Department of Accounting Education

Mabini Street, Tagum City

Davao del Norte
Telefax: (084) 655-9591, Local 116

Big Picture
Week 4 & 5: Unit Learning Outcomes (ULO): At the end of the unit, you are expected
to:
a. apply the concept relevant costs in various types of decision making
b. understand the technical aspect of the feasibility study.

Big Picture in Focus: ULOa. apply the concept relevant costs

in various types of decision making.

Metalanguage
In this section, the most essential terms relevant to the topic and to demonstrate ULOa
will be operationally defined to establish a common frame of reference as to how the
texts work in your chosen field or career.
• Relevant costs – a cost that is applicable to a particular decision in the sense
that it will have a bearing on which alternative the manager selects.

Please proceed immediately to the “Essential Knowledge”.

Essential Knowledge

Managers must constantly make decisions and they must estimates how each
decision could affect operating income. Managers often select the course of action
that maximizes expected operating income over the period affected by the decision.
To do this, they analyze relevant information. The management accountant’s role in
this process is to supply information on changes in costs and revenues to facilitate the
decision process.

One of the most important roles played by the manager in the organization is decision
making (which means choosing from at least two alternative courses of action).
The decision making process usually starts when a problem is encountered.
Alternative courses of action or possible solutions are then evaluated, and the best
alternative is chosen. Throughout this process, the manager makes use of accounting
information and applies analytical techniques or methods to come up with the best
possible solution to the problem under consideration.

Decision making – is the process of studying and evaluating two or more available
alternatives leading to a final choice.

Steps in the decision making process

I. Define strategies: business goals and tactics to achieve them
II. Identify the alternative choices or courses of action
III. Collect and analyze the relevant data on the choices
IV. Choose the best alternative to achieve goals

1
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Factors to be considered in the selection of the best alternative

1) Qualitative factors – are those that cannot be easily and accurately be
expressed in terms of money or any other numerical unit of measure.
2) Quantitative factors – are those that can easily be expressed in terms of money
or other units of measure.

Types of costs used in decision making

1) Relevant costs – are expected future costs that differ under decision
alternatives.
2) Differential costs – refer to the increases (increments) or decreases
(decrements) in total costs between two alternatives.
3) Avoidable costs – costs that will be saved or those that will not be incurred if a
certain decision is made. For decision making purposes, this type of costs is
usually relevant.
4) Out-of-pocket costs – are costs that require current or near future cash outlays
or incurring of a liability for a decision at hand.
5) Opportunity costs – refer to the income or benefit sacrificed or foregone when
an alternative is chosen. For decision making purposes, these costs are
usually considered relevant.
6) Sunk costs – refer to the non-recoverable costs incurred in the past. For
decision making purposes, these costs are considered irrelevant.
7) Joint costs – are costs incurred in simultaneously processing or manufacturing
two or more products which are difficult to identify individually as separate types
of products until a certain processing stage known as “the point of separation
or split off point”. For decision making purposes, these costs are usually
considered irrelevant.

Approaches in solving decision making problems

1) Total approach – is an approach in which the total revenues and costs are
determined for each alternative and the results are compared to serve as bases
for making decisions. This type of analysis is time consuming and requires more
effort and cost to prepare, because, it requires the analysis of all data, whether
relevant or irrelevant.

2) Differential analysis – is an area of accounting concerned with the effect of

alternative courses of action on revenues and costs. The relevant revenue
and cost data in the analysis of future possibilities are the differences between
the alternative under consideration. The amount of such difference is
differentials.
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Types of Decisions
1) Make or Buy
It is a management decision about whether an item should be made
internally or bought from an outside supplier. To put idle capacity to use,
firms often consider manufacturing a part or subassembly they are currently
purchasing.

Differential cost analysis is appropriate for shorty run make or buy decisions
involving the construction of plant assets or component parts of the finished
product on the company premises rather than acquiring them outside.

Decision guidelines: The alternative that gives lower relevant costs savings
and should be preferred.

The tabulation of relevant costs in making and buying a part is as follows:

Cost to make Cost to Buy
Purchase price Px
DM, DL, VOH, Material handling costs Px
Avoidable fixed overhead x
Savings if the part is bought (x)
Rental income from released facilities (x)
Contribution margin from a new product
being produced using the released facilities (x)
Rental expense if the part is bought (x)
P XXX P XXX

Sample Problem
R Motors uses production of large diesel engines. The cost to manufacture one
unit of T305 is presented below:
DM P 2,000
Materials handling (20% of DM) 400
DL 16,000
Manufacturing overhead ( 150% of DL) 24,000
P 42,000
Materials handling, which is not included in manufacturing overhead , represents
the direct variable costs of receiving department that are applied to direct materials
and purchased components on the basis of their cost. R’s annual manufacturing
overhead is one-third variable and two-thirds fixed. S castings, one of R’s reliable
vendors, has offered to supply T305 at unit price of P 30,000.
Assume R motors is able to rent all the idle capacity for P 50,000 per month. If R
decides to purchase the 10 units from Castings, R’s monthly cost for T305 would
be?
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Solution:

Cost to make: Cost to buy:

Direct material P 2,000 Purchase price P 30,000
Material handling Material handling
400 6,000
(2,000*20%) (30,000*20%)
Direct labor 16,000 Total unit cost P36,000
Manufacturing overhead Multiply by: number of
8,000 units 10
(24,000*1/3)
Total unit cost P26,400 Total 360,000
Multiply by: number of units 10 Rent income (50,000)
Total costs P264,000 Total costs P310,000

Cost to buy: P 310,000

Cost to make: 264,000
P 46,000 increase in cost if purchase outside.

2) Adding or Dropping Products/Services

Some product lines or business segments tend to under-perform compares
to others. In deciding whether to add a new product line or drop an existing
one, the management must consider relevant benefits and costs.

As a rule, product lines or business segments should be evaluated based

on traceable revenues and costs. Allocated fixed costs should be removed
from the analysis of income since the company will incur in the entire amount
with or without the product line or segment.

Decision guidelines: If the direct segment margin is positive and there is no

other more beneficial alternative, then, continue!

The segment margin maybe determined either under conditions with

alternative use of the capacity or there is no alternative use of the
capacity. One determined, decisions shall be made as follows;
With no alternative use of capacity
- If the segment margin is positive, continue the division.
With alternative use of capacity
- Compare the segment margin from the net benefit of the
alternative. If the segment margin is greater then, continue.

Otherwise discontinue the division and undertake the alternative that gives
the higher profit.
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Segment margin equals:

CM-Avoidable Fixed expenses = Controllable segment margin

Alternative computation:
CM PX
Controllable direct cost (x)
Controllable margin x
Non controllable Fixed expenses (x)
Segment (direct) margin P XX

Sample Problem

Doyle Company has 3 divisions: R, S, and T. Division R's income statement shows
the following for the year ended December 31:
Sales P1,000,000
Cost of goods sold (800,000)
Gross profit P 200,000
Selling expenses 100,000
Administrative expenses 250,000
Net loss P (150,000)

Cost of goods sold is 75 percent variable and 25 percent fixed. Of the fixed costs,
60 percent are avoidable if the division is closed. All of the selling expenses relate
to the division and would be eliminated if Division R were eliminated. Of the
administrative expenses, 90 percent are applied from corporate costs. If Division
R were eliminated, Doyle’s income would be?

Solution:

Sales P 1,000,000
Variable costs:
COGS (800,000*75%) 600,000
Selling expenses 100,000 (700,000)
Contribution margin 300,000
Avoidable costs:
COGS (800,000*25%*60%) 120,000
Administrative exp. (250,000*10%) 25,000 (145,000)
Controllable segment margin P 155,000
*The overall profit of Doyle will decrease by P155,000 if R Division is eliminated.

3) Sell Now or Process Further

It is a choice of selling a product now or processing it further to earn
additional revenue. This choice is based on an incremental analysis of
whether the additional revenues to gained will exceed the additional costs
to be incurred as part of the additional processing work.
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Joint product costs – is used to describe those manufacturing costs that

are incurring is producing the joint products up to split-off point. This cost is
irrelevant in decisions regarding what to do with a product from the split-off
point forward because they have already been incurred and therefore are
sunk costs.

Split-off point – is the point in the manufacturing process at which the joint
product can be recognized as separate products.

Separable costs – are costs incurred after the split-off point for the benefit
of only one particular product.

Decision guidelines: If there is a profit from further processing, then process

further.

Basic computational guideline is:

Incremental sales P xx
Incremental cost (xx)
Savings from further processing xx
Incremental profit or loss P XX

Sample Problem

India Corporation has P200,000 of joint processing costs and is studying

whether to process J and K beyond the split-off point. Information about J and
K follows.
Product J Product K
Tons produced 25,000 15,000
Separable variable processing costs
beyond split-off P64,000 P100,000
Selling price per ton at split-off 15 52
Selling price per ton after additional processing 21 58

If India desires to maximize total company income, what should the firm do with
regard to Products J and K?

Solution:

Product J Product K
Selling price after additional processing P 21 P 58
Less: Selling price at split-off point 15 52
Incremental revenue 6 6
Multiply by: Units produced 25,000 15,000
Total incremental revenue 150,000 90,000
Less: Additional processing costs 64,000 100,000
Incremental Profit (Loss) P 86,000 P (10,000)
Decision Process
Sell now
further
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

4) Special Sales Pricing/Accept or Reject Special Order

A special order is a one-time order that is not considered part of the
company’s ongoing business. Managers may be asked to consider
accepting a special order for their product at a reduced price to make use of
the excess or idle facilities.

Decision guideline: If there is an incremental profit, accept!

In deciding whether to accept or reject a special order, the paramount
consideration is incremental profit, determined as follows:
Incremental sales Px
Incremental costs (x)
Incremental profit or (loss) X
Opportunity costs (benefit) from the alternative use of capacity (x)
Net advantage (disadvantage) of accepting special order P XX
Sample Problem

Sound, Inc., reported the following results from the sale of 24,000 units of IT-
54:
Sales P528,000
Variable manufacturing costs 288,000
Fixed manufacturing costs 120,000
Variable selling costs 52,800
Fixed administrative costs 35,200

Rhythm Company has offered to purchase 3,000 IT-54s at P16 each. Sound
has available capacity, and the president is in favor of accepting the order. She
feels it would be profitable because no variable selling costs will be incurred.
The plant manager is opposed because the "full cost" of production is P17.
What will be the change in income if the special order is accepted?

Solution:

Incremental Sales (3,000*P16) P48,000

Incremental Costs (3,000*P12) (36,000)
(288,000/24,000 = 12)
Incremental Profit P12,000
*If the special order is accepted the profit will increase by P12,000.

5) Utilization of Scarce Resources

It is a judgment regarding the best use of scarce resources so as to
maximize the total net income of a business. Scarcity of different resources
puts constraints on the amount of product that can be produced using those
resources.

When capacity becomes pressed because of a scarce resources, the firm

is said to have a constraint. Because of the constrained scarce resources,
the company cannot fully satisfy demand, so the manager must decide how
the scarce resources should be used.
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Decision guideline: Prioritize the product that gives that gives the highest
CM per limited resource.

To optimize scarce resources, sales and production should be allocated to

a product that gives the highest profit per scarce resource. If the scarce
resource is direct labor hour, then produce the product that gives the highest
CM per DL hour , computed as follows:
CM per hour= UCM/No. Of hours per unit
CM per hour= UCM x no. Units per hour

Sample Problem

Smith Manufacturing has 27,000 labor hours available for producing X and Y.
Consider the following information:
Product X Product Y
Required labor time per unit (hours) 2 3
Maximum demand (units) 6,000 8,000
Contribution margin per unit P5.00 P6.00
Contribution margin per labor hour. P2.50 P2.00

If Smith follows proper managerial accounting practices, what will be the

product mix that the company should set?

Solution:

Based on the contribution margin per labor hour Product X (P2.50 per LH) will
be the top priority for production and followed by Product Y (P2.00 per LH). The
decision is based on the constraint resources which is the labor hours.

Product X
Maximum demand 6,000 units
Multiply by: Require labor time per unit 2 hrs
Total hours need 12,000 hrs.

Product Y
Total labor hours available 27,000 hours
Total hours needed for Product X (12,000 hours)
Excess/idle labor hours 15,000 hours
Divided by: Require labor time per unit 3 hrs.
Total units produced 5,000 units

*The product mix consist of 6,000 units of Product X and 5,000 units of Product Y.

6) Shutdown or Continue Operations

It is a choice that the company make if it is essential for a firm to shut down
temporarily or to continue operations. This type of decision usually arises
when a firm is highly seasonal/cyclical and is expected to experience cyclical
lows during foreseeable periods.
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Decision guideline:
Continue operations; if sales > shutdown point
Shutdown operations; if sales < shutdown point

Shutdown Point – is a level of operations at which a company experiences

no benefit for continuing operations and therefore decides to shutdown
temporarily.
Fixed costs – Shutdown costs
Shutdown point =
Unit Contribution Margin

Shutdown costs – means all costs associated with shutting down or

suspending the business operation. This includes safety and security, re-
start-up costs and etc.

Sample Problem
Ben Corporation had been experiencing a slowdown in business activities in
August and September and is considering temporarily shutting down its
operations during those months. The accounting Department has provided the
following normal operating data for considerations.
Unit sales price P 150
Unit variable production costs 60
Unit variable marketing costs 10
Monthly fixed overhead 500,000
Monthly fixed expenses 200,000
Regular sales in units 10,000 per month
Estimated sales in units in Aug and September 5,000 per month

If the company shut down its operations, the following costs are expected to be
incurred.

Security and safety P 200,000

Re-start up costs P 100,000
Regular fixed overhead 40% of the total remain
Regular fixed expenses will be reduced by 30%

Which alternative, continuing or discontinuing the operations , is advisable and

by how much is its advantage?

Solution:

Security & safety

P 400,000
(200,000* 2 mons.)
Re-start-up costs 100,000
Fixed overhead
400,000
(500,000*40%*2 mons.)
Fixed expenses
280,000
(200,000*70%*2mons.)
Total shutdown costs P1,180,000
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

1,400,000 – 1,180,000
Shutdown point =
150 - 70

= 2,750 units

If continue the operation:

Sales (5,000*2mons*P150) P1,500,000
Less: Variable costs (5,000*2mons*P70) 700,000
Contribution margin 800,000
Less: Fixed costs 1,400,000
Net Loss P(600,000)

If shutdown the operation:

Shutdown cost P 1,180,000

Decision: To continue the operation because of an advantage of P580,000

(P1,180,000 – P600,000).

7) Pricing Products and Services

The pricing decision can be critical because
1) The prices charged for a firm’s products largely determine the
quantities customers are willing to purchases, and
2) The prices should be high enough to cover all the costs of the firm.

Cost-plus Pricing
The most basic approach in pricing decision is that the price of the product
or service should cover all the costs that are traceable to the product and
services, variable as well as fixed.

The formula is expressed as follows:

Target selling price = [ Cost + (Markup percentage * Cost)]

Products however, may be costed in at least two different ways:

1) By the Absorption approach – where the cost base is defined as the
cost to manufacture one unit and therefore excluded all selling,
general and administrative expenses.
2) By the Contribution approach – where cost base consists of all
variable cost associated with a product including variable selling,
general and administrative expenses.

Determining the markup percentage

 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Under the absorption approach to cost-pus pricing:

Desired return of assets
- SGA expenses
employed
Markup percentage
= Unit
on absorption cost
Volume in units X manufacturing
costs

Under the contribution approach to cost-pus pricing:

Desired return of assets
- Fixed costs
Markup percentage employed
=
on absorption cost Unit variable
Volume in units X
costs

Self Help: You can also refer to the sources below to help
you further understand the lesson.

Cabrera, M.E (2017). Management Accounting: Concepts and Applications. GIC

Enterprises & Co.

Bobadilla, D. (2015). Comprehensie reviewer in management advisory services.

Manila, Philippines: Lares Bookstore.

Guia, M. B. M.(2016). Basics of managerial accounting. Ma-a, Davao City: MS Lopez

Printing & Pub.

Let’s Check!
I. Questions:

1. Why are historical costs irrelevant?

________________________________________________________
________________________________________________________
________________________________________________________

2. What is a differential cost?

________________________________________________________
________________________________________________________
________________________________________________________

II. True or False:

 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Write “TRUE” if the statement is true otherwise write “FALSE” if the

statements is incorrect.

1) Future costs that do not differ between the alternatives in a decision

are avoidable costs.
2) The book value of an old machine is always considered a sunk cost
in a decision.
3) In a decision to drop a product, the product should be charged for
rent in proportion to the space it occupies even if the space has no
alternative use and the rental payment is unavoidable.
4) In a special order situation that involves using existing idle capacity,
opportunity costs are zero.
5) In a sell or process further decision, an avoidable fixed production
cost incurred after the split-off point is relevant to the decision.

III. Multiple Choice:

Encircle the letter that correspond to your answer.

1. When a multi-product factory operates at full capacity, decisions must

be made about what products to emphasize. In making such decisions,
products should be ranked based on:
a. Selling price per unit
b. Contribution margin per unit
c. Contribution margin per unit of the constraining resource
d. Unit sales volume

2. Two or more products produced from a common input are called:

a. common costs. c. Joint costs.
b. Joint products. d. Sunk costs.

3. A manager is attempting to determine whether a segment of the

business should be eliminated. The focus of attention for this decision
should be on
a. the net income shown on the segment's income statement.
b. sales minus total expenses of the segment.
c. sales minus total direct expenses of the segment.
d. sales minus total variable expenses and avoidable fixed expenses of
the segment.

4. Which of the following costs is NOT relevant to a special order decision?

a. the direct labor costs to manufacture the special order units
b. the variable manufacturing overhead incurred to manufacture the
special-order units
c. the portion of the cost of leasing the factory that is allocated to the
special order
d. All of the above costs are relevant.

5. Narciso Corporation is preparing a bid for a special order that would

require 880 liters of material R19S. The company already has 280 liters
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

of this raw material in stock that originally cost P6.20 per liter. Material
R19S is used in the company's main product and is replenished on a
periodic basis. The resale value of the existing stock of the material is
P5.45 per liter. New stocks of the material can be readily purchased for
P6.20 per liter. What is the relevant cost of the 880 liters of the raw
material when deciding how much to bid on the special order?
a. P5,006 c. P4,796
b. P5,456 d. P5,946

6. The following information relates to next year's projected operating

results of the Aluminum Division of Wroclaw Corporation:
Contribution margin ...................... P1,500,000
Fixed expenses .............................. 1,700,000
Net operating loss ..........................P (200,000)

If Aluminum Division is dropped, P1,000,000 of the above fixed costs

would be eliminated. What will be the effect on Wroclaw's profit next year
if Aluminum Division is dropped instead of being kept?
a. P500,000 decrease c. P1,000,000 decrease
b. P800,000 increase d. P1,200,000 increase

7. Julius International produces weekly 15,000 units of Product JI and

30,000 units of JII for which P800,000 common variable costs are
incurred. These two products can be sold as is or processed further.
Further processing of either product does not delay the production of
subsequent batches of the joint products. Below are some information:
JI JII
Unit selling price without further processing P24 P18
Unit selling price with further processing P30 P22
Total separate weekly variable costs of further
processing P100,000 P90,000

To maximize Julius’ manufacturing contribution margin, the total

separate variable costs of further processing that should be incurred
each week are
a. P90,000 c. P100,000
b. P95,000 d. P190,000

8. Bear Valley produces three products: A, B, and C. One machine is used

to produce the products. The contribution margins, sales demands, and
time on the machine (in minutes) are as follows:
time on
Demand CM machine
------ ---- --------
A 100 $25 10
B 80 18 5
C 150 30 10
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

There are 2400 minutes available on the machine during the week. How
many units should be produced and sold to maximize the weekly
contribution?
A B C A B C
a. 100 80 150 c. 50 80 150
b. 90 0 150 d. 100 80 100

9. Picnic Items, Inc. manufactures coolers of 10,000 units that contain a

freezable ice bag. For an annual volume of 10,000 units, fixed
manufacturing costs of P500,000 are incurred. Variable costs per unit
amount are direct materials – P80; direct labor – P15, and variable
factory overhead – P20

Bags Corp. offered to supply the assembled ice bag for P40 with a
minimum order of 5,000 units. If Picnic accepts the offer, it will be able
to reduce variable labor and overhead by 50%. The direct materials for
the freezable bag will cost Picnic P20 if it will produce it. Considering
Bags Corp. offer, Picnic should
a. Buy the freezable ice bag due to P150,000 advantage.
b. Produce the freezable ice bag due to P25,000 advantage.
c. Produce the freezable ice bag due to P50,000 advantage.
d. Buy the freezable bag due to P50,000 advantage.

10. The Garey Company has 3,000 circuit boards (all alike) which are out of
date and are carried in inventory at a total cost of P216,000. The circuit
boards can be reworked and upgraded at a cost of P63,000 and then
sold for P110,000. As an alternative, the company can sell these circuit
boards to an outside buyer for P48,000. If Garey chooses to upgrade the
circuit boards rather than sell them to the outside buyer, the opportunity
cost to Garey is
a. P116,000
b. P48,000
c. P27,000
d. P1,000
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Let’s Analyze!
Problem I:
Neilsen’s Woodworking Company came to you for assistance when the bookkeeper
presented the income statement showing large loss for the second year of operations.
The loss of P70,000 was expected for the first year when the company operated at
low level. However, the management of Neilsen’s Woodworking was shocked to
discover a loss of P160,000 for the second year.

The president of the company could not understand how they could be operating at
near capacity and losing money. The company was consistently short of cash, a
common problem when operations are expanding.

From your preliminary examinations, you found very poor accounting records. You are
satisfied that the data in the financial statements are correct and that there is no
significant fraud. The company manufactures a line of kitchen cabinets. Because of
the lack of detailed record, it is impossible to develop data about the cost of the
product. the selling price was set by the president to undersell competition. Condensed
income statement are presented below:

NEILSEN’S WOODWORKING
Income Statement
2018 and 2019
2018 2019
Sales (P40 each) P 100,000 P 400,000

Operating expenses
Beginning inventory of materials 0 20,000
Operating expenses 190,000 570,000

Total P 190,00 590,000

Ending inventory of materials 20,000 30,00

Expenses P170,000 560,000

Net Loss P (70,000) P (160,000)

Other data:
2018 2019

Units produced 2,500 units 10,000 units

Units sold 2,500 units 10,000 units

Assets invested in business P 100,000 P 100,000

Capacity in units 12,000 12,000
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

Required:
1) Why did the company loss P160,000 in the second year? How much would
the company lose if they operated at capacity?
2) What price must be set to earn a profit of 8% of sales?
3) What price must be set to earn a contribution margin ratio of 30%?
4) What price must be set to earn 15% on the assets invested in the business?

Problem II:
Crystal Sport Equipment manufactures round, rectangular and octagonal trampolines.
Data on sales and expenses for the past month follow:

Trampoline

Total Round Rectangular Octagonal

Sales P 1,000,000 P 140,000 P 500,000 P 360,000

Less: Variable Expenses 410,000 60,000 200,000 150,000

Contribution margin 590,000 80,000 300,000 210,000

Less: Fixed Expenses 216,000 41,000 110,000 65,000

Advertising (traceable) 95,000 20,000 40,000 35,000

Depreciation of special
19,000 6,000 7,000 6,000
equipment

Line supervisors’ salaries 200,000 28,000 100,000 72,000

General factory overhead* 530,000 95,000 257,000 178,000

Net operating income

P 60,000 P (15,000) 43,000 32,000
(loss)

*A common fixed costs that is allocated on the basis of sales pesos.

Management is concerned about the continued losses shown by the round
trampolines and wants a recommendation as to whether or not the line should de
discontinued. The special equipment used to produce that trampolines has no resale
value. If the round trampoline model is dropped, the two line supervisors assigned to
the model would be discharged.

Required:
I. Should production and sale of the round trampolines be discontinued? You may
assume that the company has no other use for the capacity now being used to
produce the round trampolines. Show computations to support your answer.
II. Recast the above data in a format that would be more usable to management
is assessing the long-run profitability of the various product lines.
 Department of Accounting Education
Mabini Street, Tagum City
Davao del Norte
Telefax: (084) 655-9591, Local 116

In a Nutshell
In this part you are going to jot down what you have learned in this unit. The said
statement of yours could be in a form of concluding statements, arguments, or
perspective you have drawn from this lesson.
Now it’s your turn!
1. ________________________________________________________.
2. ________________________________________________________.
3. ________________________________________________________.
4. ________________________________________________________.
5. ________________________________________________________.

Q&A List
Do you have any question for clarification?

Questions/Issues Answers

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Keywords index
Relevant costs Shutdown costs
Cost to make Shutdown point
Cost to buy Constraint resources
Opportunity cost Segment margin