacture or purchase of a component part.
C. Determination of product price. 18. Fixed costs are ignored in allocating scarce resources because
D. Replacement of equipment. a. they are sunk.
b. they are unaffected by the allocation of scarce resources.
3. The relevance of a particular cost to a decision is determined by c. there are no fixed costs associated with scarce resources.
A. Riskiness of the decision. C. Amount of the cost. d. fixed costs only apply to long-run decisions.
B. Number of decision variables. D. Potential effect on the
decision. 19. Among the costs relevant to a make-or-buy decision include
variable manufacturing costs as well as
4. A fixed cost is relevant if it is a. Unavoidable costs. c. Avoidable fixed costs.
A. a future cost. B. avoidable. C. sunk. b. Plant depreciation. d. Real estate taxes.
D. a product cost.
20. In a make or buy decision, the opportunity cost of capacity could
5. Management accountants are concerned with incremental unit a. be considered to decrease the price of units purchased from
costs. These costs are similar to the following except suppliers.
a. The economic marginal cost. c. The cost to produce b. be considered to decrease the cost of units manufactured by the
an additional unit. company.
b. The variable cost d. The manufacturing unit cost. c. be considered to increase the price of units purchased from
suppliers.
6. The type of cost vital to decision making but not recorded in the d. not be considered since opportunity costs are not part of the
accounting records accounting records.
a. Sunk costs b. Opportunity costs c. Direct 21. Which of the following activities within an organization would be
costs d. Out of pocket costs least likely to be outsourced?
a. accounting b. product design c.
7. What is the opportunity cost of making a component part in a transportation d. data processing
factory given no alternative use of the capacity?
a. The variable manufacturing cost of the component. 22. Which of the following costs are relevant to a make-or-buy
b. The total manufacturing cost of the component. decision?
c. The total variable cost of the component. a. original cost of the production equipment
d. Zero. b. annual depreciation of the equipment
c. the amount that would be received if the production equipment
8. In analyzing whether to build another regional service office, the were sold
salary of the Chief Executive Officer (CEO) at the corporate headquarters is d. the cost of direct materials purchased last month and used to
a. Relevant because salaries are always relevant. manufacture the component
b. Relevant because this will probably change if the regional service
office is build. 23. A purchasing agent has two potential firms to buy materials from
c. Irrelevant because it is future cost that will not differ between the for production. If both firms charge the same price, the material cost is
alternatives under consideration. a. an irrelevant cost b. a sunk costc. a
d. Irrelevant since another imputed costs for the same will be committed cost. d. an opportunity cost
considered.
24. Which of the following is NOT relevant in a make-or-buy decision
9. Assume a company produces three products: A, B, and C. It can about a part the entity uses in some of its products?
only sell up to 3,000 units of each product. Production capacity is unlimited. a. The reliability of the outside supplier.
The company should produce the product (or products) that has (have) the b. The alternative uses of owned equipment used to make the part.
highest c. The outside supplier’s per-unit variable cost to make the part.
a. contribution margin per hour of machine time. d. The number of units of the part needed each period.
b. gross margin per unit.
c. contribution margin per unit. 25. When only differential manufacturing costs are taken into account
d. sales price per unit. for special-order pricing, an essential assumption is that
10. All of the following are examples of imputed costs except a. Manufacturing fixed and variable costs are linear.
A. The stated interest paid on a bank loan. b. Selling and administrative fixed and variable costs are linear.
B. The use of the firm's internal cash funds to purchase assets. c. Acceptance of the order will not affect regular sales.
C. Assets that are considered obsolete that maintain a net book value. d. Acceptance of the order will not cause unit selling and
D. Decelerated depreciation. administrative variable costs to increase.

11. The distinction between avoidable and unavoidable costs is similar 26. If a firm is at full capacity, the minimum special order price must
to the distinction between cover
a. variable costs and fixed costs. c. step-variable costs a. variable costs associated with the special order
and fixed costs. b. variable and fixed manufacturing costs associated with the special
b. variable costs and mixed costs. d. discretionary costs order
and committed costs. c. variable and incremental fixed costs associated with the special
order
12. Total unit costs are d. variable costs and incremental fixed costs associated with the
a. Relevant for cost-volume-profit analysis. special order plus foregone contribution margin on regular units not produced
b. Needed for determining product contribution. e. both c and d.
c. Irrelevant in marginal analysis.
d. Independent of the cost system used to generate them. 27. Idle capacity in the interim (normally temporary) will generate
short-term benefit in accepting sales at price that
13 If a cost is irrelevant to a decision, the cost could not be a. Positively motivate employees.
a. a sunk cost. b. a future cost. c. b. Result in less than normal contribution margin.
a variable cost. d. an incremental cost. c. Increase total fixed costs.
d. Reduce the overall operating income to sales ratio.
14 Sunk costs
a. Are substitute for opportunity costs. 28. Pinoy Company temporarily has excess production capacity, the
b. In and of themselves are not relevant to decision making. idle plant facilities can be used to manufacture a low-margin item. The low-
c. Are relevant to decision making. margin item should be produced if it can be sold for more than its
d. Are fixed costs. a. Variable costs plus opportunity cost of idle facilities.
b. Indirect costs plus any opportunity cost of idle facilities.
15 The variable cost of a unit of product made yesterday is c. Fixed costs.
a. An incremental cost. c. A differential cost. d. Variable costs.
 a. P21,600 b. P43,200 c. P19,800 d.
29. An opportunity cost commonly associated with a special order is P39,600
a. The contribution margin on lost sales.
b. The variable costs of the order. 3. Chow Inc. has its own cafeteria with the following annual costs
c. Additional fixed costs related to the increased output. Food P 400,000
d. Any of the above. Labor 300,000
30. An increase in direct fixed costs could reduce all of the following Overhead 440,000
except Capital P1,140,000
a. product line contribution margin. c. product line operating The overhead is 40% fixed. Of the fixed overhead, P100,000 is the salary of
income. the cafeteria supervisor. The remainder of the fixed overhead has been
b. product line segment margin. d. corporate net income. allocated from total company overhead. Assuming the cafeteria supervisor
will remain and that Chow will continue to pay said salary, the maximum cost
31. Which of the following costs is NOT relevant to a special order Chow will be willing to pay an outsider firm to service the cafeteria is
decision? a. P1,140,000 b. P1,040,000 c.
a. the direct labor costs to manufacture the special order units P700,000 d. P964,000
b. the variable manufacturing overhead incurred to manufacture the
special-order units 4. Listed below are a company’s monthly unit costs to manufacture
c. the portion of the cost of leasing the factory that is allocated to the and market a particular product.
special order Unit Costs Variable Cost Fixed Costs
d. All of the above costs are relevant. Direct materials $2.00
Direct labor 2.40
32. There is a market for both product X and product Y. Which of the Indirect Manufacturing 1.60 $1.00
following costs and revenues would be most relevant in deciding whether to Marketing 2.50 1.50
sell product X or process it further to make product Y? The company must decide to continue making the product or buy it from an
A. Total cost of making X and the revenue from sale of X and Y. outside supplier. The supplier has offered to make the product at the same
B. Total cost of making Y and the revenue from sale of Y. level of quality that the company can make it. Fixed marketing costs would
C. Additional cost of making Y, given the cost of making X, and be unaffected, but variable marketing costs would be reduced by 30% if the
additional revenue from Y. company were to accept the proposal. What is the maximum amount per unit
D. Additional cost of making X, given the cost of making Y, and that the company can pay the supplier without decreasing its operating
additional revenue from Y. income?
a. $8.50 b. $6.75 c. $7.75 d.
33. A manager is attempting to determine whether a segment of the $5.25
business should be eliminated. The focus of attention for this decision should
be on 5. Picnic Items, Inc. manufactures coolers of 10,000 units that contain
a. the net income shown on the segment's income statement. a freezable ice bag. For an annual volume of 10,000 units, fixed
b. sales minus total expenses of the segment. manufacturing costs of P500,000 are incurred. Variable costs per unit amount
c. sales minus total direct expenses of the segment. are direct materials – P80; direct labor – P15, and variable factory overhead –
d. sales minus total variable expenses and avoidable fixed expenses P20
of the segment. Bags Corp. offered to supply the assembled ice bag for P40 with a minimum
order of 5,000 units. If Picnic accepts the offer, it will be able to reduce
34. A product should be dropped if variable labor and overhead by 50%. The direct materials for the freezable
a. It has negative incremental profit. bag will cost Picnic P20 if it will produce it. Considering Bags Corp. offer,
b. It has a negative contribution margin. Picnic should
c. Dropping it will increase the total profit of the company. a. Buy the freezable ice bag due to P150,000 advantage.
d. It is not essential to the company’s product line. b. Produce the freezable ice bag due to P25,000 advantage.
c. Produce the freezable ice bag due to P50,000 advantage.
35. The consulting firm of Magaling Corporation is considering the d. Buy the freezable bag due to P50,000 advantage.
replacement of their computer system. Taking into account the income tax 6. Savage Industries is a multi-product company that currently
effect and considering the carrying value of the old system (CVOS) and the manufactures 30,000 units of Part QS42 each month for use in production.
salvage value of the new system (SVNS), which combination below applies to The facilities now being used to produce Part QS42 have fixed monthly cost
the decision making process? of P150,000 and a capacity to produce 84,000 units per month. If Savage
A. B. C. D. were to buy Part QS42 from an outside supplier, the facilities would be idle,
CVO Irrelevant Irrelevant Relevant Relevant but its fixed costs would continue at 40% of their present amount. The
S variable production costs of Part QS42 are P11 per unit.
SVNS Irrelevant Relevant Irrelevant Relevant If Savage Industries is able to obtain Part QS42 from an outside supplier at a
unit purchase price of P12.875, the monthly usage at which it will be
36. In equipment-replacement decisions, which one of the following indifferent between purchasing and making Part QS42 is
does not affect the decision-making process? A. 30,000 units. B. 32,000 units. C.
a. Current disposal price of the old equipment. 80,000 D. 48,000
b. Operating costs of the old equipment.
c. Original fair market value of the old equipment. 7. Great Electronics is operating at 70% capacity. The plant manager
d. Cost of the new equipment. is considering making component 501 now being purchased for P110 each, a
price that is projected to increase in the near future. The plant has the
37. The Mark X Corp. contemplates the temporary shutdown of its equipment and labor force required to manufacture the component. The
plant facilities in a provincial area which is economically depressed due to design engineer estimates that each component requires P40 of direct
natural disasters. Below are certain manufacturing and selling expenses. materials and P30 of direct labor. The plant overhead is 200% of direct labor
1. Depreciation 5. Sales commissions peso cost, and 40% of the overhead is fixed cost. A decision to manufacture
2. Property tax 6. Delivery expenses component 501 will result in a gain or (loss) for each component of
3. Interest expense 7. Security of premises a. P28 b. P16 c. P(20) d.
4. Insurance of P4
facilities
Which of the following expenses will continue during the shutdown period? 8. Part BX is a component that Motors and Engines Co. uses in the
a. All expenses in the list. c. Items 1, 2 and 3 only. assembly of motors. The cost to produce one BX is presented below:
b. All except 5 and 6. d. Items 1, 2, 3, 4, 6, and 7 only. Direct materials P 4,000
PROBLEM Materials handling (20% of direct 800
1. A proprietor who just inherited a building is considering using it in materials)
a new business venture. Projections for the business are: revenue of $100,000, Direct labor 32,000
fixed cost of $30,000, and variable cost of $50,000. If the business is not Overhead (150% of direct labor) 48,000
started, the owner will work for a company for a wage of $23,000. Also, there Total manufacturing costs P84,800
have been two offers to rent the building, one for $1,000 per month and one Materials handling which is not included in manufacturing overhead,
for $1,200 per month. What are the expected annual net economic profits represents the direct variable costs of the receiving department that are applied
(losses) to the owner if the new business is started? to direct materials and purchased components on the basis of their cost.
A. $20,000 B. $(3,000) C. $(15,000) D. The company’s annual overhead budget is one-third variable and two-thirds
$(17,400) fixed. Pre-casts Co., offers to supply BX at a unit price of P60,000. Should
the company buy or manufacture?
2. Bolsa Co. estimates that 60,000 special zipper will be used in the a. Buy, due to advantage of P24,800 per product.
manufacture of industrial bags during the next year. Sure Zipper Co. has b. Manufacture, due to advantage of P7,200 per unit.
quoted a price of P6 per zipper. Bolsa would prefer to purchase 5,000 units c. Buy, due to advantage of P12,800 per unit.
per month but Sure is unable to guarantee this delivery schedule. In order to d. Manufacture, due to advantage of P19,200 per unit.
ensure the availability of these zippers, Bolsa is considering the purchase of
all 60,000 units at the beginning of the year. Assuming that Bolsa can invest 9. Panghulo Company manufactures part H for use in its production
cash at 12%, the company’s opportunity cost of purchasing the 60,000 units cycle. The cost per unit for 3,000 units of Part N are
are the beginning of the year is Direct labor P50 Fixed overhead P30
 Direct P10 Variable overhead P20 The selling price is P50 per unit. The company currently operates at full
materials capacity of 10,000 units. Capacity can be increased to 13,000 units by
Quebadia Company has offered to sell Panghulo 3,000 units of part H for operating overtime. Variable costs increase by P14 per unit for overtime
P100 per unit. If Panghulo accepts Quebada’s offer, the released facilities production. Fixed overhead costs remain unchanged when overtime
could be used to save P70,000 in relevant costs in its manufacture of Part I. In operations occur. PQR Company has received a special order from a
addition, P15 per unit of fixed overhead applied to Part H would be totally wholesaler who has offered to buy 2,000 units at P45 each.
eliminated. . What is the incremental cost associated with this special order?
The alternative that is more desirable and the corresponding net cost savings is a. P84,000 b. P31,000 c. P62,000 d.
a. b. c. d. P42,000
Alternative Manufacture Manufacture Buy Buy
Net cost savings P10,000 P20,000 P55,00 P85,000 16. Clay Co. has considerable excess manufacturing capacity. A
0 special job order’s cost sheet includes the following applied manufacturing
overhead costs: fixed costs - $21,000, and variable costs - $33,000.
10. Tyler Company currently sells 1,000 units of product M for $1 The fixed costs include a normal $3,700 allocation for in-house design costs,
each. Variable costs are $0.40 and avoidable fixed costs are $400. A discount although no in-house design will be done. Instead, the job will require the use
store has offered $0.80 per unit for 400 units of product M. The managers of external designers costing $7,750. What is the total amount to be included
believe that if they accept the special order, they will lose some sales at the in the calculation to determine the minimum acceptable price for the job?
regular price. Determine the number of units they could lose before the order a. $36,700 b. $40,750 c. $54,000 d.
become unprofitable. $58,050
a. 267 units. b. 500 units. c. 600 units. d.
750 units 17. Sandow Co. is currently operating at a loss of $15,000. The sales
11. The Blue Plate Co. is operating at 50% capacity producing 100,000 manager has received a special order for 5,000 units of product, which
units of ceramic plates a year. With the economic boom that the country is normally sells for $35 per unit. Costs associated with the product are: direct
expected to have in the coming year, the company plans to utilize 75% material, $6; direct labor, $10; variable overhead, $3; applied fixed overhead,
capacity. Part of the manufacturing process is hand-painting which has a $4; and variable selling expenses, $2. The special order would allow the use of
variable cost of material at P4.50 and labor at P5.50 per plate. This painting a slightly lower grade of direct material, thereby lowering the price per unit by
process has variable overhead at P1.00 which is 40% of total variable factory $1.50 and selling expenses would be decreased by $1. If Sandow wants this
overhead. Total factory overhead is P500 per 100 plates. No increase in fixed special order to increase the total net income for the firm to $10,000, what
factory overhead is expected even with the substantial increase in production. sales price must be quoted for each of the 5,000 units?
An offer to sub-contract the incremental hand-painting job was given at a. $23.50 b. $24.50 c. $27.50 d.
P10.50 per plate but the company will have to lease an equipment at P10,000 $34.00
annual rental. The plates sell for P50.00 per plate a piece at the contribution
margin rate of 45%. 18. Tagaytay Open-Air Flea Market is along the highway leading to
Should Blue Plate Company sub-contract? Why? Taal Vista Lodge. Arnel has a stall which specializes in hand-crafted fruit
a. No, because the company will lose P135,000. baskets that sell for P60 each. Daily fixed costs are P15,000 and variable
b. Yes, because the company will save P65,000. costs are P30 per basket. An average of 750 baskets are sold each day. Arnel
c. Yes, because the company will earn P15,000 more. has a capacity of 800 baskets per day. By closing time, yesterday, a bus load
d. No, because there is no benefit for the company. of teachers who attended a seminar at the Development Academy of the
Philippines stopped by Arnel’s stall. Collectively, they offered Arnel P1,500
12. Pixie Co. produces Component 6417 for use in one of its electronic for 40 baskets. Arnel should have
gadgets. Normal annual production for the item is 100,000 units. The cost a. Rejected the offer since he could have lost P500.
per unit lot of the part are as follows: b. Rejected the offer since he could have lost P900.
Direct material P520 c. Accepted the offer since he could have P300 contribution margin.
Direct labor 200 d. Accepted the offer since he could have P700 contribution margin.
Manufacturing overhead
Variable 240 19. Kirklin Co. is a manufacturer operating at 95% of capacity. Kirklin
Fixed 320 has been offered a new order at $7.25 per unit requiring 15% of capacity. No
Total manufacturing costs per 100 P1,280 other use of the 5% current idle capacity can be found. However, if the order
units were accepted, the subcontracting for the required 10% additional capacity
Bobbie Inc. has offered to sell Pixie all 100,000 units it will need during the would cost $7.50 per unit. The variable cost of production for Kirklin on a
coming year for P1,200 per 100 units. If Pixie accepts the offer from Bobbie, per-unit basis follows:
the facilities used to manufacture Component 6417 could be used in the Materials $3.50
production of Component 8275. This change would save Pixie P180,000 in Labor 1.50
relevant costs. In addition, a P200,000 cost item included in fixed overhead is Variable overhead 1.50
specifically related to Part 6417 and would be eliminated. Pixie should $6.50
a. Buy Component 6417 because of P300,000 savings. In applying the contribution margin approach to evaluating whether to accept
b. Buy Component 6417 because of P140,000 savings. the new order, assuming subcontracting, what is the average variable cost per
c. Continue producing Component 6417 because of P40,000 savings. unit?
d. Continue producing Component 6417 because of P60,000 savings. A. $6.83 B. $7.00 C. $7.17 D.
$7.25
13. Chow Foods operates a cafeteria for its employees. The operations
of the cafeteria requires fixed costs of P470,000 per month and variable costs 20. Sta. Elena Company manufactures men’s caps. The projected
of 40% of sales. Cafeteria sales are currently averaging P1,200,000 per income statement for the year before any special order is as follows:
month. The company has the opportunity to replace the cafeteria with Amount Per Unit
vending machines. Gross customer spending at the vending machines is Sales P 400,000 P 20
estimated to be 40% greater than the current sale because the vending Cost of goods sold 320,000 16
machines are available at all hours. By replacing the cafeteria with vending Gross margin P 80,000 P 4
machines, the company would receive 16% of the gross customer spending Selling expenses 30,000 3
and avoid cafeteria costs. A decision to replace the cafeteria with vending Operating income P 50,000 P 1
machines will result in a monthly increase (decrease) in operating income of Fixed costs included in above projected income statement are P80,000 in cost
a. P182,000 b. P258,800 c. (P588,000) of goods sold and P9,000 in selling expenses.
d. P18,800 A special order offering to buy 2,000 caps for P17 each was made to Sta.
Elena. No additional selling expenses will be incurred if the special order is
14. ABC Company receives a one-time special order for 5,000 units of accepted. Sta. Elena has the capacity to manufacture 2,000 more caps.
Kleen. Acceptance of this order will not affect the regular sales of 80,000 As a result of the special order, the operating income would increase by
units. The cost to manufacture one unit of this particular product is: a. P34,000 b. P24,000 c. P10,000 d.
Variable costs (per Fixed costs (per P0
unit) year)
Direct materials $1.50 21. High Class Townhouse, Inc. manages five upscale townhouse in
Direct labor 2.50 Makati, Ortigas, and Greenhills area. Shown below are the summary income
Overhead 0.80 $100,000 statements for each complex:
Selling and 3.00 50,000 In Thousand Pesos
administrative One Two Three Four Five
Variable selling costs for each of these 5,000 units will be $1.00. What is the Rent 10,000 12,10 23,470 18,780 10,650
differential cost to ABC Company of accepting this special order? Income 0
A. $39,000 B. $34,000 C. $30,250 D. Expenses 8,000 13,00 26,000 24,000 13,000
$29,000 0
15. PQR Company expects to incur the following costs at the planned Profit 2,000 (900) (2,530) (5,220) (2,350
production level of 10,000 units: Included in the expenses is P12,000,000 of corporate overhead allocated to the
Direct materials P100,000 townhouse based on rental income. The complex that the company should
Direct labor 120,000 consider selling is (are)
Variable overhead 60,000 a. Three, Four & Five. c. Two, Three, Four & Five.
Fixed overhead 30,000 b. Four & Five. d. Four.
 2. Enter into a long-term contract with another company who will
22. Division A of Decision Experts Corporation is being evaluated for serve the area’s customers. This company will pay Dynamics a royalty of
elimination. It has contribution to overhead of P400,000. It receives an P2.00 per unit based upon an estimate of P30,000 units being sold.
allocated overhead of P1 million, 10% of which cannot be eliminated. The 3. Close the Naga plant and not expand the operations of the Laguna
elimination of Division A would affect pre-tax income by plant.
a. P400,000 decrease. c. P500,000 decrease. The total home office costs of P250,000 will remain the same under each
b. P400,000 increase. d. P500,000 increase. situation.

23. Data covering QMB Corporation’s two product lines are as 26. The estimated net profit from total operations of Dynamics, Inc.
follows: that would result from expansion of Laguna plant (Alternative 1) is
Product “W” Product “Z” a. P425,000 b. P485,000 c. P535,000 d.
Sales P36,000 P25,200 P618,000
Income before income 15,936 (8,388)
tax 27. The estimated net profit from total operations of Dynamics, Inc.
Sales price per unit 30.00 14.00 that would result from negotiation of long-term contract on a royalty basis
Variable cost per unit 8.50 15.00 (Alternative No. 2) is
The total unit sold of “W” was 1,200 and that of “Z” was 1,800 units. a. P425,000 b. P485,000 c. P535,000 d.
If Product “Z” is discontinued and this results in a 400 units decrease in sales P560,000
of Product “W”, the total effect on income will be
a. P13,600 decrease. b. P6,800 decrease. c. 28. The estimated net profit from total operations of Dynamics, Inc.
P8,600 decrease. d. P5,000 decrease. that would result from shutdown of Naga plant with no expansion of other
locations (Alternative No. 3) is
24. Ysabelle Industries, Inc. has an opportunity to acquire a new a. P330,000 b. P345,000 c. P425,000 d.
equipment to replace one of its existing equipments. The new equipment P475,000
would cost P900,000 and has a five-year useful life, with a zero terminal
disposal price. Variable operating costs would be P1 million per year. The 29. JKL Company is considering replacing a machine with a book
present equipment has a book value of P500,000 and a remaining life of five value of P100,000, a remaining useful life of 4 years, and annual straight-line
years. Its disposal price now is P50,000 but would be zero after five years. depreciation of P25,000. The existing machine has a current market value of
Variable operating costs would be P1,250,000 per year. Considering the five P80,000. The replacement machine would cost P160,000, have a 4-year
years in total, but ignoring the time value of money and income taxes. useful life, save P50,000 per year in cash operating costs. If the replacement
Ysabelle should machine would be depreciated using straight-line method and the tax rate is
a. Replace due to P400,000 advantage. 40%, what would be the increases in annual income taxes if the company
b. Not replace due to P150,000 disadvantage. replaces the machine?
c. Replace due to P350,000 advantage. A. P21,000 B. P14,000 C. P32,000 D.
d. Not replace due to P100,000 disadvantage. P20,000
25. Nakinnat Corporation’s Outlet No. 5 reported the following results
of operations for the period just ended: Questions 30 and 31 are based on the following information.
Sales P2,500,000 The Sampaguita Steam Laundry bought a laundry truck that can be used for 5
Less: Variable expenses 1,000,000 years. The cost of the truck is P225,000 with a salvage value of P35,000.
Contribution margin P1,500,000 Since the truck is not working efficiently, management has thought of selling
Less: Fixed expenses the truck immediately and buy a delivery wagon which will serve the
Salaries & wages P 750,000 company’s purposes more properly. The estimated net returns of the truck for
Insurance on inventories 50,000 5 years is P150,000. If the truck is sold, management can only recover
Depreciation on equipment 325,000 P175,000. (In all calculations, use the straight line method of depreciation)
Advertising 500,000 1,625,000
Net income (loss) (P125,000) 30. The net gain (loss) that will arise if the Company decides to sell the
The management is contemplating on dropping outlet No. 5 due to the truck is:
unfavorable operational results. If this would happen, one employee will have a. P(50,000) b. P(75,000) c. P75,000 d.
to be retained with an annual salary of P150,000. The equipment has no resale P140,000
value. Outlet No. 5 should
a. Not be dropped due to foregone overall income of P350,000. 31. If the firm decides to keep the truck, the net gain (loss) over the 5-
b. Be dropped due to foregone overall income of P325,000. year period is
c. Not be dropped due to foregone overall income of P25,000. a. P(40,000) b. P(75,000) c. P50,000 d.
d. Be dropped due to overall operational loss of P25,000. P140,000

Questions 26 through 28 are based on the following information. 32. Arlene Inc. currently has annual cash revenues of P2,400,000 and
The owners of Dynamics, Inc. has engaged you to assist them in arriving at annual operating cost of P1,850,000 (all cash items except depreciation of
certain decisions. Dynamics maintains its home office in Manila and rents P350,000). The company is considering the purchase of a new machine
factory plants in Bulacan, Laguna and Naga, all of which produce the same costing P1,200,000 per year. The new machine would increase (1) revenues to
product. P2,900,000; (2) operating cost to P2,050,000; and (3) depreciation to
The management of Dynamics provided you with a projection of operations P500,000 per year. Assuming a 35% income tax rate, Arlene’s annual
for 1981 as follows: incremental after-tax cash flows from the machine would be
TOTAL Bulacan Laguna Naga a. P330,000 b. P345,000 c. P292,500 d.
Sales P P P 700,000 P 400,000 P300,000
2,200,000 1,100,000
Variable costs 725,000 332,500 212,500 180,000 33. Julius International produces weekly 15,000 units of Product JI and
Fixed costs: 30,000 units of JII for which P800,000 common variable costs are incurred.
Factory 550,000 280,000 140,000 130,000 These two products can be sold as is or processed further. Further processing
Administrative 175,000 105,000 55,000 15,000 of either product does not delay the production of subsequent batches of the
Allocated home 250,000 112,500 87,500 50,000 joint products. Below are some information:
office costs JI JII
Total costs 1,700,000 830,000 495,000 375,000 Unit selling price without further processing P24 P18
Net profit from 500,000 270,000 205,000 25,000 Unit selling price with further processing P30 P22
operations Total separate weekly variable costs of further P100,000 P90,000
The sales price per unit is P12.50. processing
To maximize Julius’ manufacturing contribution margin, the total separate
Due to the poor results of operations of the plant in Naga, Dynamics has variable costs of further processing that should be incurred each week are
decided to cease operations and offer the plant’s machinery and equipment for a. P95,000 b. P90,000 c. P100,000 d.
sale by the end of 1980. The company expects to sell these assets at a good P190,000
price to cover all termination costs.
Dynamics, however, wishes to continue serving its customers in Naga and is 34. A manufacturing company's primary goals include product quality
considering one of the following three alternatives: and customer satisfaction. The company sells a product, for which the market
1. Expand the operations of Laguna plant by using space presently demand is strong, for $50 per unit. Due to the capacity constraints in the
idle. This move would result in the following changes in that plant Production Department, only 300,000 units can be produced per year. The
operations; current defective rate is 12% (i.e., of the 300,000 units produced, only
Increase over plant’s current operations 264,000 units are sold and 36,000 units are scrapped). There is no revenue
Sales 50% recovery when defective units are scrapped. The full manufacturing cost of a
Fixed costs – factory 20% unit is $29.50, including
– 10% Direct materials $17.50
administrative Direct labor 4.00
Under this proposal, variable costs would be P4.00 per unit sold. Fixed manufacturing 8.00
overhead
The company's designers have estimated that the defective rate can be reduced as separate types of products until the products reach a certain processing
to 2% by using a different direct material. However, this will increase the stage known as the split-off point.
direct materials cost by $2.50 per unit to $20 per unit. The net benefit of using
the new material to manufacture the product will be FURTHER PROCESSING [Relevant] Costs to be incurred after the
A. $(120,000) B. $120,000 C. $750,000 split-off point if product is processed further
D. $1,425,000 COSTS

35. The Table Top Model Corp. produces three products. “Tic,” “Tac.”, SPLITT OFF POINT That point in the manufacturing process where some or
and “Toc.” The owner desires to reduce production load to only one product all of joint products can be recognized as individual products.
line due to prolonged absence of the production manager. Depreciation
expense amounts to P600,000 annually. Other fixed operating expenses EXERCISES:
amount to P660,000 per year. The sales and variable cost data of the three
products are (000’s omitted)
Tic Tac Toc 1. MAKE OR BUY
Sales P6,600 P5,300 P10,800 The Honda motors executive is trying to decide whether the company should
Variable 3,900 1,700 8,900 continue to produce an engine component or buy it from Toyota at P100 each.
costs Demand for the coming year is expected to be the same as for the current year,
Which product must be retained and what is the opportunity cost of selecting 200 units. Data for current year follows:
such product line? Direct materials P 10,000
a. Retain product “Tac”; opportunity cost is P4.6 million. Direct labor 4,000
b. Retain product “Tac”; opportunity cost is P3.14 million. Variable factory 2,000
c. Retain product “Tic”; opportunity cost is P4.04 million. overhead
d. Retain product “Toc”; opportunity cost is P4.84 million. Fixed factory overhead 5,000
TOTAL 21,000
36. A company produces and sells three products:
If Honda makes the components, the unit costs of direct materials
Products
will increase by 20%.
C J P
Sales $200,00 $150,000 $125,000
If Honda buys the components, 30% of the fixed costs will be avoided. The
0
other 70% will continue regardless of whether the components are
Separable (product) fixed 60,000 35,000 40,000
manufactured or purchased. Assume that variable overhead varies with output
costs
volume.
Allocated fixed costs 35,000 40,000 25,000
REQUIRED:
Variable costs 95,000 75,000 50,000
a. Assuming that the capacity now used to make the components will
The company lost its lease and must move to a smaller facility. As a result,
become idle if the components are purchased, should Honda make
total allocated fixed costs will be reduced by 40%. However, one of its
or buy the components?
products must be discontinued in order for the company to fit in the new
b. Assume that the capacity in question can be rented to another firm
facility. Because the company's objective is to maximize profits, what is its
for P2,500 for the coming year, should the company make or buy?
expected net profit after the appropriate product has been discontinued?
2. SPECIAL ORDER DECISIONS
A. $10,000 B. $15,000 C. $20,000 D.
Nokia Corporation produces sells Nokia N73 at a price of P27,000 per unit.
$25,000
N90’s cost per unit are:
Direct materials P 7,500
Questions 37 and 38 are based on the following information.
Direct labor 3,900
Hermo Company has just completed a hydro-electric plant at a cost of
Variable manufacturing 4,500
$21,000,000. The plant will provide the company's power needs for the next
overhead
20 years. Hermo will use only 60% of the power output annually. At this level
Fixed manufacturing overhead 6,600
of capacity, Hermo's annual operating costs will amount to $1,800,000, of
TOTAL P 22,500
which 80% are fixed.
Quigley Company currently purchases its power from MP Electric at an A special order for 1,000 units was received from Smart Co. Additional
annual cost of $1,200,000. Hermo could supply this power, thus increasing shipping costs for this sale are P 3,000 per unit.
output of the plant to 90% of capacity. This would reduce the estimated life of REQUIRED:
the plant to 14 years. What is the minimum selling price per unit that should be set for
Nokia’s order if:
37. If Hermo decides to supply power to Quigley, it wants to be a. Nokia is operating at full capacity?
compensated for the decrease in the life of the plant and the appropriate b. Nokia has excess capacity?
variable costs. Hermo has decided that the charge for the decreased life should 3. ADD OR DROP PARTS OF OPERATIONS
be based on the original cost of the plant calculated on a straight-line basis. George Products sells three products A, B and C, uses common facilities to
The minimum annual amount that Hermo would charge Quigley would be produce and sell all three. Neither product affects sales of the others. Pertinent
A. $450,000. B. $630,000. C. $990,000. D. data on the three products follow:
$800,000 A B C Total
Sales volume per 800 1,000 600
38. The maximum amount Quigley would be willing to pay Hermo month
annually for the power is Unit sales price P 30 P 20 P 40
A. $600,000. B. $1,050,000. C. Sales revenue P 24,000 P 20,000 P 24,000 P 68,000
$1,200,000. D. $1,000,000 Unit variable cost P 22 P 14 P 35
Fixed cost per month P 4,800 P 4,000 P 4,800 P 13,600
Income ??? ??? ??? ???
Management has asked the accounting department to allocate fixed costs to
DECISION MAKING – the process of choosing a course of action, each product so it can evaluate how well each product is doing. Total fixed
preferably the most advantageous to the organization, from at least two costs is 20% of total peso sales, so the accountant charged fixed cost to each
alternatives. product at 20% of the product sales.
When a product line income statement was prepared the report showed an
TYPES OF COSTS USED IN DECISION MAKING apparent loss for product C. the company sales manager argued, “ We should
drop Product C. We incur losses from this product.”
RELEVANT COSTS Future cost expected to be different between REQUIRED:
or among alternatives. a. Do you agree with the sales manager that the product C be
DIFFERENTIAL COSTS Increases (incremental) or decreases it total dropped? Why
costs that result from selecting one alternative instead of another. b. If the product C is dropped, by how much would the company’s
overall profit decrease?
AVOIDABLE COSTS [Relevant] Costs that will be saved or those c. If the selling price of Product B declined to 40%, should the
that will not be incurred if a certain decision is made product segment be dropped?

SUNK COSTS Costs incurred already and cannot be avoided regardless

of what a manager decides to do. 4. SELL OR PROCESS FURTHER
MILO Company produces four products for a joint cost of P20,000. The
Out-of-Pocket COSTS Costs that require expenditure of cash or products are currently processed beyond the split off point, and the final
incurrence of a liability as a result of management decision products are sold as follows:
Product Sales Additional Processing Cost
OPPORTUNITY COSTS Income or benefit sacrificed or forgone s
when an alternative is chosen over another M P 36,000 P 22,000
I 26,400 12,000
JOINT COSTS [Irrelevant] Costs incurred in simultaneously L 10,400 8,000
manufacturing two or more products that are difficult to identify individually O 2,400 3,00
The firm could sell the products at the split-off point for the following c. past costs that are expected to be different in the future.
amounts: d. anticipated future costs that will differ among various alternatives.
M P 16,000
I 7,200 ANS: D DIF: 1
L 2,000
O 0 4. Which of the following is the least likely to be a
REQUIRED: relevant item in deciding whether to replace an old machine?
a. Determine which products the firm should sell at split-off point. a. acquisition cost of the old machine
b. Determine what firm’s profit would be if it takes the most b. outlay to be made for the new machine
profitable action. c. annual savings to be enjoyed on the new machine
d. life of the new machine

5. CONTINUE OR SHUTDOWN OPERATION ANS: A DIF: 1

The North Company expects that the volume of sales will drop below the
current level of 5,000 units per month. an operating statement for the monthly 5. If a cost is irrelevant to a decision, the cost could not be
sales of 5,000 units show the following: a. a sunk cost.
Sales (5,000 @ P 3) P 5,000 b. a future cost.
Less: c. a variable cost.
Variable costs (5,000 @P 2 P 10,000 d. an incremental
Non-variable costs 5,000 15,000 cost.
Net income 0
If plant operations are suspended, a shutdown cost of P2,000 per month will ANS: D DIF: 1
remain as incurred. Since there is no immediately possibility of profit under
present conditions, the problem of the company is just how to minimize the 6. Which of the following costs would be relevant in
loss. short-term decision making?
REQUIRED: a. incremental fixed costs
a. Shutdown point in units and in pesos b all costs of inventory
b. Should the company shutdown operations if the company expect .
demand to be c. total variable costs that are the same in the considered alternatives
1. 4,000 units d the cost of a fixed asset that could be used in all the considered
2. 2,000 units . alternatives

ANS: A DIF: 1

6. PRODUCT COMBINATION DECISION 7. The term incremental cost refers to

Data concerning four product lines are as follows: a. the profit foregone by selecting one choice instead of another.
A B C D b the additional cost of producing or selling another product or service.
Selling price P 60 P 50 P 26 P 16 .
Variable cost per unit 50 20 10 8 c. a cost that continues to be incurred in the absence of activity.
Hours required for 1 10 20 8 2 d a cost common to all choices in question and not clearly or feasibly
unit . allocable to any of them.
Market limit (units) 12,000 None 5,00 4,000
0 ANS: B DIF: 1
Total fixed costs P 100,000
Total hours available 180,000 8. A cost is sunk if it
The full amount of fixed costs shall be incurred regardless of the specific a. is not an incremental cost.
types of product produced. b. is unavoidable.
REQUIRED: c. has already been incurred.
a. Assume that there is no market limitation: d. is irrelevant to the decision at hand.
1. Which product(s) would have to be produced and sold
2. how many units can be produced? ANS: C DIF: 1
3. how many units is the company’s’ profit?
b. Assume that there are market limitations, determine the best 9. Most___________ are relevant to decisions to acquire
product combination. capacity, but not to short-run decisions involving the use of that capacity.
b. How much is the profit associated with the best product a. sunk costs
combination? b incremental costs
.
c. fixed costs
d prime costs
7. RAW Company has 2,000 motorcycle parts that are carried in .
inventory at P25,000. The parts can be reworked at a cost of
P6,000 and sold for P 10,000. Otherwise, the company can sell the ANS: C DIF: 1
parts as scrap for P 3,500 less P 500 cost to dispose
10. Irrelevant costs generally include
REQUIRED:
a. Should the parts be reworked or sold as scrap? Sunk Historical costs Allocated
b. What is the opportunity cost? costs costs
MULTIPLE CHOICE a. yes yes no
b. yes no no
1. Which of the following is not a characteristic of c. no no yes
relevant costing information? It is d. yes yes yes
a. associated with the decision under
consideration. ANS: D DIF: 1
b. significant to the decision maker.
c. readily quantifiable. 11. In deciding whether an organization will keep an old
d. related to a future endeavor. machine or purchase a new machine, a manager would ignore the
a. estimated disposal value of the old machine.
ANS: C DIF: 1 b. acquisition cost of the old machine.
c. operating costs of the new machine.
2. A fixed cost is relevant if it is d. estimated disposal value of the new machine.
a. a future cost.
b avoidable. ANS: B DIF: 1
.
c. sunk. 12. The potential rental value of space used for production
d a product cost. activities
. a. is a variable cost of production.
b represents an opportunity cost of production.
ANS: B DIF: 1 .
c. is an unavoidable cost.
3. Relevant costs are d is a sunk cost of production.
a. all fixed and variable costs. .
b. all costs that would be incurred within the relevant range of
production.
ANS: B DIF: 1 a. production cost.
b variable production cost.
13. The opportunity cost of making a component part in a .
factory with excess capacity for which there is no alternative use is c. variable costs.
a. the total manufacturing cost of the component. d production cost plus a normal profit margin.
b. the total variable cost of the component. .
c. the fixed manufacturing cost of the
component. ANS: C DIF: 1
d. zero.
22. Which of the following costs is irrelevant in making a
ANS: D DIF: 1 decision about a special order price if some of the company facilities are
currently idle?
14. Which of the following are relevant in a make or buy a. direct labor
decision? b. equipment depreciation
c. variable cost of utilities
Variabl Avoidable fixed Unavoidable fixed d. opportunity cost of
e costs costs production
costs
ANS: B DIF: 1
a. no yes yes
b. yes no yes 23. The _______________ prohibits companies from
c. no no yes pricing products at different amounts unless these differences reflect
d. yes yes no differences in the cost to manufacture, sell, or distribute the products.
a. Internal Revenue Service
ANS: D DIF: 1 b Governmental Accounting Office
.
15. In a make or buy decision, the opportunity cost of c. Sherman Antitrust Act
capacity could d Robinson-Patman Act
a. be considered to decrease the price of units purchased from suppliers. .
b be considered to decrease the cost of units manufactured by the company.
. ANS: D DIF: 1
c. be considered to increase the price of units purchased from suppliers.
d not be considered since opportunity costs are not part of the accounting 24. An ad hoc sales discount is
. records. a. an allowance for an inferior quality of marketed goods.
b. a discount that an ad hoc committee must decide on.
ANS: A DIF: 1 c. brought about by competitive pressures.
d. none of the above.
16. Which of the following are relevant in a make or buy
decision? ANS: C DIF: 3

Prime Sunk costs Incremental 25. A manager is attempting to determine whether a

costs costs segment of the business should be eliminated. The focus of attention for this
decision should be on
a. yes yes yes a. the net income shown on the segment's income statement.
b. yes no yes b sales minus total expenses of the segment.
c. yes no no .
d. no no yes c. sales minus total direct expenses of the segment.
d sales minus total variable expenses and avoidable fixed expenses of the
ANS: B DIF: 1 . segment.

17. In a make or buy decision, the reliability of a potential ANS: D DIF: 1

supplier is
a. an irrelevant decision factor. 26. Assume a company produces three products: A, B, and
b relevant information if it can be quantified. C. It can only sell up to 3,000 units of each product. Production capacity is
. unlimited. The company should produce the product (or products) that has
c. an opportunity cost of continued production. (have) the highest
d a qualitative decision factor. a. contribution margin per hour of machine time.
. b gross margin per unit.
.
ANS: D DIF: 1 c. contribution margin per unit.
d sales price per unit.
18. Which of the following qualitative factors favors the .
buy choice in a make or buy decision for a part?
a. maintaining a long-term relationship with ANS: C DIF: 1
suppliers
b. quality control is critical 27. For a particular product in high demand, a company
c. utilization of idle capacity decreases the sales price and increases the sales commission. These changes
d. part is critical to product will not increase
a. sales volume.
ANS: A DIF: 1 b. total selling expenses for the product.
c. the product contribution margin.
19. When a scarce resource, such as space, exists in an d. the total variable cost per unit.
organization, the criterion that should be used to determine production is
a. contribution margin per unit. ANS: C DIF: 1
b. selling price per unit.
c. contribution margin per unit of scarce resource. 28. An increase in direct fixed costs could reduce all of the
d. total variable costs of production. following except
a. product line contribution margin.
ANS: C DIF: 1 b product line segment margin.
.
20. Fixed costs are ignored in allocating scarce resources c. product line operating income.
because d corporate net income.
a. they are sunk. .
b they are unaffected by the allocation of scarce resources.
. ANS: A DIF: 1
c. there are no fixed costs associated with scarce resources.
d fixed costs only apply to long-run decisions. 29. When a company discontinues a segment, total
. corporate costs may decrease in all of the following categories except
a. variable production costs.
ANS: B DIF: 1 b allocated common costs.
.
21. The minimum selling price that should be acceptable in c. direct fixed costs.
a special order situation is equal to total d variable period costs.
. facilities for $60,000 per year. Q Co. currently produces 10,000 parts per year.
Which alternative is preferable and by what margin?
ANS: B DIF: 1 a. Make-$20,000
b Make-$50,000
30. In evaluating the profitability of a specific .
organizational segment, all _______________ would be ignored. c. Buy-$10,000
a. segment variable costs d Buy-$40,000
b. segment fixed costs .
c. costs allocated to the segment
d. period costs ANS: C DIF: 3

ANS: C DIF: 1 36. Armstrong Co. has 15,000 units in inventory that had a
production cost of $3 per unit. These units cannot be sold through normal
31. K Co. uses 10,000 units of a part in its production channels due to a significant technology change. These units could be
process. The costs to make a part are: direct material, $12; direct labor, $25; reworked at a total cost of $23,000 and sold for $28,000. Another alternative
variable overhead, $13; and applied fixed overhead, $30. K Co. has received a is to sell the units to a junk dealer for $8,500. The relevant cost for Armstrong
quote of $55 from a potential supplier for this part. If K Co. buys the part, 70 to consider in making its decision is
percent of the applied fixed overhead would continue. K Co. would be better a. $45,000 of original product costs.
off by b. $23,000 for reworking the units.
a. $50,000 to manufacture the part. c. $68,000 for reworking the units.
b. $150,000 to buy the part. d. $28,000 for selling the units to the junk dealer.
c. $40,000 to buy the part.
d. $160,000 to manufacture the part. ANS: B DIF: 1

ANS: C DIF: 3 R Corp.

32. P Co. has only 25,000 hours of machine time each R Corp. sells a product for $18 per unit, and the standard cost card for the
month to manufacture its two products. Product X has a contribution margin product shows the following costs:
of $50, and Product Y has a contribution margin of $64. Product X requires 5
hours of machine time, and Product Y requires 8 hours of machine time. If P Direct material $1
wants to dedicate 80 percent of its machine time to the product that will Direct labor 2
provide the most income, P will have a total contribution margin of Overhead (80% fixed) 7
a. $250,000. Total $10
b. $240,000.
c. $210,000. 37. Refer to R Corp. R received a special order for 1,000
d. $200,000. units of the product. The only additional cost to R would be foreign import
taxes of $1 per unit. If R is able to sell all of the current production
ANS: B DIF: 5 domestically, what would be the minimum sales price that R would consider
for this special order?
33. Down Co. has 3 divisions: R, S, and T. Division R's a. $18.00
income statement shows the following for the year ended December 31, 2001: b. $11.00
c. $5.40
Sales $1,000,000 d. $19.00
Cost of goods sold (800,000)
Gross profit $ 200,000 ANS: D DIF: 1
Selling expenses $100,00
0 38. Refer to R Corp. Assume that R has sufficient idle
Administrative expenses 250,000 (350,000) capacity to produce the 1,000 units. If R wants to increase its operating profit
Net loss $ (150,000) by $5,600, what would it charge as a per-unit selling price?
a. $18.00
Cost of goods sold is 75 percent variable and 25 percent fixed. Of the fixed b. $10.00
costs, 60 percent are avoidable if the division is closed. All of the selling c. $11.00
expenses relate to the division and would be eliminated if Division R were d. $16.60
eliminated. Of the administrative expenses, 90 percent are applied from
corporate costs. If Division R were eliminated, Down Co. income would ANS: C DIF: 3
a. increase by $150,000.
b decrease by $ 75,000. 39. Handy Combs, Inc. makes and sells brushes and combs.
. It can sell all of either product it can make. The following data are pertinent to
c. decrease by $155,000. each respective product:
d decrease by $215,000.
. Brushes Combs
Units of output per machine
8 20
ANS: C DIF: 3 hour
Selling price per unit $12.00 $4.00
34. Sandow Co. is currently operating at a loss of $15,000. Product cost per unit
The sales manager has received a special order for 5,000 units of product, Direct material $1.00 $1.20
which normally sells for $35 per unit. Costs associated with the product are: Direct labor 2.00 0.10
direct material, $6; direct labor, $10; variable overhead, $3; applied fixed Variable overhead 0.50 0.05
overhead, $4; and variable selling expenses, $2. The special order would
allow the use of a slightly lower grade of direct material, thereby Total fixed overhead is $380,000.
lowering the price per unit by $1.50 and selling expenses would be decreased
by $1. If Sandow wants this special order to increase the total net income for The company has 40,000 machine hours available for production. What sales
the firm to $10,000, what sales price must be quoted for each of the 5,000 mix will maximize profits?
units? a. 320,000 brushes and 0 combs
a. $23.50 b 0 brushes and 800,000 combs
b. $24.50 .
c. $27.50 c. 160,000 brushes and 600,000 combs
d. $34.00 d 252,630 brushes and 252,630 combs
.
ANS: A DIF: 3
ANS: A DIF: 1
35. Q Co. produces a part that has the following costs per unit:
40. Boston Shoe Cobblers has been asked to submit a bid
Direct material $8 on supplying 1,000 pairs of military dress boots to the Pentagon. The
Direct labor 3 company's costs per pair of boots are as follows:
Variable
1
overhead Direct material $8
Fixed overhead 5 Direct labor 6
Total $17 Variable overhead 3
Variable selling cost (commission) 3
Z Corp. can provide the part to Q for $19 per unit. Q Co. has determined that Fixed overhead (allocated) 2
60 percent of its fixed overhead would continue if it purchased the part. Fixed selling and administrative cost 1
However, if Q no longer produces the part, it can rent that portion of the plant
Assuming that there would be no commission on this potential sale, the lowest Robco manufactures and sells FM radios. Information on last year's operations
price the firm can bid is some price greater than (sales and production of the 2000 model) follows:
a. $23.
b. $20. Sales price per unit $30
c. $17. Costs per unit:
d. $14. Direct material 7
Direct labor 4
ANS: C DIF: 1 Overhead (50% variable) 6
Selling costs (40% variable) 10
41. Schoof Company has two sales territories-North and Production in units 10,000
South. Financial information for the two territories for 2001 follows: Sales in units 9,500

North South 46. Refer to Robco. At this time (April 2001), the 2001
Sales $980,000 $750,000 model is in production and it renders the 2000 model radio obsolete. If the
Direct costs: remaining 500 units of the 2000 model radios are to be sold through regular
Variable (343,000) (225,000) channels, what is the minimum price the company would accept for the
Fixed (450,000) (325,000) radios?
Allocated common costs (275,000) (175,000) a. $30
Net income (loss) $(88,000) $ 25,000 b. $27
c. $18
Because the company is in a start-up stage, corporate management feels that d. $4
the North sales territory is creating too much of a cash drain on the company
and it should be eliminated. If North is discontinued, one sales manager ANS: D DIF: 3
(whose salary is $40,000 per year) will be relocated to the South territory. By
how much would Schoof's income change if the North territory is eliminated? 47. Refer to Robco. Assume that the remaining 2000 model
a. increase by $88,000 radios can be sold through normal channels or to a foreign buyer for $6 per
b. increase by $48,000 unit. If sold through regular channels, the minimum acceptable price will be
c. decrease by $267,000 a. $30.
d. decrease by $227,000 b. $33.
c. $10.
ANS: D DIF: 3 d. $4.

Big City Motors ANS: C DIF: 3

Big City Motors is trying to decide whether it should keep its existing car Chip Division of Supercomp Corp.
washing machine or purchase a new one that has technological advantages
(which translate into cost savings) over the existing machine. Information on The Chip Division of Supercomp Corp. produces a high-quality computer
each machine follows: chip. Unit production costs (based on capacity production of 100,000 units per
year) follow:
Old New
machine machine Direct material $50
Original cost $9,000 $20,000 Direct labor 20
Accumulated depreciation 5,000 0 Overhead (20% variable) 10
Annual cash operating costs 9,000 4,000 Other information:
Current salvage value of old machine Sales price 100
2,000 SG&A costs (40% variable) 15
Salvage value in 10 years 500 1,000
Remaining life 10 yrs. 10 yrs. 48. Refer to Chip Division of Supercomp Corp. Assume,
for this question only, that the Chip Division is producing and selling at
42. Refer to Big City Motors. The $4,000 of annual capacity. What is the minimum selling price that the division would consider
operating costs that are common to both the old and the new machine are an on a "special order" of 1,000 chips on which no variable period costs would be
example of a(n) incurred?
a. sunk cost. a. $100
b. irrelevant cost. b $72
c. future avoidable cost. .
d. opportunity cost. c. $81
d $94
ANS: B DIF: 1 .

43. Refer to Big City Motors. The $9,000 cost of the ANS: D DIF: 3
original machine represents a(n)
a. sunk cost. 49. Refer to Chip Division of Supercomp Corp. Assume,
b. future relevant cost. for this question only, that the Chip Division is operating at a level of 70,000
c. historical relevant cost. chips per year. What is the minimum price that the division would consider on
d. opportunity cost. a "special order" of 1,000 chips to be distributed through normal channels?
a. $78
ANS: A DIF: 1 b $95
.
44. Refer to Big City Motors. The $20,000 cost of the new c. $100
machine represents a(n) d $81
a. sunk cost. .
b future relevant cost.
. ANS: A DIF: 3
c. future irrelevant cost.
d opportunity cost. 50. Refer to Chip Division of Supercomp Corp. Assume,
. for this question only, that the Chip Division is presently operating at a level
of 80,000 chips per year. Accepting a "special order" on 2,000 chips at $88
ANS: B DIF: 1 will
a. increase total corporate profits by $4,000.
45. Refer to Big City Motors. The estimated $500 salvage b increase total corporate profits by $20,000.
value of the existing machine in 10 years represents a(n) .
a. sunk cost. c. decrease total corporate profits by $14,000.
b opportunity cost of selling the existing machine now. d decrease total corporate profits by $24,000.
. .
c. opportunity cost of keeping the existing machine for 10 years.
d opportunity cost of keeping the existing machine and buying the new ANS: B DIF: 3
. machine.
Virginia Iron Works
ANS: B DIF: 1
The capital budgeting committee of the Virginia Iron Works is evaluating the
Robco possibility of replacing its old pipe-bending machine with a more advanced
model. Information on the existing machine and the new model follows:
 Existing machine New machine The incremental cost to purchase the new machine is
Original cost $200,000 $400,000 a. $11,000.
Market value now 80,000 b. $20,000.
Market value in year 5 0 20,000 c. $13,000.
Annual cash operating costs 40,000 10,000 d. $18,000.
Remaining life 5 yrs. 5 yrs.
ANS: D DIF: 1
51. Refer to Virginia Iron Works. The major opportunity
cost associated with the continued use of the existing machine is 57. The objective in solving the linear programming
a. $30,000 of annual savings in operating costs. problem is to determine the optimal levels of the
b $20,000 of salvage in 5 years on the new machine. a. coefficients.
. b. dependent variables.
c. lost sales resulting from the inefficient existing machine. c. independent variables.
d $400,000 cost of the new machine. d. slack variables.
.
ANS: C DIF: 1 REF: App 12
ANS: A DIF: 1
58. A linear programming problem can have
52. Refer to Virginia Iron Works. The $80,000 market value a. no more than three resource constraints.
of the existing machine is b only one objective function.
a. a sunk cost. .
b an opportunity cost of keeping the old machine. c. no more than two dependent variables for each constraint equation.
. d no more than three independent variables.
c. irrelevant to the equipment replacement decision. .
d a historical cost.
. ANS: B DIF: 1 REF: App 12

ANS: B DIF: 1 59. A linear programming model must

a. have only one objective function.
53. Refer to Virginia Iron Works. If the company buys the b. have as many independent variables as it has constraint
new machine and disposes of the existing machine, corporate profit over the equations.
five-year life of the new machine will be ____________________ than the c. have at least two dependent variables for each equation.
profit that would have been generated had the existing machine been retained d. consider only the constraints that can be expressed as
for five years. inequalities.
a. $150,000 lower
b. $170,000 lower ANS: A DIF: 1 REF: App 12
c. $230,000 lower
d. $150,000 higher 60. In a linear programming problem, constraints are
indicated by
ANS: A DIF: 3 a. the independent variables.
b the dependent variables in the constraint equations.
54. Golden, Inc. has been manufacturing 5,000 units of Part .
10541, which is used in the manufacture of one of its products. At this level of c. the coefficients of the objective function.
production, the cost per unit of manufacturing Part 10541 is as follows: d iso-cost lines.
.
Direct material $2
Direct labor 8 ANS: B DIF: 1
Variable overhead 4
Fixed overhead 61. The feasible region for an LP solution is
6
applied a. defined only by binding constraints on the optimal
Total $20 solution.
b. defined as the solution space that satisfies all constraints.
Brown Company has offered to sell Golden 5,000 units of Part 10541 for $19 c. identified by iso-cost and iso-profit lines.
a unit. Golden has determined that it could use the facilities currently used to d. identified by all of the above.
manufacture Part 10541 to manufacture Part RAC and generate an operating
profit of $4,000. Golden has also determined that two-thirds of the fixed ANS: B DIF: 1 REF: App 12
overhead applied will continue even if Part 10541 is purchased from Brown.
To determine whether to accept Brown's offer, the net relevant costs to make 62. A linear programming solution
are a. always involves more than one constraint.
a. $70,000. b. always involves a corner point.
b. $84,000. c. is the one with the highest vertex
c. $90,000. coordinates.
d. $95,000. d. is provided by the input-output coefficients.

ANS: B DIF: 3 ANS: B DIF: 1 REF: App 12

55. Relay Corporation manufactures batons. Relay can 63. The objective function and the resource constraints
manufacture 300,000 batons a year at a variable cost of $750,000 and a fixed have the same
cost of $450,000. Based on Relay's predictions, 240,000 batons will be sold at a. dependent variables.
the regular price of $5.00 each. In addition, a special order was placed for b. coefficients.
60,000 batons to be sold at a 40 percent discount off the regular price. The c. independent variables.
unit relevant cost per unit for Relay's decision is d. all of the above.
a. $1.50.
b. $2.50. ANS: C DIF: 1 REF: App 12
c. $3.00.
d. $4.00. 64. Which of the following items continuously checks for
an improved solution from the one previously computed?
ANS: B DIF: 3
An algorithm Simplex method
56. Big City Motors is trying to decide whether it should
keep its existing car washing machine or purchase a new one that has a. yes yes
technological advantages (which translate into cost savings) over the existing b. yes no
machine. Information on each machine follows: c. no no
d. no yes
Old New machine
machine ANS: A DIF: 1 REF: App 12
Original cost $9,000 $20,000
Accumulated depreciation 5,000 0 65. Which of the following variables is associated with the
Annual cash operating costs 9,000 4,000 "less than or equal to" constraints?
Current salvage value of old machine 2,000
Salvage value in 10 years 500 1,000 Surplu Slack
Remaining life 10 yrs. 10 yrs. s
a. yes yes
b yes no 73. Consider the following linear programming problem
. and assume that non-negativity constraints apply to the independent variables:
c. no yes
d no no Max CM = $14X + $23Y
. Subject to
Constraint 1: 4X + 5Y < 3,200
ANS: C DIF: 1 REF: App 12 Constraint 2: 2X + 6Y < 2,400

66. ____________________ programming relates to a Which of the following are feasible solutions to the linear programming
variety of techniques that are used to allocate limited resources among problem?
activities to achieve a specific objective. a. X = 600, Y = 240
a. Integer b. X = 800, Y = 640
b. Input-output c. X = 0, Y = 400
c. Mathematical d. X = 1,200, Y = 0
d. Regression
ANS: C DIF: 3 REF: App 12
ANS: C DIF: 1 REF: App 12
74. Contracting with vendors outside the organization to
67. The graphical approach to solving a linear obtain or acquire goods and/or services is called
programming problem becomes much more complex when there are more a. target costing.
than two b insourcing.
.
constraint decision variables c. outsourcing.
s d product harvesting.
.
a. yes no
b. no yes ANS: C DIF: 1 REF: App 12
c. yes yes
d. no no 75. Which of the following activities within an organization
would be least likely to be outsourced?
ANS: C DIF: 1 REF: App 12 a. accounting
b. data processing
68. The feasible region for a graphical solution to a profit c. transportation
maximization problem includes d. product design
a. all vertex points.
b all points on every resource constraint line. ANS: D DIF: 1 REF: App 12
.
c. the origin. 76. An outside firm selected to provide services to an
d all of the above. organization is called a
. a. contract vendor.
b. lessee.
ANS: C DIF: 1 REF: App 12 c. network organization.
d. centralized insourcer.
Generic Co.
ANS: A DIF: 1 REF: App 12
In the two following constraint equations, X and Y represent two products (in
units) produced by the Generic Co. 77. Costs forgone when an individual or organization
chooses one option over another are
Constraint 1: 3X + 5Y < 4,200 a. budgeted costs.
Constraint 2: 5X + 2Y > 3,000 b sunk costs.
.
69. Refer to Generic Co. What is the maximum number of c. historical costs.
units of Product X that can be produced? d opportunity costs.
a. 4,200 .
b. 3,000
c. 600 ANS: D DIF: 1 REF: App 12
d. 1,400
78. Which of the following costs would not be accounted
ANS: D DIF: 3 REF: App 12 for in a company's recordkeeping system?
a. an unexpired cost
70. Refer to Generic Co. What is the feasible range for the b an expired cost
production of Y? .
a. 840 to 1,500 units c. a product cost
b 0 to 840 units d an opportunity cost
. .
c. 0 to 631 units
d 0 to 1500 units ANS: D DIF: 1 REF: App 12
.
SHORT ANSWER
ANS: B DIF: 3 REF: App 12
1. Why is depreciation expense irrelevant to most
71. Refer to Generic Co. A solution of X = 500 and Y = 600 managerial decisions, even when it is a future cost?
would violate
a. Constraint 1. ANS:
b Constraint 2. Depreciation expense is simply the systematic write-off of a sunk cost (the
. cost of a long-lived asset). Depreciation expense is therefore always irrelevant
c. both constraints. unless it pertains to an asset that is not yet acquired.
d neither constraint.
. DIF: 3

ANS: A DIF: 1 REF: App 12 2. What is an opportunity cost and why is it a relevant
cost?
72. One constraint in an LP problem is: 12X + 7Y > 4,000.
If the optimal solution is X = 100 and Y = 500, this resource has ANS:
a. slack variable of 700. An opportunity cost is not a "cost" in the traditional out-of-pocket sense.
b surplus variable of 700. Opportunity costs are benefits that are sacrificed to pursue one alternative
. rather than another. Once an alternative is selected, the opportunity costs
c. output coefficient of 700. associated with that alternative will not appear directly in the accounting
d none of the above. records of the firm as other costs of that alternative will. These costs are,
. however, relevant because the company is giving up one set of benefits to
accept a second set. Rational decision making assumes that the chosen
ANS: B DIF: 1 REF: App 12 alternative provides the greater benefit.
 than selling his grain to the local grain elevator. If Billy converts the grain to
DIF: 3 alcohol, he will incur additional costs of $0.60 per bushel and he will be able
to sell his crop to the oil refiner for the equivalent of $2.50 per bushel.
3. Define segment margin and explain why it is a relevant Otherwise, Billy can sell his corn crop to the local grain elevator for $1.85 per
measure of a segment's contribution to overall organizational profitability. bushel. If Billy elects to sell the grain to the refinery, he will not incur the
variable selling costs. What should Billy do? Support your answer with
ANS: calculations.
Segment margin is the amount of income that remains after deducting all
avoidable (both variable and fixed) costs from sales. This measure is the ANS:
appropriate gauge of a segment's viability because it is a direct measure of Billy's alternatives are to sell the corn as a grain or as alcohol. This decision
how total organizational profits would change if the segment was can be made by comparing the incremental costs to convert the grain to
discontinued. alcohol to the increase in price he can receive for marketing the crop as
alcohol rather than grain. By converting the crop to alcohol, Billy increases
DIF: 3 his total revenue by $0.75 per bushel ($2.60 - $1.85) and he incurs additional
costs of $0.50 ($0.60 for the additional processing, less the $0.10 savings on
4. What is the relationship between scarce resources and the variable grain marketing costs). Thus, by converting the grain to alcohol,
an organization's production capacity? Billy could increase his net income by $0.25 per bushel.

ANS: DIF: 3
In the long run, capacity is likely to be constrained by two fundamental
resources: labor and machinery. However, in the short run, additional 9. Refer to Farmer Billy. Assume that the current date is
constraints can push capacity to levels below labor and machine capacity. March 15. On this date, Farmer Billy must make a decision as to whether he is
Constraints can be induced by raw material shortages, interruptions in financially better off to plant his farm to corn, leave his land idle (no income is
distribution channels, labor strikes in the plants of suppliers of important derived from idle land), or rent his land to another farmer for $50 per acre.
components, or governmental restrictions on markets (gas rationing, Quotas). Corn prices have been severely depressed in recent years and Farmer Billy's
best guess is that corn prices will be around $2.00 per bushel at the time his
DIF: 3 crop is ready for harvest. What should Billy do? Show calculations.

5. Under what circumstances is the sum of variable ANS:

production and selling costs the appropriate minimum price for special orders? It has already been determined (answer to #80) that planting corn is preferred
to leaving the land idle (by $13 per acre). By renting the land, Farmer Billy is
ANS: even better off. Under the rental alternative, Farmer Billy is $37 per acre
Variable costs would serve as the bottom price for a special order only if the better off than if he plants corn ($50 - $13). By renting the land, Billy avoids
special order could be produced on production capacity that would otherwise all costs except the fixed production costs ($0.60 per bushel or $78 per acre).
be idle. Whenever presently employed capacity is partially or wholly
surrendered to produce a special order, the special order price would be based DIF: 3
on both variable costs and the profit sacrificed on the best alternative use of
the capacity. 10. Lisa and Yvette make and sell the "Kitchen Mystic," a
wall hanging depicting a witch. The Kitchen Mystics are sold at specialty
DIF: 3 shops for $50 each. The capacity of the plant is 15,000 Mystics per year. Costs
to manufacture and sell each wall hanging are as follows:
6. Why are fixed costs generally more relevant in long-run
decisions than short-run decisions? Direct material $ 5.00
Direct labor 6.00
ANS: Variable overhead 8.00
In the long run, all costs are relevant. In the short run, many costs that apply to Fixed overhead 10.00
the existing production technology are sunk. In particular, depreciation Variable selling expenses 2.50
charges and lease payments on long-term assets are unavoidable. In the long
run, these assets are replaced and, thus their associated costs are relevant in Lisa and Yvette have been approached by an English company about
the replacement decision. purchasing 2,500 Mystics. The company is currently making and selling
15,000 per year. The English company wants to attach its own label, which
DIF: 3 increases costs by $.50 each. No selling expenses would be incurred on this
order. Lisa and Yvette believe that they must make an additional $1 on each
Farmer Billy wall hanging to accept this offer.

Farmer Billy grows corn in a small rural area of Texas. Billy's costs per bushel a. What is the opportunity cost per unit of selling to the English
of corn (based on an average yield of 130 bushels per acre) follow: organization?
b. What is the minimum selling price that should be set?
Direct material $1.10
Direct labor 0.40 ANS:
Variable overhead 0.30
Fixed overhead 0.60 a. Opportunity cost = Selling price minus total variable costs $50 - ($5 +
Variable selling $6 + $8 + $2.50) = $28.50
0.10
costs b. Direct material ($5.00 + $.50) $ 5.50
Fixed selling costs 0 Direct labor 6.00
Variable overhead 8.00
Billy defines direct material costs as seed, fertilizer, water, and other Fixed overhead 10.00
chemicals. The variable overhead costs represent maintenance and repair costs Variable selling 0
of machinery. The fixed overhead costs are completely comprised of Opportunity cost [from (a) less
depreciation expense on machinery and real estate taxes. fixed overhead included] 18.50
Extra amount required to accept offer 1.00
7. Refer to Farmer Billy. Assume that the current date is Minimum price $49.00
March 15. On this date, Farmer Billy must make a decision as to whether he is
financially better off to plant his farm to corn or leave his land idle (no income DIF: 3
is derived from idle land). Corn prices have been severely depressed in recent
years and Farmer Billy's best guess is that corn prices will be around $2.00 per 11. Tiny Tim's Accounting Service provides two types of
bushel at the time his crop is ready for harvest. Should Billy plant corn or services: audit and tax. All company personnel can perform either service. In
leave his land idle? Explain. efforts to market its services, Tiny Tim's relies on radio and billboards for
advertising. Information on Tiny Tim's projected operations for 2001 follows:
ANS:
Billy should make his decision by comparing the incremental income from Audit Taxes
planting the corn crop to the incremental expenses that would be incurred to Revenue per billable hour $35 $30
grow, harvest, and market the crop. The incremental revenue is simply the Variable cost of professional
25 20
$2.00 per bushel and the incremental costs are all variable costs ($1.10 + labor
$0.40 + $0.30 + $0.10 = $1.90). Based on this comparison, Farmer Billy Material cost per billable hour 2 3
would be $13 per acre better off to plant than to let his land remain idle. Allocated fixed costs per year 100,000 200,000
Projected billable hours for 2001 14,000 10,000
DIF: 3
a. What is Tiny Tim's projected profit or (loss) for 2001?
8. Refer to Farmer Billy. Assume for this question only b. If $1 spent on advertising could increase either audit services billable
that Billy decided to plant the corn. It is now harvest time and Billy's actual time by 1 hour or tax services billable time by 1 hour, on which
costs are the same as those listed previously. A local oil refiner has approached service should the advertising dollar be spent?
Billy about converting his crop to grain alcohol (used to make gasohol) rather
ANS: opportunity cost
= DM + DL + V - FOH + OP COST
a. Audit Tax Total $77.50 = $15 + $40 + $10 + ($50,000/4,000 units)
Revenue: b. Make: Save ($80.00 - $77.50) × 4,000 = $10,000
14,000 × $35 $490,000 $ 490,000 c. Incremental mfg. = $65 + $72.50
10,000 × $30 $ 300,000 300,000 ($30,000/4,000) =
Variable Costs: + opportunity cost $50,000/4,000 12.50
Labor: =
14,000 × $25 (350,000) (350,000) To make $85.00
10,000 × $20 (200,000) (200,000) Buy: Save ($85 - $80) × 4,000 units = $20,000
Material:
14,000 × $2 (28,000) (28,000) DIF: 3
10,000 × $3 (30,000) (30,000)
Contribution margin $112,000 $ 70,000 $ 182,000 15. Brown Corp is working at full production capacity
Fixed costs (100,000) (200,000) (300,000) producing 10,000 units of a unique product, XYZ. Manufacturing costs per
Profit (loss) $ 12,000 $(130,000) $(118,000) unit for XYZ follow:

b. Each billable hour of audit services generates $8 of contribution Direct material $2

margin Direct manufacturing labor 3
($35 - $25 - $2), tax services generates $7 of contribution margin Manufacturing overhead 5
($30 - $20 - $3). The advertising should be spent on the audit $10
services.
The unit manufacturing overhead cost is based on a variable cost per unit of
DIF: 3 $2 and fixed costs of $30,000 (at full capacity of 10,000 units). The non-
manufacturing costs, all variable, are $4 per unit, and the selling price is $20
12. Timothy Warren operates a woodworking shop that per unit. A customer, the Miami Co., has asked Brown to produce 2,000 units
makes tables and chairs. He has 25 employees working 40 hours per week, of a modification of XYZ to be called ABC. ABC would require the same
and he has 750 hours per week available in machine time. Timothy knows that manufacturing processes as XYZ and the Miami Co. has offered to share
he must make at least four chairs for every table. He has also determined the equally the non-manufacturing costs with Brown. ABC will sell at $15 per
following additional requirements: unit.

Labor Machine Contribution Required:

hours hours margin a. What is the opportunity cost to Brown of producing the 2,000 units
Table 5 2 $18 of ABC (assume that no overtime is worked)?
Chair 3 1 4
b. The Jones Co. has offered to produce 2,000 units of XYZ for Brown,
Write the object function and constraints for the above problem. so Brown can accept the Miami offer. Jones would charge Brown $14
per unit for the XYZ. Should Brown accept the Jones offer?
ANS:
Objective function: Max CM→ 18X + 4Y c. Suppose Brown had been working at less than full capacity
producing 8,000 units of XYZ at the time the ABC offer was made.
Subject 4X - Y > 0 What is the minimum price Brown should accept for ABC under
to: these conditions (ignoring the $15 price mentioned previously)?
5X + 3Y ≤ 1,000
2X + Y ≤ 750 ANS:
X = # of tables
Y = # of chairs a. XYZ
SP $20
13. Define and discuss outsourcing. - VC ($2 + $3 + $2 +
(11)
$4)
ANS: = CM $9 × 2,000 units = $18,000
Outsourcing occurs when an organization "farms out" some of its normal ABC
business activities or processes. Several areas that are most frequently SP $15
outsourced by an organization include payroll, accounting, transportation, and - VC ($2 + $3 + $2 +
(9)
possibly legal. When a company outsources some of its functions, it is able to $2)
divert more energy to those areas that produce a firm's core competencies or = CM $6 x 2,000 units = 12,000
have the ability to create revenues for the firm. Opportunity cost $ 6,000

DIF: 3 b. Make ($15 - $14) = $1 × 2,000 units = $2,000 without giving up any
current production = DO IT.
14. The management of Smith Industries has been
evaluating whether the company should continue manufacturing a component c. The variable cost to make and sell = $11 ($2 + $3 + $2 + $4) would
or buy it from an outside supplier. A $100 cost per component was determined be the minimum. Any price over $11 would increase the contribution
as follows: margin.

Direct material $ 15 DIF: 3

Direct labor 40
Variable manufacturing 16. The Davis Company normally produces 150,000 units
10
overhead of AB per year. Due to an economic downturn, the company has some idle
Fixed manufacturing overhead 35 capacity. AB sells for $15 per unit.
$100
The firm's production, marketing, and administration costs at its normal
Smith Industries uses 4,000 components per year. After Jones Corp. submitted capacity are:
a bid of $80 per component, some members of management felt they could
reduce costs by buying from outside and discontinuing production of the Per Unit
component. If the component is obtained from Jones Corp., Smith's unused Direct material $1.00
production facilities could be leased to another company for $50,000 per year. Direct labor 2.00
Variable overhead 1.50
Required: Fixed overhead
a. Determine the maximum amount per unit Smith could pay an outside ($450,000/150,000 units) 3.00
supplier. Variable marketing costs 1.05
Fixed marketing and administrative
b. Indicate if the company should make or buy the component and the costs
total dollar difference in favor of that alternative. ($210,000/150,000 units) 1.40
Total $9.95
c. Assume the company could eliminate one production supervisor with
a salary of $30,000 if the component is purchased from an outside Required:
supplier. Indicate if the company should make or buy the component a. Compute the firm's operating income before income taxes if the firm
and the total dollar difference in favor of that alternative. produced and sold 110,000 units in 2001.

ANS: b. For 2002, the firm expects to sell the same number of units as it sold
in 2001. However, in a trade newspaper, the firm noticed an
a. Cost to make = incremental manufacturing cost and invitation to bid on selling AB to a state government. There are no
 marketing costs associated with the order if Davis is awarded the
contract. The company wishes to prepare a bid for 40,000 units at its
full manufacturing cost plus $ 0.25 per unit. How much should it
bid? If Davis is successful at getting the contract, what would be its
effect on operating income?

c. Assume that the company is awarded the contract on January 2,

2002, and in addition it also receives an order from a foreign vendor
for 40,000 units at the regular price of $15 per unit. The foreign
shipment will require the firm to incur its normal marketing costs.
The government contract contains a 10-day escape clause (i.e., the
firm can reject the contract within 10 days without any penalty). If
the firm accepts the government contract, overtime pay at 1 1/2 times
the straight time rate will be paid on the 40,000 units. In addition,
fixed overhead will increase by $60,000 and variable overhead will
behave in its normal pattern. The company has the capacity to
produce both orders. Decide the following:

1. Should the firm accept the foreign offer? Show the effect on
operating income of accepting the order.

2. Assuming the foreign order is accepted, should the firm accept the
government order? Show the effect on operating income of
accepting the government order.

ANS:

a. Sales (110,000 × $15) $1,650,000

- VC (110,000 ×
(610,500)
$5.55)
= CM $1,039,500
- FC ($450,000 +
(660,000)
$210,000)
= Operating Income $ 379,500
b. Full cost to $7.50
manufacture =
+ profit .25
Bid $7.75
SP $7.75
- VC (4.50)
CM $3.25 × 40,000 units = $130,000 increase in
operating income.
c. 1. SP $15.00
- VC (6.55) ($1 + $3 + $1.50 + $1.05)
CM $ 8.45 × 40,000 = $338,000
- FC (60,000)
Increase in Operating
$278,000
Income
2. Both orders can be accepted even if the increased costs of
$40,000 for labor and $60,000 for fixed overhead are
assigned to the government order.

DIF: 5