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MAS-O4: RELEVANT COSTI NG

DECISION MAKING process of choosing from at least two alternatives. For business entities,
- is the
management must choose in favor of the option that maximizes the company profit.

SHORT_TERM DECISION ALTERNATIVES

1. Make-ar_bgyapartoraproductline Ll"+i, 't..'-i ,,i{,, ir\r,,l
2. Acsept-ortgj.eet a special order
3. Setl or-pracess further a product line
4 . C_q!-l!1, y -qruha+dowit a bu s ness se g m e nt
e- i

5. Choosing the -Oesf product combination

6. Selecting a cl-Bnge in profit factors
TYPICAL DECISION MAKING PROCESS
1. Defining the problem.
2" Specifying the objective and criteria.
3. Identifying the alternative courses of action.
4. Evaluating the possible consequences of the alternatives.
5. Collecting the data needed to make decision.
6. Choosing the best alternative and making the decision.
7. Evaluating the results of tlre decision.

FACTORS CONSIDERED IN DECISION MAKING

> Qualitative Factors - factors that cannot be expressed effectively in numerical terms.
'r Quantitative Factors - factors that can be expressed in monetary or other numerical units.
Quantitative approaches in decision making:
1) TOTAL approach - the total revenues and costs are determined for each alternative, and the
results are compared to serve as a basis for the decision to make.
2) DIFFERENTIAT- approach - only the differences or chanEes in costs and revenues are considered.
NOTE: In decision-making cases that involve a conflict between qualitative and quantitative factors,
quali$ usually prevails over quantity:
TERMINOLOGIES USED IN SHORT-TERM DECISION MAKING
RELEVANT COSTS Future costs that are different among alternatives; it is considered as the
avoidable costs of a particular decision.

DIFFERENTIAL COSTS Increases (increments) or decreases (decrements) in total costs that result from
selecting one alternative instead of another. IRelevant]
AVOIDABLE COSTS Costs that will be saved or those that will not be incurred if a certain decision is
made. .[Relevant]

OPPORTUNITY COSTS Income sacrificed or benefit foregone when a certain alternative is chosen over
a nother alternative. IRelevant]

SUNK COSTS Costs that are incurred already and cannot be avoided regardless of what
decision is made. IIrrelevant]
SHUTDOWN COSTS Usual costs that a. company will continue even lf it decides to discontinue or
shutdown the operation of a company segment. IIrrelevant]

JOINT COSTS Costs incurred in simultaneously manufacturing two or more (joint) products
that are difficult to identify individually as separate types of products until the
products ieach a certain processing stage known as the split-off point.
. [Irrelevant]
FURTHER PR.OCESSING Costs incurred beyond the split-off point as separated joint products are to be
COSTS processed further. [Relevant]

SPLIT OFF POINT The earliest stage in the production where joint products can be recognized as
distinct and separate products.
BOTTLENECK Any particular resource or operation where the capacity is less than the demand
RESOURCES placed upon it.

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RELE\/AI\T COSTING

S}IORT-TERM DSCI5TO!{ M,AKING GIJIOELINES

Basic rule: cltor:se the action that urili yield tne BE:;T PROfIf POSIIIOill.

Highest revenues

Lowest costs ts*- Hiqhest possiL!!e profrt

i sunk r:csts a;rd lri'elevant"

5. BEST PRODUCT wi;l;n- i;r(n.Ltql-- si;;i;l be I Identify and measure the constraint
COMBINATION praduced and salo vtken there is a ! on the iin'ritetl resource(s). F{ank the
(Optirnization of given limited resaLrrc€:s o," i prorluct(s) according to the highest
Scarce Resources) bottleneck operatian? contribittion margin per unit of
t __-_ i ttftiltea
tintited resaurces.
CHANGI IN PROFIT 'muH any
I Should anv of fltc prafit taclc;rs i ldeniify the factor to change and the
of' t!rc
"rnntE'.-tir;i"T,lpntif,
urlit sale:;, I amount of contemplated change.
FACTORS I such as seilinq price,
cost.. fixed cost ancl sales I Chanqe the profit factor if it will

_EXE_&t-I"1E_5--.rrLi.lVpJl j--Co*SIJ,i.!:i

1. TOTAL ANALYS'IS vs. DIFFERENTIAL ANALYSIS

London Company.has a single product callecl Heathro"r,r. The company currently sells.8.000 units ot
Heathrow atPjl! perunit. Thecomparry'scostsatthislevel of activityaregivenLrelow:

Variahle Costs;
D'irect nrateriais PL0
Direct laboi I
Variable Overhead 5
Vanable Seiiing ExDenst: __*-z
P"ai
Fixed'Costs:
Fixed 0verhead t-} 50,0rJ0
Fixed Sellin.q Expense 20.000
@
REQUIR,ED: io,l)0,
1. What is L.onclon Company's present profit? ri'i (
2. Londorr Company could increase,' its sales tr\r 250.4 if it spends P 20,000 for advertisements.
Determine the effect on cornpaily pr,:,fit using:
A) rctal analysis l!F-
B) Differentiaianalysis tirrr
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RELEVANT COSTING

2. MAKE OR BUY (OUTSAURCING DECrS.{ON)

BMW Motors must decide whether it must continue to produce an engine component or buy it from
Sarao-Philippines for P 2,50O each. The demand for the coming - year- is. 20 units. The costs.ef ",
producing a sirrgle unit of the engine component are as follows: p\trk+ ll:,j-L ';,'
Direct materials P 1,300 !1;i, :rri"-r':,- : n
Direct labor 7OA :1! r- n i:l,t r,.{ {
t/ ti:' ++' ii' irt
Factory Overhead (80% fixed) 1,000 Aqi , ,- rlri' -

IfBMW buys the components, tfie facitity now used to *"L*30.",frf";,rJ'..n o;'*nted out ,r ''"--
another firm for P 4.000.
REQUIRED: , ,. ,... -._ ( . ht,
Slroulcl BMW make or buy the components? \,''r'(E ' jpillM" ! i I\..i ---_!

3. ACCEPT OR REJECT (SPECTAL ORDER DECTSTAN)

Antonia Company sells a product for a regular unit price of P 75.00. The cost of producing and
selling a unit of this product at the normal activity level of 50.000 units per month is as follows;
Manufacturing costs:
Direct materials P 32.50 per unit
Direct labor 7.50 per unit
Variable manufacturing overhead 3.00 per unit
Fixed manufacturing overhead P 100,000 per month
Selling and administrative cosfs:
Variable P 2.50 per unit
Fixed P 36,000 per mcnth
An order has been received from a customer for 5,000 units at a discounted unit price of P 50.00.
This order has no effect on normal sales and would not change the amount of total fixed costs. The
variable selling & administrative expense would be P O.50 lesg per unit on this order than on normal
sales. l' - ' l',.1; .' :

REQUIRED.,
Should Antonia accept or reject the special order? : Ih 1
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1a.
4. SPECIAL ORDER PRICING e 1..
' rry h\ .t
Conrada Company sells I-Phone 10 at a price of P 28,O00 per unit. The cost-. o6r unit are:
"" bF
Direct materials
Direct labor
Variable overhead
P B,OOO

4,000
;,;il ",\ , i.;r
Fixed overhead _*_39!0
TOTAL P 20,000 { il i. '. l'rK
A special order for 1,000 units was received fromr Marcia Bona, Bona, a welllkhown cell phone dealer
based in cavite. Additional shipping costs for this sale are p 2,000 per unit.
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REQUIRED: b., t,
What is the minimum selling price per unit fo1 the special order if:
A)
Conrada is operating at FULL capacity? 4,r,'.-, ,
Conrada has EXCESS capacity? .) ;
B)
"_
5. SHUTTING DOWN OPERATIONS
The most recent monthly income statement for Fermina Stores is given below:
Eraneh UevAe-qr-arch Totat
Sales p1,200,000
-C_ebu
p800,000 p2,000,000
Le-s-s"' Variable expenses (840-A0i) (360,000) (1.200,000)
Contribution margin p 360.000 p44O,00O. p900,000
Less.' Traceable fixed expenses (210.000) (180,000) (390.000)
Segment margin P 150,000 p 260,000 p 410,000
less.' Common fixed expenses (180.000) .tLZQ.Qle (300.000)
Profit (loss) (P 30,00Q p_140*p-09 p.Ll=0,O00

If Cebu Branch were eliminated, then its traceable fixed expenses could be avoided. The total
common fixed expenses are merely allocated and would be unaffected.
t/ A) Whatwill be the new company profit (loss) if Cebu Branch is eliminated? l'ltl&
a. P 260,000 c. (p 40,000) (lH, /-\ lt_3 fl.t1
b. P 140,000 (P 70,000) ttufr
",tr,>
B) What will be the decrease in company profit if Cebu Branch is closed anO ZOLaJf?J traceable fixed
b expense would remain unchanged while Davao sales would decrease bV 2oio?
a. P 352,000 c. P 136,000
b. P 280,000 d. No decrease; profit will increase .t '
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PROPUCT ELIMIhIATION PCIINT :

Chrissy Company expt-.cts that sales will dr-c;; Lrelo..a.r tire cr.;rr-ent level of 5,000 r-rnits per nronth. An
income stat(:ment prepared fcrthr-'rrrcinl:hi? s.'rins L.f 5,(-tll0 uniis shoy,, the foliowinq:
Saies (5,C00 O Pr) p 15,000
[_ess:
Variai:i€ costs {5,000 i@ P 2) P '10,ij0c}
Fixed costs
Frofit - Nit -
If plant openations are susltertri*:rj, a shut,-iowrr cost (i.e., oiant maintenance and taxes) of p 2,000
per month wili remain as inrj(rri.ed. Since there is n,.r im,rredtate possihiiity of proftt under preG6il[
conditions, the probler':r oF the company is just ho',r to nrininrize tite loss.
REQUIRED: T I

1. What is the shuttJown point in unitsi' 3,i'-,i vttttl l

2. Should the conrpany cantinue or-shrtdon',r operatlons if sales next month are expecterl to be:
A) ,+.000 units? rjtf.,'1-r:; l.ti , ttL n,{ ?'t
B) 2,000 units-t ,,l,:_,-, ), ,
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Ai4-ca,q!rG t 2, 0 o-Q*u
Contribution l.1arg irr
:ljzed.,QsEtE (5-Q!:l) (Ij,Qoq) G-0_Q0)
Profit (loss) i-----,.----=-_---t___-_-"__ -- __l-
7. SEI-L OR PROCESS TURTHER 1,1i [,1x,1
Gorgonia Contpany produces lcrl:r produr;ts iar a fgttil--e€I cf(t, 10,000.t, The firrn could sell the
pr,:ducts at the :pJ:!_pf_pginl for the foiloninE arr:olrnls: @
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At presetlt, the prr:duito ,i* pro."rserl beyonrl tire si:lit-off point arrd they are scrlcl as follows:
!lc,{t,tpJs__ __ lqlpq . __E!ill!i.ql_rqt-,[1p9g9,111g Cq_st Pi'rt]l: I .r lirrg ii '.^''.
M P 40,00ii [, 28,000
L30,000 15, C{}r.1
L. ,/_t,,00{.J 14, COC
o 7,1;co 3.00r:)
!'

REQIIIR.ED:
1. Which product(s) shr:uicl the fir..n seil at :piit-ofi'point) I

2. If the company takes ihe most crrof;tatrle aciion, then wlrat rryill be its profit? 75k
a. BEST PRODUCT COi.iBINATION
Kulang Co. produces three prodt.:cis;: A, B and C. orie machine is usecl to procluce the prgducts.
The contribution rnargins, sale:> derr;antJs, and tirrre on the nraclrine iin hours) are as follows:

Marlei_Lirn!t tldtCalltr.tbUl,iai-r,l4arqjil 5!q!:E*Ar1pc11jne 1i.,,-l,i'1i-..f

A 100 units P20 -na- 10 perunit
B B0 units P i,8 5 per unit *: ;
C 150 units' F25 10 per unit
- ..r ,t ,
There are 2,4
?r*9Lhours available o;'r the machine during the w,:ek. l"otal fixed cost is p g606.
,! REQUIRED:
1. What is the best prcduct combination th:t nraxirnizes the weekly contritrution? I
i3 a. 100 units of A; B0 units uf B; 15C unrt:: of Ct l)
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b. 50 units of A; B0 units of B; 150 units of C' F(.r\ t\ '74,
c. 90 units 6f /{; 0 unit of B; 150 unit-s of C ltrt.r. ,I

d. 100 units cf A; E0 rinits of B; 100 unrts of C &

2. How much i' u",u"p#ii;#;;;;. -,1i,., cnrnbinaricn? lr r,,:, -L
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RELEVANT COSTING

WRAP-UP EXERCISES (MULTIPLE.CHOICE)

', l-. Which of the following costs is generally considered irrelevant in decision-making process?
s a. Direct labor
b. Direct materials
c. Fixed factory overhead
d, Variable factory overhead
', 2. The salary you would otherwise earn by working rather than attending the CPA review is a good
exarnple of
a. A sunk cost
b, An opportunity cost
c, An incremental cost
d. An out-of-pocket cost
l- 3. An opportunity cost is usually:
f- a. Relevant, but is not part of traditional accounting records.
b. Not relevant, but is part of traditional accounting records.
c. Relevant, arrd is part of traditional accounting records.
d. Not relevant, and is not part of traditional accounting records.
if / 4. What is the opportunity cost of making a component part in a factory with excess capacity for which
\ there is no alternative use?
a) The total manufacturing cost of the component
b. The variable cost of the component
c. The fixed cost of the component
d. Zero

Ir 5. If there ts excess capacity, the minimum acceptable prrce for a special order must cover
l.-, a. Usual fixed manufacturing costs
b. Variable and usual fixed manufacturing costs
c: Variable manufacturing costs associated with the special order
d. Variable manufactuiing cbsts plus contffirition marginfFegone on lost regulat unfta
ilr 6. If the margin that wlll be lost by dropping a product line is more than the fixed costs that will be
I avoided, then
a. The product line operates at a loss
b. The product llne shall be continued
c. The product line shall be shutdown
d. The product line has no significant impact on company profit
1-1
V 7 . If there are no shlrtdown costs, then a company's shutdown point is
a. Nil or zero
b. Below its break-even point
c, Above its break-even point
d. Equai to its break-even point
)'.

i-, B. Which is usually considered iy"!g"gnt in'sell or process further'decision making?

a. Jotnt costs
b. Further processing costs
c. Sales value at the split-off point
d. Sales value after further processing
.\
tl!' 9. A company that has a limited number of machine hours and abundant labor hours should produce first
the product that has the highest
a. Denrand in units
b. Contribution margin per unit
c. Contribution margin per labor hour
d. Contribution margin per machine hour

h 10. The role of sunk costs in decision making can be summed up in which of the following sayings?
a. No pain, no gain
b. Bygones are bygones
c. A penny saved is a penny earned
d. The love of money is the root of all evil