EXAMPLE (1)

Y Company has already incurred $93,000 cost in partially producing its three products. Their
selling prices when partially and fully processed are shown in the table below with the
additional costs necessary to finish their processing.

Required: Based on this information, should any products be processed further?

SOLUTION

➢ EXAMPLE (2)

Suppose that ABC Company produces two products X and Y.

Per unit X Y
Sales Price $ 20 $ 30
Variable Expense 16 21

If the company has 15,000 machine hours available, in one hour ABC Company can
produce 70 units of X or 30 units of Y.
Required
Which product ABC Company should produce and emphasize?
SOLUTION
X Y
Sales price per unit $ 20 $ 30
Variable expense per unit (16) (21)
Contribution margin per unit $4 $9
X Units produced each machine hour X 70 X 30
Contribution margin per machine hour $ 280 $ 270
X Capacity – number of machine hours X 15,000 X 15,000
Total contribution margin at full capacity $ 4,200,000 $ 4,050,000
 ABC company should emphasize and produce X product, because it has the higher
contribution margin per unit machine hour (the constraint) resulting in a higher contribution
margin of the company.

EXAMPLE (3)
‘
Suppose that ABC Company produce X product, the following costs are incurred
for producing 20,000 units:
Direct materials $ 20,000
+ Direct labor 80,000
+ Variable manufacturing overhead 40,000
+ Fixed manufacturing overhead 80,000
Total manufacturing cost $ 220,000
Cost per unit ($ 220,000 / 20,000) $ 11

Another manufacturer has offered to sell product X for $ 10, a total purchase cost of $
200,000. If ABC Company outsources and leaves it plant idle, it can save $ 50,000 of fixed
overhead cost. Or, the company uses the released facilities to make another product that will
contribute $ 70,000 to profits. In this case, the company will not be able to avoid any fixed
costs.
Required
Identify and analyze the alternatives. What is the best course of action?
SOLUTION

Item Make X
Buy X
Make other
Facilities idle
products
Relevant costs:
Direct Materials $ 20,000 ----- -----
Direct Labor 80,000 ----- -----
Variable Overhead 40,000 ----- -----
Fixed Overhead 80,000 $ 30,000 $ 80,000
Purchase Cost from Outsider (20,000 x $ 10) ----- 200,000 200,000
Total Cost of Obtaining X 220,000 230,000 280,000
Profit from Other Products ----- ----- (70,000)
Net Cost of Obtaining 20,000 Units of X $ 220,000 $ 230,000 $ 210,000

ABC Company buy product X from outside supplier and use the released facilities to
make other products.
 ➢ EXAMPLE (4)

Suppose that ABC Company spent $ 125,000 to produce 50,000 units from X
product. If you know the following relevant information:
• If X sold as it is without further processing, it will be sold for $ 3.80 per unit.
• If X is processed further, it will cost $ 0.15 per unit to be further processed
and it will be sold for $ 4 per unit.
Required
1. Identify the sunk cost; is the sunk cost relevant to ABC Company’s
decision?
2. Should ABC company sell X or process it further? Show the expected net
income difference between the two alternatives?
SOLUTION
1. Mangers do not consider the $ 125,000 spent to produce 50,000 units from X
as they are not relevant to the decision, because they are sunk cost, which is
a past cost that cannot be changed regardless of which future action the
company takes (regardless of whether it sells the product as it is or processes
it further).
2. Incremental analysis for sell as it is or process further decision.
Sell As It Is Process Further Difference
Expected revenue from selling 50,000 units of X at $ 3.80 $ 190,000
Expected revenue from selling 50,000 units of X at $ 4 $ 200,000 $10,000
Additional costs of further processing 50,000 units of $ (7,500) (7,500)
0.15

Net Revenue $ 190,000 $ 192,500 $ 2,500

The optimal decision is to further processing X as this can increase profit by $

2,500.
 We assume that ABC Company already has the equipment and labor
necessary to further processing X and the fixed costs will not differ between
alternatives. Therefore they are irrelevant. However, if ABC Company has to
acquire equipment, or hire employees to further processing, the extra fixed costs
will be relevant as they differ between alternatives.