EXERCISES – DIFFERENTIAL COST ANALYSIS

PROBLEM 1 – TOTAL APPROACH VS. INCREMENTAL APPROACH

Jerome Company, which sells a chemical product called Fallurin, received a special order for 1,000 liters
of Fallurin from a valued customer. Because of the large volume of this order, the customer is asking for a
discount of 40% OFF the regular selling price of P25 per liter. Pertinent data are as follows:

Normal plant capacity 5,000 liters

Present sales volume-regular 3,500 liters
Production Costs
Materials P 3.00 per liter
Labor 2.00 per liter
Factory Overhead:
Variable 3.00 per liter
Fixed 7,500 per month
Selling and Administrative
Variable 2.00 per liter
Fixed 11,250 per month

It was ascertained that the special order will not require additional selling and administrative costs and
that the same will not affect regular sales.

Jerome wants to make a decision on whether to accept or reject the special order. Decide whether to
accept or reject the special order using:

1. The total projected approach (comparative statement).

2. The incremental approach (relevant costs).

PROBLEM 2 – MAKE OR BUY

Lingkod Company, a manufacturer of furniture sets, is considering to purchase the seat cushions needed
for its chairs. The expected purchase price of these seat cushions is P50 per unit.

Lingkod has been making its own seat cushions since it started operating. If it would continue to produce
these cushions, the company would expect to incur the following costs:

Raw materials P 13
Direct labor 15
Variable overhead 5
Fixed overhead (based on the average production requirement of 10,000 units) 20
Total production cost per unit P53
Required:
1. Should Lingkod manufacture the seat cushions? Why or why not?
2. Assume that 40% of the fixed factory overhead could be eliminated if the company would
discontinue the manufacture of seat cushions. Should Lingkod manufacture the seat cushions?
Why or why not?
3.
a. Assume that 40% of the fixed factory overhead could be eliminated if the company would
discontinue the manufacture of seat cushions.
b. Assume further that MATERIALS and LABOR COSTS are expected to INCREASE by 20%
next period.
c. Moreover, the facilities being used in the manufacture of seat cushions can be utilized to
manufacture another part of the main product in case such facilities become vacant when the
company decides to stop producing the seat cushions. This alternative use of resources would
result into cost savings of P100,000 for Lingkod Company.
d. Assume further that the company’s requirement for seat cushions is expected to increase by
4,000 units next period.

PROBLEM 3 – ACCEPT OR REJECT THE SPECIAL ORDER

Assume that Grace Company presently produces and sells 20,000 units of Product G which represents
only 80% of its normal capacity of 25,000 units. Its regular selling price is P50 per unit and its
manufacturing, selling and administrative costs are as follows:

Materials P 10

Labor 12

Variable overhead 8

Fixed overhead (P60,000/20,000) 3

Variable selling and administrative costs 7

Fixed selling and administrative costs (P40,000/20,000) 2

Total unit cost P 42

Grace received an order from a provincial distributor for 3,000 units. The customer asks for a special
discount of 30%. It is expected that the company will incur no additional selling and administrative costs.
SHOULD GRACE ACCEPT THE SPECIAL ORDER?
PROBLEM 4 - ACCEPT OR REJECT THE SPECIAL ORDER
Kapol Company’s normal capacity is 60,000 units. Since the past few months, it has utilized only one half
of this capacity. For last month, the result of its operations is summarized in the following statement:

Sales (30,000 units) P 1,500,000

Less Variable Costs 600,000

Contribution Margin 900,000

Less fixed costs 500,000

Profit P 400,000

Of the variable and fixed costs shown on the statement, ¾ are manufacturing costs; the balance represents
selling and administrative costs.
This month, a customer submitted a proposal to buy 35,000 units of Kapol Company’s product at P25 per
unit. The only selling cost to be incurred for this order is P4.00 per unit representing freight charges that
will be shouldered by Kapol. If this special order proves to be acceptable, Kapol is willing to reduce sales
to regular customers so as not to exceed its normal capacity.
Should the order be accepted?

PROBLEM 5 - CONTINUE OR DISCONTINUE A DIVISION

Simon Forest Corporation operates two divisions, the Timber Division and the Consumer Division. The
Timber Division manufactures and sells logs to paper manufacturers. The Consumer Division operates
retail lumber mills which sell a variety of products in the do-it-yourself homeowner market. The company
is considering disposing of the Consumer Division since it has been consistently unprofitable for a
number of years. The income statements for the two divisions for the year ended December 31, 2002 are
presented below:
Timber Division Consumer Division Total
Sales P1,500,000 P500,000 P2,000,000
Cost of goods sold 900,000 350,000 1,250,000
Gross profit 600,000 150,000 750,000
Selling & admin expenses 250,000 180,000 430,000
Net income P 350,000 P(30,000) P 320,000

In the Consumer Division, 70% of the cost of goods sold are variable costs and 30% of selling and
administrative expenses are variable costs. The management of the company feels it can save P60,000 of
fixed cost of goods sold and P50,000 of fixed selling expenses if it discontinues operation of the
Consumer Division.

Required:
1. Determine the sales revenue that may be forgone when Consumer Division is discontinued.
2. Determine the avoidable costs:
a. Manufacturing
b. Non-manufacturing

3. Determine the net advantage (disadvantage) of dropping Consumer Division.

4. Should Consumer Division be dropped?

PROBLEM 6 – CONTINUE OR DISCONTINUE AN OPERATING SEGMENT

Beth Neri Enterprises sells three products, Skinny, Bony and Thinny. Beth, the proprietor, is concerned
about the losses incurred by Thinny, and is considering to discontinue its production and sales.
Sales and costs data about Beth Neri’s three products are as follows:

Skinny Bony Thinny Total

Sales price per unit P5 P7 P9 P 21

Variable cost per unit 2 3 7 12

Contribution margin per unit P3 P4 P2 P9

Fixed cost per unit 1 2 3 6

Profit (Loss) per unit P2 P2 (P 1) P3

Fixed costs are allocated among the three products based on the floor area they occupy.
Beth is thinking that if she would eliminate Thinny, its loss of P1 per unit would likewise be eliminated
thereby increasing her total profit per unit from P3 [P2 + P2 – P1] to P4 [P2 + P2].
Is Beth’s analysis correct?
PROBLEM 7 – SELL OR PROCESS FURTHER
Neth Abogada, Inc. produces a product called Balut. The company buys duck eggs, the materials needed
to make balut, from different suppliers in Pateros at P1.50 each. To convert the eggs into balut, the same
are processed by boiling for about 30 minutes. Processing costs, composed of labor and factory overhead
average at P0.50 per unit. Neth sells the product at P3.00 per unit.
Neths product may be sold as Balut, or it may be processed further to come up with another product
called Pritong Balut which actually is fried Balut dipped in bread crumbs or cornstarch. Pritong Balut has
proven to be highly salable and commands a price of P3.75 per unit. Materials, labor and overhead costs
required to convert balut into Pritong Balut amounts to P0.40 per unit. Neth is contemplating to stop
selling Balut and instead concentrate on selling Pritong Balut.
Should Neth push through with her plan.

PROBLEM 8 – SELL OR PROCESS FURTHER

Botjina Paper Products produces chipboard, newsprint and kraft from pulp which it buys at P5 per kilo.
On the average, the company uses 100,000 kilos of pulp and incurs conversion cost of P500,000 per
month. Monthly production and sales price figures for each product are as follows:

PRODUCTION SALES PRICE

Chipboard 200,000 sheets P 2.40 per sheet

Newsprint 50,000 reams 20.00 per ream

Kraft paper 30,000 sheets 1.50 per sheet

The total joint cost is allocated based on the weight (in kilos) of the products manufactured during the
month. (Assume that the allocation results are: 17% of the total joint cost is allocated to chipboard, 80%
to newsprint and 3% to kraft paper.)
One of the joint products, the kraft paper, may be processed further to produce document envelopes which
can be sold at P2.00 per unit. Each sheet of kraft paper may be converted into one document envelope at a
cost of P.60.
SHOULD THE KRAFT PAPER BE SOLD AT THE SPLIT OFF POINT OR CONVERTED INTO
DOCUMENT ENVELOPE?

PROBLEM 9 – PRODUCT MIX OR COMBINATIONS

EGG Company produces three products, A, B, and C. A machine is used to produce the products. The
contribution margin, sales demands, and time of the machine (in minutes) are as follows:
Demand CM Machine Time
Product A 1,000 P 20 10
Product B 800 18 5
Product C 1,500 25 10
There are 400 hours available on the machine during the week. How many units should be produced
and sold to maximize the weekly contribution margin?