BALUCAN, LUIGI E.

CHAPTER 11 RELEVANT COSTS FOR NON-ROUTINE DESCISION MAKING

Exercise1 (Identifying Relevant Costs)

Case1 Case2

Item Relevant Not Relevant Relevant Not Relevant

a. Salesrevenue X X

b. Direct materials...............................................X X

c. Directlabor........................................ ……….X X

d. Variable manufacturing overhead…………...X X

e. Bookvalue–ModelE7000 machine....................................X X

f. Disposalvalue– ModelE7000 machine.............................. X X

g. Depreciation–ModelE7000 machine.................................X X

h. Marketvalue–ModelF5000 machine(cost)……X X

i. Fixedmanufacturing overhead............................................X X

j. Variablesellingexpense.....................................X X

k. Fixedsellingexpense.........................................X X

l. Generaladministrative overhead.......................X X

Exercise2 (IdentificationofRelevantCosts)

Requirement 1

Fixed cost per mile (P3,500*÷10,000miles) P0.35

Variable operating cost per mile 0.08
Average cost per mile P0.43

Depreciation P2, 000

Insurance 960
Garage rent 480
Automobile tax and license 60
Total P3, 500
REQUIREMENT 2

In this case, the variable operating costs would be relevant. There are irrelevant things Ingrid must
consider in making decision such as depreciation, insurance cost and taxes and licenses. Depreciation is
irrelevant because it cannot be recovered and it is already incurred; insurance is also irrelevant because it
increases as a result of the trip and lastly, taxes and licenses because either of the two- use her car or rent a car
cost will be incurred. However, any decrease in resale value will have an impact and that makes it relevant
therefore, variable cost is relevant because everything varies depending on its decision.

REQUIREMENT 2

In estimating incremental cost, there are two factors two consider. First is the purchase price of the new
car and second, the fixed cost of the automobile insurance, tax and license. The rest of the costs are irrelevant
such as the price of the old car and etc.

Exercise3 (Make or Buy a Component)

Requirement 1

PerUnit
Differential
Costs 15,000units
Make Buy Make Buy
Costofpurchasing P200 P3,000,000
Directmaterials P 60 P 900,000
Directlabor 80 1,200,000
Variable manufacturing overhead 10 150,000
Fixedmanufacturingoverhead,traceable1 20 300,000
Fixedmanufacturingoverhead,common 0 0 0 0
Total costs P170 P200 P2,550,000 P3,000,000

Difference in favor of continuing to make P30 P450,000

Requirement
Make Buy
Costofpurchasing(part1) P3,000,000
Cost of making (part1 P2, 550,000
Opportunity cost—segment margin for gone
On a potential new product line 650,000 __________
Total cost P3, 200,000 P3, 000, 000
Difference in favour of purchasing
From the outside supplier P200, 000
The company must accept the offer and purchase the parts from the outside supplier.
Exercise4(Evaluating Special Order)
Per Total
Unit 10 bracelets
Incremental revenue P3, 499.50 P34, 995.00
Incremental costs:
Variable costs:
Direct materials 1,430.00 14,300.00
Direct labor 860.00 8,600.00
Variable manufacturing overhead 70.00 700.00
Special filigree 60.00 600.00
Total variable cost P2, 420.00 P24, 200.00
Fixed costs:
Purchase of special tool. 4,650.00
Total incremental cost 28.850.00
Incremental net operating income P 6.145.00

In the case of exercise 4, only incremental cost is relevant specifically the variable manufacturing cost. Other
costs are fixed and should not affect the decision of the Glamour Jewelers.
Even though the price for the special order is below the Glamour Jeweler Company’s regular price for such an
item, the special order would be added to the company’s net operating income and should be accepted.

Exercise5 (Utilization of a Constrained Resource)

Requirement 1
X Y Z
Contribution margin per unit P18 P36 P20
Direct labor cost per unit P12 P32 P16
Direct labor rate per hour. 8 8 8
Direct labor-hours required per unit (2) ÷ (3) 1.5 4.0 2.0
Contribution margin per direct labor-hour (1) ÷ (4) P12 P9 P10

Requirement 2

The company should concentrate its labor time on producing product X:

X Y Z
Contribution margin per direct labor-hour P12 P9 P10
Direct labor-hours available ×3,000 ×3,000 ×3,000
Total contribution margin P36,000 P27,000 P30,000

In this case even if X has the lowest contribution margin per unit, the second lowest contribution margin ratio,
it has the highest contribution margin per direct labor-hour and labor seems to be the company’s constraint, this
measure should guide management in its production decisions.

Requirement 3

Jaycee Company’s money should be willing to pay in overtime wages for additional direct labor time will
depends on how the time would be used. If there are unfilled orders for all of the products, Jaycee preferably
use the additional time to make more of product X. Each hour of direct labor time generates P12 of
contribution margin over and above the usual direct labor cost. Therefore, Jaycee should be willing to pay up to
P20 per hour for additional labor time, but would of course prefer to pay far less. The upper limit of P20 per
direct labor hour signals to managers how valuable additional labor hours are to the company.
Exercise 6 (Sell or Process Further)
ProductA Product B Product C
Sales value after further processing P80, 000 P150,000 P75,000
Sales value at split-off point 50,000 90,000 60,000
Incremental revenue 30,000 60,000 15,000
Cost of further processing 35,000 40,000 12,000
Incremental profit (loss) P (5,000) P20,000 P3,000

Exercise 7 (Identification of Relevant Cost)

1. The relevant cost of fishing trip would be:

Fuel and upkeep on boat per trip P 25

Junk food consumed during the trip 8
Snagged Fishing lures 7
Total P40

2. In Shin’s case, the costs are really incurred in order to be able to catch and cost to be incurred in fishing
would be the same and it doesn’t affect how many fish will be catch. It’s the fishing activity cost money
not catching the fish therefore, it really doesn’t cost him anything to catch the last fish.

3. In Shins decision making process in giving up fishing, all cost listed are relevant because those cost are
needed to conduct such activity. If Shin did not fish no expenditures to be incurred.

Exercise 8 (Dropping or Retaining a Segment)

1. No, the housekeeping program should not be discontinued. It is a way of generating a positive
program segment margin and providing a valuable service to seniors. To support this conclusion,
stated below are the computation:

Contribution margin lost if the housekeeping program is dropped P80,000

Fixed costs that can be avoided:

Liability insurance P15,000

Program administrator’s salary  37,000   52,000

Decrease in net operating income for the organization as a whole P(28,000)

Depreciation on the van is a sunk cost and the van has no salvage value since it would be donated to
another organization. The general administrative overhead is allocated and none of it would be avoided
if the program were dropped; thus it is not relevant to the decision.
 Per Unit
Differential Costs 20,000 Units
Make Buy Make Buy
Cost of purchasing $23.50 $470,000
Cost of making:
Direct materials $ 4.80 $ 96,000
Direct labor 7.00 140,000 Revenues
Variable manufacturing overhead 3.20 64,000 Variable expen
Fixed manufacturing overhead    4.00 *              80,000               Contribution m
Total cost $19.00 $23.50 $380,000 $470,000 Fixed expense
Depreciation
Liability ins
Program adm
General adm
Total fixed exp
Net operating

Exercise 9(Special Order)

1. If accepted, an increase of P9, 000,000 in monthly profit of Kimura Company.

Computation:

Selling Price per unit P12

Direct Materials per unit 2.05
Direct Labor per unit 3
Variable FOH 0.50
Variable Selling and admin exp 1.50
Total profit per unit 4.50
Multiply: No of units x 2, 000
Total increase in profit 9, 000

2. In Kimura Company’s case, 500 units were already manufactured last year therefore manufacturing cost
that were incurred are not relevant. The only relevant cost now is the manufacturing Selling and
administrative expenses in establishing a minimum price per unit.

Exercise 10 (Make or Buy a Component)

The costs that are relevant in a make-or-buy decision are those costs that can be avoided as a result of
purchasing from the outside.

*
The remaining $6 of fixed manufacturing overhead cost would not be relevant, since it will
continue regardless of whether the company makes or buys the parts.
The $150,000 rental value of the space being used to produce part represents an opportunity cost of continuing
to produce the part internally. Thus, the completed analysis would be:
Make Buy
Total cost, as above $380,000 $470,000
Rental value of the space (opportunity cost)  150,000             
Total cost, including opportunity cost $530,000 $470,000

Net advantage in favor of buying $60,000

Profits would increase by $60,000 if the outside supplier’s offer is accepted.

Exercise 11 (Economist’s Approach to Pricing)

P17.90 price P13.90 price

1. Unit Sales 860 1, 340
Sales P15, 394 P18, 626
COGS @ 4.10 3,526 5, 494
CM 11,868 13, 123
Fixed Expenses 425 425
Net Operating income P11, 443 P12, 707

2. (1.75)
Elasticity of Demand= In ( 1+ change in quantity sold)
In (1+% change in price)
=In (1+ (1,340-860)/860)
= In (1+ 13.90-17.90/17.90
=In(1-0.55814/ In(0.22346) = In ( 1.55814)/(0.77654) =0.44394- 0.25291= -1.75

3. Profit maximizing markup on variable cost= -1

1+ Elasticity of demand

-1
1+ (1.75) = 1.333

Profit Maximizing Price = 1+ profit Maximizing Markup on variable cost x Variable cost per unit
= 1+ 1.3333) x P4.10= P 9.60

Exercise 12 (Target Costing)

Sales (50, 000 batteries x P65 per battery) P3, 250,000

Less: Desired Profit (20% x P2, 500, 000) 500,000
Target cost for batteries P 2, 750,000
Target cost per battery = (2, 750,000/50,000)
= P55 per battery

Exercise 13 (Pricing a New Product)

Requirement:
Get the minimum acceptable selling price for the new amaretto cappuccino.

Solution:

Opportunity cost per minute P34

Divide Seconds per minute 60
Value per second 0.5666666667
Multiply: time in filling beverage x45
Total 25.5
Add: variable cost 4.60
Minimum selling price acceptable 30.1

Module Exercises

Required:
Should the company accept the order? Provide both qualitative and quantitative justification for your decision.
Assume that no other orders are expected beyond the regular business and the special order.

Total Project Approach Status Quo Alternative Difference

Sales P 2, 040,000 P2,200,000 P 160,000
Less: Variable Costs 1,232,500 1,367,500 135,000
Contribution Margin 807,500 832,500 25,000
Less: Fixed Cost 425,000 425,000 0
Operating Profit P382,500 P407,500 P25,000
 In this case, the company must accept order because data shows that it will increase operating profit of
P25, 000.Even if the offered price is lower than the company’s normal price sells to customers, still it will add
up to its operating income.

OPTIMAL MIX

Required:
a. Is the grinding constraint an internal constraint or external constraint?
It is an internal constraint because it happens within the company’s production section.

b. Determine the optimal mix. What is the total contribution margin?

Y Z
Contribution Margin per unit P200 P400
Divide: Required Grinding per unit 2 HOURS 5 HOURS
Contribution Margin per hour of P100 P80
Grinding time

To get the contribution margin of optimal mix, 100 units of Gear Y multiplied by Contribution
margin per unit of Gear Y amounting to P200. P20, 000

c. Suppose that there is additional demand constraint: Market conditions will allow the sale of only 80
units of each gear. Now, what are the optimal mix and the total contribution margin per week?

(80 units x P200= P16, 000)+(8 units x P 400= 3, 200)=P19,200