STRATEGIC COST MANAGEMENT

QUIZ 2

MODULE 3 Used for

ABSORPTION, VARIABLE, AND internal
THROUGHPUT COSTING purposes only.

Inventory All four Three

ABSORPTION VS VARIABLE components components

?
● Product Cost - Manufacturing or inventory only
•
costs
➔ Direct Materials Income Product vs Period Variable vs
Statement Costs Fixed
➔ Direct Labor
➔ Variable OH Product costs are All variable
➔ Fixed OH reported in the costs are
● Under Absorption Costing, all these costs income statement deducted from
are treated as product costs. when the related revenue to
➔ This is why it is also known as the inventories have arrive at the
been sold. contribution
full costing method. Otherwise, it will margin. While
● Under Variable Costing, 000DM, DL, Variable be presented in fixed costs are
0
OH are treated as product cost while Fixed the balance sheet deducted to
•
OH is treated as period cost or expense.
➔ This is treated as such because this
as inventories. obtain profit.

will still be incurred regardless Period costs are All fixed costs
whether there has been an presented in the regardless if it’s
operation or none for a given traditional income manufacturing
statement. or selling and
period.
administrative
➔ EX. Factory Rent are expressed
as incurred.
Absorption Variable
It is presented
Rationale All manufacturing FOH will be using the
costs whether incurred contribution
variable or fixed regardless of margin
are necessary usage. These approach.
ingredients for costs are
production to take incurred PRESENTING THE INCOME STATEMENT

÷
place and should whether the
not be ignored in capacity is used
● Operating income might differ between the
determining to make an two costing methods because of the
product costs. output. difference in amount in fixed factory
overhead recognized as an expense during
Acceptability Consistent with Violates GAAP. the accounting period.
GAAP. ● This is caused by the difference between
Accounting production and sales volume.
Accepted for principles that
Financial calls for the
Reporting and recognition of Absorption (Traditional I/S)
Tax Purposes. expense by
matching it with Sales Pxx
the related Less: COGS (xx)
revenue in the Gross Profit Pxx
same Less: Expenses (xx)
accounting
Operating Income Pxx
period. Thus,
not acceptable ● COGS - Product Cost
for Financial ● Expenses - Period Cost
Reporting and
Tax Purposes.

1 diamla, foronda, gan

 of Chemical X costs of P2.50 per gallon. Direct
Variable (Contribution I/S)
labor per gallon costs P1.50. Manufacturing
overhead per unit, variable and fixed are P0.50
Sales Pxx
and P2.00 respectively. Variable selling expense
Less: Variable Costs (xx)
per unit is at1 P0.40. Fixed expenses total P6,000
Contribution Margin Pxx
for the year ended. Sales price per gallon is
Less: Fixed Costs (xx)
P10.00.
Operating Income Pxx

Production (10,000) > Sold (8,000)

ILLUSTRATION
Problem 1.1 At the end of ACOSTA Corp’s first Absorption Costing
year of operations, it was able to produce a total of Sales (10 x 8,000) 80,000
10,000 gallons of Chemical X, a highly poisonous Less: COGS
liquid. Out of this production, only 8,000 gallons DM (2.5 x 8,000) 20,000
were sold. The ingredients to produce each gallon
DL (1.5 x 8,000) 12,000
of Chemical X costs of P2.50 per gallon. Direct
8
labor per gallon costs P1.50. Manufacturing
VOH (0.50 x 8,000)
FOH (2.0 x 8,000)
4,000
16,000 (52,000)
overhead per unit, variable and fixed are o
'

P0.50 Gross Profit 28,000

ee
and P2.00 respectively. Variable selling expense
per unit is at P0.40. Fixed expenses totalo P6,000
Less: Selling and Admin Exp
Variable (0.4 x 8,000) 3,200
for the year ended. Sales price per gallon is Fixed (6,000) 6,000 (9,200)
P10.00. Net Income 18,800
Compute for the net income under Absorption and Variable Costing
Variable Costing respectively. Sales (10 x 8,000) 80,000
Production (10,000) > Sold (8,000) Less: Variable Costs - Manufacturing
DM (2.5 x 8,000) 20,000
Absorption Costing DL (1.5 x 8,000) 12,000
Sales (10 x 8,000) 80,000 VOH (0.50 x 8,000) 4,000 (36,000)
Less: COGS Manufacturing Margin 44,000
(1.50 + 2.50 + 0.50 + 2.00 x 8,000) (52,000) Less. Variable Selling and Admin Exp
Gross Profit 28,000 VS&A (0.40 x 8,000) 3,200 (3,200)
Less: Selling and Admin Exp Contribution Margin 40,800
(0.40 x 8,000) + 6,000 (9,200) Less: Fixed Costs
Net Income 18,800 Manuf Exp (2.00 x 10,000) 20,000
Selling Exp (6,000) 6,000 (26,000)
Variable Costing Net Income 14,800
Sales (10 x 8,000) 80,000
Less: Variable Costs The only difference between the two methods lies
(2.50+1.50+0.50+0.40 x 8,000) (39,200) in the fixed overhead cost or the fixed
Contribution Margin 40,800 manufacturing cost. Under the variable costing
Less: Fixed Costs method, the entire P20,000 (10,000 units x 2.00)
(2.00 x 10,000) +6,000 (26,000)
will be expensed regardless of whether the entire
Net Income 14,800 number of units produced were sold - the 10,000
units is expense outright. While under the
Other formula to consider: absorption costing method, P4,000 ( 10,000 units
x 2 - 8,000 units x 2) (20,000 -16,000) will be
Variable Costing 14,800
recorded in inventories, and only after the
Changes in Inventory x FOH rate
inventories have been sold, is the right time to
(10,000 units - 8,000 units x 2.00) 4,000
recognize that P4,000 (2,000 units) to the income
Absorption Income 18,800
statement.

LONGCUT METHOD:
Problem 1.1 At the end of ACOSTA Corp’s first
year of operations, it was able to produce a total of
10,000 gallons of Chemical X, a highly poisonous
liquid. Out of this production, only 8,000 gallons
were sold. The ingredients to produce each gallon
Problem 1.2 Using the same facts, except this
time, assume 10,000 gallons of Chemical X were
sold, the net income under both absorption costing
and variable costing, respectively.
2 diamla, foronda, gan
 Other formula to consider:
Production (10,000) = Sold (10,000)
Variable Costing 30,100
Absorption Costing Changes in Inventory x FOH rate
Sales (10 x 10,000) 100,000 (10,000 units - 11,000 units x 2.00) (2,000)
Less: COGS Absorption Income 28,100
(1.50 + 2.50 + 0.50 + 2.00 x 10,000) (65,000)
Gross Profit 35,000
IN SUMMARY:
Less: Selling and Admin Exp
(0.40 x 10,000) + 6,000 (10,000) Production > Sales ; Absorption Income >
Net Income 25,000 Variable Cost Income

Variable Costing Production = Sales ; Absorption Income =

Sales (10 x 10,000) 100,000 Variable Cost Income
Less: Variable Costs
(2.50+1.50+0.50+0.40 x 10,000) (49,000) Production < Sales ; Absorption Income <
Contribution Margin 51,000 Variable Cost Income
Less: Fixed Costs
(2.00 x 10,000) +6,000 (26,000)
Net Income 25,000 Variable Costing xx
Changes in Inventory x FOH rate +/- xx
Absorption Income xx
Problem 1.3 Using the same facts, except this
time, assume 11,000 gallons of Chemical X were
sold, the net income under both absorption costing PART 3
and variable costing, respectively. Problem 2 (Product costs and period costs,
Roque). During January of the current year,
*Not first year of operation since there is a ALINAB Company produced and sold 1000 units
beginning Inventory of 1000 units of Product A with costs as follows:

Materials 6,000
Production (10,000) < Sold (11,000) Labor 3,000
Variable factory overhead 2,500
Absorption Costing Fixed factory overhead 1,500
Sales (10 x 11,000) 110,000 Total manufacturing costs 13,000
Less: COGS
(1.50 + 2.50 + 0.50 + 2.00 x 11,000) (71,500) Selling and administrative costs incurred during
Gross Profit 38,500 the moth were:
Less: Selling and Admin Exp Variable selling and administrative 3,000
(0.40 x 11,000) + 6,000 (10,400) Fixed selling and administrative 2,000
Net Income 28,100 P5,000
Variable Costing Determine the ff. amounts:
Sales (10 x 11,000) 110,000 1.Product costs per unit under absorption costing:
Less: Variable Costs Product costs per unit = TMC / units sold
(2.50+1.50+0.50+0.40 x 11,000) (53,900) = 13,000 / 1,000
Contribution Margin 56,100 = 13/u
Less: Fixed Costs 2. Product costs per unit under variable costing:
(2.00 x 10,000) + 6,000 (26,000) Product costs per unit = (DM + DL + VOH)/ units
Net Income 30,100 sold = 6,000 + 3,000 + 2,500/
1,000 = 11,500/ 1,000
Fixed manufacturing cost in variable costing = 11.5/u
method is always multiplied to the number of units
produced. 3. COGS per unit:
COGS per unit = DM + DL + VOH + FOH / units
Fixed manufacturing cost in absorption costing sold
method is always multiplied to the number of units = 13,000 / 1,000
sold. = 13/u

3 diamla, foronda, gan

4. Variable costs per unit (which will be deducted Variable expense per unit 10
from sales price in arriving at unit contribution Fixed expense 100,000
margin)
Beginning inventory 4,000 units
Normal capacity 20,000 units
Sales xx
Less: VC 14.5
*fixed production overhead per unit is based on
MFG (11,500/1,000) 11.5
normal capacity
SAE (3,000/ 1,000) 3
Contribution margin xx
Under each scenario, compute for the profit under
both full costing and direct costing, respectively.
Problem 3 (Variable costing ending inventory,
BOBADILLA). The following information pertains 1. Sales 22,000 units; Production 21,000 units
to ANGELES Corporation.
*Production < Sales ; ACI < VCI
*Volume variance is the difference between the
Beginning inventory 2,000 units
normal capacity and actual production.
Ending inventory 5,000 units
Direct labor per unit P10
Volume variance
Direct materials per unit 8
Normal capacity 20,000
Variable overhead per unit 2
Less:Actual (21,000)
Fixed overhead per unit 5
(1,000)
Variable selling costs per unit 6
x FOH rate 20
FIxed selling costs per unit 8
Favorable volume variance (20,000)
*exceeded our capacity to produce
1. What is the value of ending inventory using the
absorption costing method?
(DM + DL + VOH + FOH) x ending inventory
Absorption costing
= (10 + 8 + 2 + 5) x 5,000
Sales (P200 x 22,000) 4,400,000
= 125,000
COGS (140 x 22,000) 3,800,000
Volume variance (20,000)
2. What is the value of ending inventory using the
Gross profit 1,340,000
variable costing method?
SAE
(DM + DL + VOH) x ending inventory
Variable (P10 x 22,000) (220,000)
= (10 + 8 + 2) x 5,000
Fixed (100,000)
= 20 x 5,000
Net Income P1,020,000
= 100,000

3. What is the difference in the amount of operating Variable costing

profit between absorption costing and variable Sales (P200 x 22,000) 4,400,000
costing? Less: Variable (2,860,000)
*Value of MI is always higher in Absorption costing Mftg (120 x 22,000) 2,640,000
(4 components)than in variable costing (3 SAE (10 x 22,000) 220,000 1
components). Contribution margin 1,540,000
Profit varies. There are cases wherein net income Fixed cost
under absorption costing is higher than that of Manufacturing (20 x 22,000) (220,000)
variable costing. Selling & admin. (100,000)
Net Income P1,040,000
VCI Pxx
(change in invty x FOH rate) = (EI - BI) FOH rate
ACI Pxx = (5,000 - 2,000) x 5 CHECKING:
= 15,000 VCI P1,040,000
(20,000)*
Problem 4 (Volume variance). The following ACI P1,020,000
information pertains to ASIS Corp.
*change in MI x FOH rate = (1,000) x 20 = 20,000
Sales price P200
Variable production cost 120 2. Sales 15,000 units; Production 18,000 units
Fixed production overhead 20*

4 diamla, foronda, gan

 STEP 1: IDENTIFICATION OF THE DECISION
*Production > Sales; ACI > VCI
MAKING PROBLEM
Volume variance
● Whenever we make decisions, there is a
Normal capacity 20,000
problem or a goal.
Less:Actual (18,000)
● In business, common problems are like:
(2,000)
x FOH rate 20 ➔ How do we expand our market
Unfavorable volume variance 40,000 share?
*did not maximize the normal capacity ➔ Should we open another branch or
acquire our competitors?
➔ How do we minimize our cost?
Variable costing ➔ How do we increase our profits?
Sales (P200 x 15,000) 3,000,000 STEP 2: DETERMINING THE ALTERNATIVES
Less: Variable (1,950,000) TO CONSIDER
Mftg. (120 x 15,000) 1,800,000 ● Decision maker would want to solve the
SAE (10 x 15,000) 150,000 1 identified problems through various options
Contribution margin 1,050,000 or alternatives. However, we should
Fixed cost consider important points in determining
Manufacturing (20 x 20,000) (400,000) the alternatives to consider.
Selling & admin. (100,000) ➔ NOTE: The alternative must be
Net Income P550,000 feasible.
● This step is very crucial because identifying
which alternatives to consider limit the
CHECKING: possible courses of action one would take.
Variable P550,000 ➔ NOTE: This step limits the possible
(60,000)* courses of actions.
Absorption P610,000 ● Brainstorming of possible options
Production 18,000 STEP 3: EVALUATING THE ALTERNATIVES
Less: Sales (15,000) ● Before we choose, we have to evaluate the
Change in MI 3,000 alternatives. After trimming down the
*change in MI x FOH rate = 3,000 x 20 = 60,000 number of alternatives to consider, the
decision maker should now evaluate the
Absorption/full costing = 610,000; alternatives. The factors to consider are
Variable/direct costing = 550,000 classified into:
➔ Quantitative factors
◆ Monetary in nature
INTRODUCTION TO SHORT-TERM ◆ Financial
DECISION MAKING ➔ Qualitative factors
◆ Other aspects that cannot
DECISION MAKING be quantified or measured
● Decision making is one of the functions of in terms of money
management. ● Decision Making is a function of
● To decide is to choose among competing management and not accountants.
options. Among all functions of ● ROLE OF MANAGEMENT
management, decision making is involved ACCOUNTANTS: is to provide quantitative
in the rest of the other functions: information that the management needs to
effectively make an informed decision. As
➔ Planning
accountants we only provide support to
➔ Directing managers, and managers are still the one
➔ Controlling responsible for making decisions.
● FOCUS: is to use quantitative information
THE DECISION-MAKING PROCESS relevant in making decisions.
1. Identification of the decision-making
problem STEP 4: CHOOSING THE BEST ALTERNATIVE
2. Determining the alternatives to consider ● After evaluating the alternatives using the
3. Evaluating the alternatives quantitative analysis done by management
4. Choosing the best alternative accountants and qualitative analysis done
5. Reviewing the decision made
5 diamla, foronda, gan
 by other experts. The manager should now actual outflow of money.
make a decision. Opportunity cost is the forgone
benefit of choosing one alternative
STEP 5: REVIEWING THE DECISION MADE over the other.
● After deciding, the manager should review
the decision made to assess whether it is ACCEPT OR REJECT A SPECIAL ORDER
appropriate or not. ILLUSTRATION. FOUNDER Corporation sells
● It goes hand in hand with the controlling brandies in 800 mL bottles. In a typical year,
function of the management. 20,000 bottles are sold though it can produce a
● Sometimes there are other costs and maximum of 22,000 bottles. For the 20,000 bottle
savings related to the decision that were normal capacity, the following octs data were
not anticipated in Step 3 because of other collected:
factors. Thus, this step is done for further
actions and future references.
Total Per unit
RELEVANT COSTS Variable P700,000 P35
● UNDERLYING QUESTION: What makes manufacturing
information or an item relevant? costs
➔ It is to be incurred in the future
◆ whatever happen in the past Variable selling 300,0000 15
will never change as a result costs
of a decision made today
◆ costs that have already Fixed 3,000,000 150
been incurred will not be manufacturing
saved and will remain as costs
incurred no matter what
decisions are made. Fixed selling costs 2,000,000 100
➔ it should differ among alternatives
◆ we have to choose among FOUNDER’s brandy sells for P500 per bottle.
competing alternatives
◆ determine which one is MEATFRY Inc. makes a special order for 2,000
better than the other. If a bottles this year and requests FOUNDER to
cost item will be incurred in reduce the sales price to P200 only. MEATFRY will
both alternatives, it will be not purchase the bottles partially (2,000 bottles or
pointless to choose one nothing).
over the other. a. In a typical year, should FOUNDER accept
◆ outcomes will be the same the special order? What is the minimum
no matter what decisions to price for this special order?
be made. b. If regular sales are forecasted to be 22,000
● Regardless of whether an item is a cost or this year, should FOUNDER accept the
revenue, it will only be relevant if it is both special order? What is the minimum price
to be incurred in the future and differs for this special order?
among alternatives. NOTE: both must be c. If regular sales are forecasted to be 20,500
met. this year, should FOUNDER accept the
special order? What is the minimum price
OTHER ITEMS: for this special order?
1. SUNK COSTS
➔ are costs that have already been TWO APPROACHES:
incurred and these costs are 1. Total Approach
irrelevant because no matter what 2. Differential/Incremental
decision is made, the cost will
remain the same, because it has A. In a typical year, should FOUNDER accept the
already been spent in the past. special order? ACCEPT
2. OPPORTUNITY COSTS What is the minimum price for this special order?
➔ can be described by comparing it 50 (100,000/2,000) (Variable Cost + Fixed Cost +
with out of pocket cost. Out of Opportunity Cost / Special Order)
pocket cost pertains to the actual
outlay of cash. It represents an
6 diamla, foronda, gan
TOTAL APPROACH OPPORTUNITY COST
Sales 10,000,000 Sales 500
(500 x 20,000)

Variable Cost 50
Variable Cost (1,000,000)
(50 x 20000)
Contribution Margin of 450
Increase in 9,000,000 Regular Sale
Contribution Margin
Multiply. Regular Sale x 2,000
Fixed Cost (5,000,000) to Forego
Increase in Profit 4,000,000 Opportunity Cost 900,000

Regular Special TOTAL DIFFERENTIAL/ INCREMENTAL

Sales Order Increase in Sales 400,000
Revenue (200 x 2000)
Sales 10,000,000 400,000 10,400,000
Increase in Variable (100,000)
Variable 1,000,000 100,000 (1,100,000) (50 x 2000)
Cost
Cost
Increase in 300,000
Contribution 9,300,000
Contribution Margin
Margin
Increase in Fixed Cost 0
Fixed Costs (5,000,000)
Increase in (900,000)
Net Income 4,300,000 (450 x 2000)
Opportunity Cost

DIFFERENTIAL/ INCREMENTAL Decrease in Profit (600,000)

Increase in Sales 400,000

Revenue (200 x 2000) C. If regular sales are forecasted to be 20,500 this
year, should FOUNDER accept the special order?
Increase in Variable (100,000) ACCEPT
Cost (50 x 2000)
What is the minimum price for this special order?
162.5 (325,000/2,000) (Variable Cost + Fixed Cost
Increase in 300,000
+ Opportunity Cost / Special Order)
Contribution Margin

Increase in Fixed Cost 0 EXCESS CAPACITY

Regular Sales 20,500
Increase in 0
Opportunity Cost Special Order 2,000
Increase in Profit 300,000 Capacity (22,000)

Regular Sale to forego 500

B. If regular sales are forecasted to be 22,000 this
year, should FOUNDER accept the special order?
REJECT DIFFERENTIAL/ INCREMENTAL
What is the minimum price for this special order? Increase in Sales 400,000
500 (1,000,000/2,000) (Variable Cost + Fixed Cost Revenue (200 x 2000)
+ Opportunity Cost / Special Order)
Increase in Variable (100,000)
EXCESS CAPACITY Cost (50 x 2000)

Regular Sales 22,000 Increase in 300,000

Contribution Margin
Special Order 2,000
Increase in Fixed Cost 0
Capacity (22,000)
Increase in (225,000)
Regular Sale to forego 2,000
7 diamla, foronda, gan
 Opportunity Cost (450 x 500) Revenue (2.5 x 500)

Increase in Profit 75,000 Increase in Variable (1,325)

Cost (2 + 0.40 + 0.25 x 500)

QUALITATIVE FACTORS Increase in (75)

1. Relationship of Company with Regular Contribution Margin
Customers
➔ consider the effects to customers Increase in Fixed Cost 0
2. Unprofitable
Increase in 0
➔ if it is justifiable in the long run, it Opportunity Cost
could be accepted
➔ accept if it is for charitable purposes Decrease in Profit (75)
because it could build company’s
image and goodwill
B. Should the company accept the offer if the
company would not need the service of the sales
ACCEPT OR REJECT A SPECIAL ORDER agent and thus, not pay the P0.25 commission
ILLUSTRATION. MARIZZUE Manufacturing sells fee? ACCEPT; Minimum Price = 2.4 (1200/500)
tissue papers to its regular customers for P5 a (Variable Cost + Fixed Cost + Opportunity Cost /
pack. Cost to produce a pack of tissue papers as Special Order)
follows: prime cost of P2 per unit, variable
overhead costs per unit of P0.40 and total fixed DIFFERENTIAL/ INCREMENTAL
manufacturing cost of P5,000. The company pays
its sales agents for P0.25 for each unit of sale. The Increase in Sales 1,250
Revenue (2.5 x 500)
depreciation expense of the delivery trucks and
other fixed administrative charges amounted to
Increase in Variable (1,200)
P2,000. Cost (2 + 0.40 x 500)

TORENTITO approached the company to buy 500 Increase in 50

packs of tissue papers to be used in his grand Contribution Margin
wedding with 10,000 guests. TORENTITO offered
to buy tissue papers at P2.50 per pack. Assume in Increase in Fixed Cost 0
all cases that the company has sufficient excess
capacity for this order. Increase in 0
Opportunity Cost
a. Should the company accept the special
order by TORENTITO based on the Increase in Profit 50
information given above. What would be
the minimum price for the company to
accept the offer? C. Should the company accept the offer if the
b. Should the company accept the offer if the company would not need to pay a sales agent but
company would not need the service of the must rent equipment for P300 to customize the
sales agent and thus, not pay the P0.25 design of the products? REJECT; Minimum Price
commission fee? = 3 (1500/500) (Variable Cost + Fixed Cost +
c. Should the company accept the offer if the Opportunity Cost / Special Order)
company would not need to pay a sales
agent but must rent equipment for P300 to DIFFERENTIAL/ INCREMENTAL
customize the design of the products? Increase in Sales 1,250
Revenue (2.5 x 500)

SOLUTION:
A. Should the company accept the special order by Increase in Variable (1,200)
Cost (2 + 0.40 x 500)
TORENTITO based on the information given
above. What would be the minimum price for the
Increase in 50
company to accept the offer? REJECT; Minimum
Contribution Margin
Price = 2.65 (1325/500) (Variable Cost + Fixed
Cost + Opportunity Cost / Special Order) Increase in Fixed Cost (300)

DIFFERENTIAL/ INCREMENTAL Increase in 0

Opportunity Cost
Increase in Sales 1,250

8 diamla, foronda, gan

 Increase in Profit (250) Price) (95 x 10,000)

Dec. in profit (P600,000)

MAKE OR BUY A COMPONENT
ILLUSTRATION. MEATFRY Inc. is currently b. It is more advantageous for the
producing its own brandy and packages them in management if there is an increase in
800 mL bottles Cost of production data under the profit. Hence, the management should buy
normal capacity of 10,000 bottles per year is its components from the supplier
shown in the following schedule: considering that there is an increase in
profit of 200,000. The maximum price
should be based on the cost to make
(1,150,000) divided by the normal capacity
Total Per unit (10,000) which is equal to P115.
Variable costs P350,000 P35
Avoidable VC (35 x P350,000
Fixed costs 1,500,000 150 10,000)

Avoidable FC 800,000
FOUNDER Corporation offers to supply
MEATFRY’S need for brandy at a price of P95 / Cost to make P1,150,000
bottle.
a. Should MEATFRY buy or make its own Cost to buy (950,000)
brandy? What is the maximum price in
which MEATFRY would be better off in Inc in profit P200,000
buying than making?
b. Assuming that the facilities freed up upon
c. There is an indifference in the cost which
halting production will be rented out for an
implies that the management can either
annual fee of P600,000, should MEATFRY
make or buy its components. The
buy or make its own brandy? What is the
maximum price should be based on the
maximum price in which MEATFRY would
cost to make (950,000) divided by the
be better off in buying than making?
normal capacity (10,000) which is equal to
c. Assuming that the facilities freed up upon
P95 (equal to the offer price).
halting production will be rented out for an
annual fee of P600,000, should MEATFRY
buy or make its own brandy? What is the Avoidable VC (35 x P350,000
maximum price in which MEATFRY would 10,000)
be better off in buying than making?
Avoidable FC 600,000
SOLUTION:
a. If the management opted to outsource, Cost to make P950,000
then there would be a decrease in profit.
Thus, the management should continue Cost to buy (950,000)
making its components. The maximum
INDIFFERENCE 0
price should be based on the total
avoidable costs (350,000) divided by the
normal capacity (10,000) which is equal to
P35. QUALITATIVE FACTORS:
1. Reliability of supplier
Avoidable VC (35 x P350,000
10,000)
SELL OR PROCESS FURTHER
ILLUSTRATION. FRESH MEATY MEAT
Avoidable FC 0 COMPANY manufactures two products from a
common input in a joint processing operation. Joint
Avoidable OC 0 processing cost incurred up to split off point totaled
$125,000 which is composed of direct materials,
Avoidable costs 350,000 direct labor and overhead. The company allocates
these costs to the joint products on the basis of no.
Inc. in cost (Purchase (950,000) of kilos generated form the joint process. Each
9 diamla, foronda, gan
product may be sold at split off point or may be
Operating $250,000
processed further and be sold at a higher selling
profit
price. THe ff. table details the no. of kilos produced
and the increments revenue and costs to process
further each product: c.
Thighs Breasts Total
Thighs Breasts TOTAL
SR 165,000 315,000 $480,000
No.of 1,000 1,500 2,500
kilos Joint cost - - (125,000)

Selling $120 $170 ---- FPC (30,000) (84,000) $250,000

price per
kilo at Operating $241,000
split off profit
point
d.
Further $30 $56 ----
processin Thighs Breasts Total
g costs
per kilo SR 165,000 255,000 $420,000

Selling $165 $210 ---- Joint cost - - (125,000)

price after
FPC (30,000) - (30,000)
processin
g Operating $265,000
profit
a. Determine which product/s should be
processed further? ILLUSTRATION 2. Suppose that ELEGANT
b. What would be the total operating income if COMPANY worked on three jobs during March,
the company opted to sell both products at and the ff. costs were incurred:
split off point?
c. What would be the total operating income if
both products are processed further before Job#101 Job#102 Job#103
selling them to customers?
d. What would be the total operating income if (500 (200 (300
the company opted to make the most viable tables) tables) tables)
decisions/alternatives?
DM P120,000 P150,000 P155,000
SOLUTION:
DL 80,000 30,000 50,000
a. Our ultimate decision would be: to process
further the thighs and sell at split off MOH 50,000 20,000 50,000
point our product breasts.
Thighs Breast TOTAL P250,000 P200,000 P255,000
COSTS
Inc. in SR $45 $40

Inc. in FPC (30) (56) During the period, the company has determined
that some of the tables produced in the three jobs
Inc. in profit $15 ($16) in process were detective and needed to be
rewarded in order to make it saleable at their
respective regular prices. The ff. details the costs
b. needed to rework the defective units and the
Thighs Breasts Total number of defects in each job.

SR 120,000 255,000 $375,000

Job#101 Job#102 Job#103
Joint cost (125,000)
No. of 75 30 50
10 diamla, foronda, gan
 defective Cost
units
Inc. in 130 320 (90)
DM per P30 P50 P52 profit
unit
x 75 x 30
DL per 15 20 100
unit 9,750 9,600 19,350

MOH per 25 10 38
QUALITATIVE FACTORS:
unit
1. Company’s image
TOTAL P70 P80 P190 2. Customer dissatisfaction
COSTS
per unit PRIORITIZING THE USE OF
CONSTRAINED RESOURCES
● Applicable to companies that produce more
than one type of product.
Job#101 Job#102 Job#103 ● For these types of companies, it is usual to
have common resources that are used as
Regular P700 P1,100 P900 input to produce each of them.
selling ● As a result, not having such resources will
price cost allocation problems when one
produces many products out of this.
Selling 500 700 800 ● Just a short-term solution.
price if ● Effectively managing these bottlenecks is a
sold as key to success.
seconds
ILLUSTRATION 1. ABC Inc. produces three
1. Decide which job number’s defective units products with the following costs and selling prices:
should be reworked. Alpha Beta Charlie
2. Increase in profit if the company opted for
the optimal decision. Selling P16 P21 P21
price per
SOLUTION: unit
1. Jobs 101 and 102 which imply increases in
Variable 7 11 13
profit should be reworked. Since under cost costs per
accounting, you are to assume that the unit
management would process further or
rework the defective units to make them Direct 1.00 1.50 2.00
salable as good units. labor hours
per unit
Job#101 Job#102 Job#103
Machine 4.50 2.00 2.50
Inc. in SR P200 P400 P100 hours per
unit
Inc. in (70) (80) (190)
Cost
a. In what order should the three products be
Inc. in 130 320 (90) produced if neither the direct labor hours nor
profit the machine hours are the company’s
production restraint?
b. In what order should the three products be
2. produced if the direct labor hours are the
Job#101 Job#102 Job#103 company’s production constraint?
c. In what order should the three products be
Inc. in SR P200 P400 P100 produced if the machine hours are the
company’s product constraint?
Inc. in (70) (80) (190)

11 diamla, foronda, gan

SOLUTION: If DC Corp wants to dedicate 80% of its machine
a. It can produce and sell any product in time to the product that will provide the most
unlimited amount. income, how much will be its contribution margin?
a. 250,000
b. 240,000
Alpha Beta Charlie
c. 200,000
CMU 9 10 8 d. 40,000
(16-7) (21-11) (21-13)
SOLUTION:
Therefore, the company will prioritize YOW AI
producing Beta because it has the highest
CMU/demand. Thus, the order of CM 50 64
production would be Beta, Alpha, and
Charlie. MHrs/u 5 8

CM/MHr 10 8
b. A constraint can also be known as a (50/5) (64/8)
bottleneck. Contribution of margin per unit of
constraint resource will be used. MHrs 20,000 5,000
(80% of 25,000)

Alpha Beta Charlie CM 200,000 40,000

(10 x 20,000) (8 x 5,000)
CMU 9 10 8
Total
CM/DL 9 6.67 4 Contribution 240,000
(9/1) (10/1.5) (8/2) (200,000 + 40,000)
Margin

Therefore, the company will prioritize Alpha

What if the number of units was given?
because it produces the highest number of
products per hour. Thus, the order of YOW AI
production would be Alpha, Beta, and
Charlie. # of units 4,000 625
(20,000/5) (5,000/8)
c. Contribution of margin per unit of constraint
will be used. CMU 50 64

CM 200,000 40,000
Alpha Beta Charlie (4,000 x 50) (625 x 64)

CMU 9 10 8 Total
Contribution 240,000
CM/MH 2 5 3.2 Margin (200,000 + 40,000)
(9/4.50) (10/2) (8/2.50)

ILLUSTRATION 3. JPR Inc. manufactures two

Therefore, the company will prioritize Beta products, SIMOUN and IBARRA. Contribution
because it gives the highest additional profit margin per unit is determined as follows:
per machine hour. Thus, the order of
production would be Beta, Charlie, and
SIMOUN IBARRA
Alpha.
Revenue P130 P80
ILLUSTRATION 2. DC Corp has only 25,000
hours of machine time each month to manufacture Variable Costs (70) (38)
its two products, YOW and AI. YOW has a
contribution margin of P50 and AI has a Contribution 60 42
contribution margin of P64. YOW requires 5 Margin
machine hours and AI requires 8 hours.
The total demand for SIMOUN is 16,000 units and
for IBARRA 8,000 units. Machine hours are a
scarce resource. Only 42,000 machine hours are
12 diamla, foronda, gan
available during the year. SIMOUN requires 6
Total
machine hours per unit while IBARRA requires 3
Contribution 516,000
machine hours per unit. (180,000 + 336,000)
Margin
1. How many units of SIMOUN and IBARRA
should JPR Inc. produce, respectively? QUALITATIVE FACTORS IN PRIORITIZING THE
a. 3,000 and 8,000 USE OF CONSTRAINED RESOURCES
b. 0 and 8,000 1. If bottlenecks are present, the long term
c. 16,000 and 0 solution is to increase the capacity. So we
d. 7,000 and 0 don’t need to allocate the limited resources.
2. The main factor to consider is the relationship
2. Choosing the best combination of products, with customers aside from the quantitative
determine the total contribution margin. information.
a. 516,000
b. 336,000 KEEP OR DROP A DIVISION
c. 960,000 ● Applies to companies with more than one
d. 420,000 product line or division and contemplates
on dropping one or a number of them.
SOLUTION: ● The reason for this move concerns usually
1. the profitability of such a line or division.
SIMOUN IBARRA ● Those who are profitable are to be kept and
those who are not are to be dropped.
CMU 60 42
ILLUSTRATION 1. SHELDON Games has three
MHrs 6 3 major product lines, WII, PS1, and PS2. Due to
concerns regarding its profitability, he is
CM/MHrs 10 14 considering dropping PS1. The following are the
(60/6) (42/3) segmented income statements of the three product
lines:
Machine
Hours Needed 18,000 24,000 WII PS1 PS2 TOTAL
(42,000 - 24,000) (8,000 x 3)
Revenues P300,000 P200,000 P250,000 P750,000

# of units 3,000 8,000 Variable (90,000) (100,000) (100,000) (290,000)

(18,000/6) (24,000/3) Costs

Contributio P210,000 P100,000 P150,000 P460,000

2. n Margin

Per MH SIMOUN IBARRA Direct/Tra (50,000) (60,000) (70,000) (180,000)

ceable
fixed costs
MHrs 18,000 24,000
Segment P160,000 P40,000 P80,000 P280,000
CM/MHrs 10 14 Margin

CM/Mhrs 180,000 336,000 Allocation (90,000) (60,000) (75,000) (225,000)

(18,000 x 10) (24,000 x 14) of
common
costs
Total
Contribution 516,000 Operating P70,000 (P20,000) P5,000 P55,000
(180,000 + 336,000) income
Margin

a. What is the impact of dropping PS1 on the

Per unit SIMOUN IBARRA overall profits of SHELDON? Should
SHELDON drop the PS1 product line? NO,
# of units 3,000 8,000 KEEP.
b. If PS1 is in some way a complement for PS2
CMU 60 42 and as a result, closing down PS1 will
decrease PS2’s sales by 10%, should
CMU 180,000 336,000
(3,000 x 60) (8,000 x 42) SHELDON drop the PS1 product line? KEEP

13 diamla, foronda, gan

c. If PS1 is in some way a substitute for PS2 and (10% of 150,000)
as a result, closing down PS1 will increase
PS2’s sales by 10%, should SHELDON drop Decrease in Overall (55,000)
the PS1 product line? KEEP Profits

SOLUTION:
a. If the company opted to drop PS1,
INCREMENTAL APPROACH
Decrease in Sales Revenue
Thus, the company shall keep PS1 since
they complement each other.
c. If PS1 is in some way a substitute for PS2,
(200,000)

Decrease in Variable Cost 100,000 Decrease in profits - PS1 (40,000)

Decrease in Contribution (100,000) Increase in CM - PS2 15,000

(10% of 150,000)
Margin

Decrease in Fixed Cost 60,000 Decrease in Overall (25,000)

Profits
Decrease in Overall profits (40,000)
Thus, the company shall keep PS1 since
Traceable fixed costs are avoidable. However, there is still a decrease in overall profits.
the common cost is not because it is an
irrelevant cost. QUALITATIVE FACTORS IN KEEPING OR
DROPPING A DIVISION
Thus, the effect of dropping PS1 is a decrease 1. Effect on the customers. Dropping a division
in overall profits for 40,000. may affect the customers and the company
might lose goodwill if it stops the division that
TOTAL APPROACH caters to the customers.
2. Effect on the employees. Dropping a
WII PS2 TOTAL division may also affect the layoff of
Revenues P300,000 P250,000 P550,000
employees which might affect the remaining
employees’ morale.
Variable Costs (90,000) (100,000) (190,000) 3. Performance of other product line
divisions. Some products/divisions may be a
Contribution P210,000 P150,000 P360,000
Margin substitute or a complement to another product
that the company offers.
Direct/Traceab (50,000) (70,000) (120,000)
le fixed costs
ILLUSTRATION 2. CELLULAR Inc. plans to
Segment P160,000 P80,000 P240,000 discontinue DAVAO branch that has a contribution
Margin margin of P240,000 and P480,000 in fixed costs.
Of the fixed costs, P210,000 can be avoided if the
Allocation of (225,000)
common costs DAVAO branch is discontinued.

Overall Profit 15,000 What is the effect of the discontinuance of DAVAO

branch on CELLULAR’s overall net operating
The overall profit when dropping PS1 will be income (indicate increase/decrease)?
15,000 while keeping PS1 will have an overall a. 450,000 decrease
profit of 55,000 which indicates a decrease of b. 270,000 decrease
40,000 in overall profits. c. 30,000 increase
d. 30,000 decrease
Thus, the company should not drop PS1 and
keep it instead. SOLUTION:
Decrease in CM (240,000)
b. If PS1 is in some way a complement for PS2,
Decrease in Fixed Costs 210,000
Decrease in profits - PS1 (40,000)
Decrease in Profits (30,000)
Decrease in CM - PS2 (15,000)
14 diamla, foronda, gan
ILLUSTRATION 3. Change Corp is deciding
whether or not to eliminate BLACK Segment of its
business. BLACK segment generates total sales of
P104,000, its direct expenses are P22,000 and its
indirect expenses are P26,000. Its cost of goods
sold is P64,000. Only P6,000 pesos of the direct
expenses and P8,000 of the indirect expenses are
avoidable.

Determine the incorrect statement

a. The segment has a net loss of P8,000
b. The segment’s revenue is greater than its
avoidable costs.
c. The segment is a good candidate for
elimination.
d. The segment’s avoidable costs are greater
than unavoidable costs.

SOLUTION:
Decrease in Sales (104,000)
Revenue

Decrease in COGS 64,000

Decrease in Expenses 14,000

(8,000 + 6,000)

Decrease in Profit (26,000)

Thus, the company should KEEP the division.

Sales Revenue 104,000

COGS (64,000)

Expenses (48,000)

Net Sales (8,000)

15 diamla, foronda, gan