ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 44  October 2022 CPA Licensure Examination

MS-44E
MANAGEMENT ADVISORY SERVICES C. LEE  E. ARAÑAS  K. MANUEL

RELEVANT COSTING WITH LINEAR PROGRAMMING

DECISION MAKING – is the process of making choices from at least two alternatives by identifying a problem,
gathering information and evaluating alternative solutions. For business entities,
management usually chooses the option that maximizes company profit.
 FACTORS CONSIDERED IN DECISION MAKING
1. Qualitative Factors – factors that cannot be expressed in money or other numerical units.
Examples: customer satisfaction, suppliers and employee morale
2. Quantitative Factors – factors that can be expressed in money or other numerical units. The two
quantitative approaches to decision making are:
✓ TOTAL approach: Total revenues and costs are determined for each alternative, and the results are
compared to serve as a basis for the decision to make.
✓ DIFFERENTIAL approach (a.k.a. incremental analysis): Only the differences or changes in costs and
revenues are considered.
 TYPES of COSTS COMMONLY ASSOCIATED WITH DECISION MAKING
RELEVANT COSTS Future costs that are different among alternatives.
DIFFERENTIAL COSTS Increases or decreases in total costs resulting from choosing one option over another.
AVOIDABLE COSTS Costs that will be saved or will not be incurred if a certain decision is made.
OPPORTUNITY COSTS Benefit foregone or highest income sacrificed when an option is chosen over another.
OUT-OF-POCKET COSTS Costs required for immediate or near future cash outlays based on a particular decision.
SUNK COSTS Historical or past costs that cannot be avoided regardless of what decision is made.
NOTE: Differential (incremental) costs, avoidable costs, opportunity costs and out-of-pocket costs are
usually considered relevant in decision making while sunk and unavoidable costs are considered irrelevant.
 TYPES of SHORT-TERM NON-ROUTINE DECISIONS
NATURE of ALTERNATIVES DESCRIPTION DECISION-MAKING GUIDELINES
1. MAKE or BUY Should a product or material be internally Choose the option that has the lower cost. In
a product or material manufactured (‘insource’) or bought from most cases, fixed costs are irrelevant. Consider
(Outsourcing Decision) outside supplier (‘outsource’)? if there is any opportunity cost.
2. ACCEPT or REJECT Should a special order that requires a price Accept the order if the additional revenue
a special order lower than the regular selling price be exceeds additional cost. In most cases, fixed
accepted or rejected? costs are irrelevant.
3. CONTINUE or Should a business segment (e.g., product line, Continue if avoidable revenue is greater than its
SHUTDOWN division, department or branch) be continued avoidable costs. Any allocated fixed cost to the
a business segment (‘keep’) or discontinued (‘drop’)? segment is usually considered irrelevant.
4. SELL or PROCESS Should a product, after undergoing the joint Process further if additional revenue from
FURTHER process, be sold at the split-off point or be processing further is greater than further
a product processed further beyond the split-off point? processing costs. Joint costs are considered
sunk costs and irrelevant.
5. SCRAP or REWORK Shall be a substandard or obsolete product Rework if additional revenue after rework is
a product be sold as scrap (‘junk’) or be reworked higher than rework costs. The original cost or
(‘modify’)? carrying value is considered irrelevant.
6. BEST PRODUCT Which product(s) should be given priority in Identify and measure constraint(s). Allocate
COMBINATION production, given limited resources and/or limited resources to products from highest to
(Optimal Use of Scarcity) market limitations? lowest CM per unit of limited resources.
7. CHANGE IN PROFIT Should any of the profit factors such as Change the profit factor if it will cause an
FACTORS selling price, unit sales, variable cost, fixed improvement on the company’s over-all profit
(CVP Analysis in MS-44C) cost and sales mix be manipulated to increase position.
profit?
 OTHER TERMINOLOGIES ASSOCIATED WITH SHORT-TERM NON-ROUTINE DECISIONS
SHUTDOWN COSTS* Costs that will remain to be incurred even if a segment is discontinued. [Irrelevant]
JOINT COSTS** Costs incurred in processing joint products until the split-off point. [Irrelevant]
SPLIT-OFF POINT** The production stage where joint products are split into separate and distinct products.
FURTHER PROCESSING COSTS** Costs incurred in processing separate products beyond the split-off point. [Relevant]
BOTTLENECK RESOURCES*** Any particular operation where the capacity is less than the demand placed upon it.
* connected with No. 3 above ** connected with No. 4 above *** connected with No. 6 above
LINEAR PROGRAMMING (LP) is a quantitative technique used to achieve the best outcome (maximum profit or
lowest cost) in a mathematical model whose requirements are represented by linear relationships.
 LP usually starts by identifying decision variables. Most LP problems are characterized by an objective function
that is to be maximized or minimized subject to multiple constraints.
➢ OBJECTIVE FUNCTION – an equation that deals with maximizing revenue/profit or minimizing costs.
Example: Maximize Z = 5 A + 10 B
➢ CONSTRAINT FUNCTIONS – inequality relationships representing resource limitation and consumption.
Example: 2 A + 4 B  100
NOTE: The non-negativity constraint of the identified decision variables is often assumed even if it is not
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specified in linear programming problems (e.g., A, B  0). 0
 LP models are useful in resource allocation problems with multiple constraints (as opposed to relevant costing
which can typically handle one constraint only). In LP, limited resources are often allocated based on the optimal
product mix that aims to achieve the maximum possible profit.
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
RELEVANT COSTING with LINEAR PROGRAMMING MS-44E
EXERCISES: RELEVANT COSTING with LINEAR PROGRAMMING
1. TOTAL ANALYSIS vs. DIFFERENTIAL ANALYSIS
ESA Company currently sells 10,000 units of its lone product at a price of P 50 per unit. The product
costs at this level of activity are given below:
Variable Costs: Fixed Costs:
Direct materials P 12 Fixed Overhead P 70,000
Direct labor 8 Fixed Selling Expense 50,000
Variable Overhead 7
Variable Selling Expense 3
REQUIRED:
A) What is the present profit?
B) The company could increase its sales by 25% if it spends P 30,000 for advertisements. Determine
the effect on company profit using: 1) Total approach 2) Differential approach
2. MAKE or BUY (OUTSOURCING DECISION)
Ferrari must decide whether it must continue to produce an engine component or buy it from Sarao-
Philippines for P 25 ,000 each. The demand for the coming year is 20 units. The costs of producing a
single unit of the engine component are as follows:
Direct materials P 14,000
Direct labor 6,000
Factory Overhead (80% fixed) 10,000
P 30,000
If Ferrari buys the components, the facility now used to make the components can be rented out to
another firm for P 100,000.
REQUIRED:
A) Should Ferrari make or buy the components?
B) How much is the maximum amount that Ferrari is willing to pay an outside supplier for the
engine component?
3. ACCEPT or REJECT (SPECIAL ORDER DECISION)
Panda Company produces and sells toy cars. Each toy car sells for P 50 and the company sells
approximately 500,000 toy cars each year. Unit cost data for 2022 are given below:
Fixed Variable Fixed Variable
Direct Material - P 15 Factory Overhead P8 P5
Direct Labor - 12 Distribution Costs 2 3
Panda has received an offer from a foreign customer to purchase 15,000 toy cars at P 40. If the offer is
accepted, the company has idle capacity to accommodate the order but the unit variable distribution costs
will increase by P 2 for insurance and import duties.
REQUIRED:
A) What is the relevant unit cost of the special order?
B) Should Panda accept or reject the special order?
4. SPECIAL ORDER PRICING
Bren Company sells “BJS” at a unit price of P 36,000, with the following unit production costs:
Direct materials P 12,000
Direct labor 8,000
Variable overhead 6,000
Fixed overhead 4,000
A special order for 1,000 units was received from Ely, a well-known BJS distributor based in Makati.
Additional shipping costs for this sale are P 4,000 per unit.
REQUIRED:
What is the minimum selling price per unit for the special order if:
A) Bren is operating at FULL capacity?
B) Bren has EXCESS capacity?
5. CONTINUE or SHUTDOWN (SHUTTING DOWN OPERATIONS)
The combined income statement of Eloy Stores for Bohol and Cebu branches is given below:
Bohol Branch Cebu Branch Total
Sales P 1,200,000 P 800,000 P 2,000,000
Less: Variable expenses (840,000) (360,000) (1,200,000)
Contribution margin P 360,000 P 440,000 P 800,000
Less: Traceable fixed expenses (210,000) (180,000) (390,000)
Segment margin P 150,000 P 260,000 P 410,000
Less: Common fixed expenses (180,000) (120,000) (300,000)
Profit (loss) (P 30,000) P 140,000 P 110,000
If Bohol Branch were eliminated, then its traceable fixed expenses could be avoided. The total common
fixed expenses are merely allocated and would be unaffected.

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A) What will be the new company profit (loss) if Bohol Branch is eliminated?
B) What will be the decrease in company profit if Bohol Branch is closed and 20% of its traceable fixed
expense would remain unchanged while Cebu’s sales would decrease by 20%?
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
RELEVANT COSTING with LINEAR PROGRAMMING MS-44E
6. PRODUCT ELIMINATION POINT
Salvador Company expects that sales will drop below the current level of 5,000 units per month. An
income statement prepared for the monthly sales of 5,000 units show the following:
Sales (5,000 @ P 3) P 15,000
Less:
Variable costs (5,000 @ P 2) P 10,000
Fixed costs 5,000 15,000
Profit - Nil -
If plant operations are suspended, a shutdown cost (i.e., plant maintenance and taxes) of P 2,000 per
month will remain as incurred. Since there is no immediate possibility of profit under present
conditions, the problem of the company is just how to minimize the loss.
REQUIRED:
A) Determine the shutdown point in units.
B) Should the company continue or shut down operations if sales next month are expected to be:
1) 4,000 units? 2) 2,000 units? 3) 3,000 units?
7. SELL or PROCESS FURTHER
Sardoncillo Company produces products C, I and T for a joint cost of P 200,000. Each product may be
sold at its split-off point or processed further. Additional processing costs are entirely variable. Relevant
data are given below:
Product Sales Value at Split-Off Additional Processing Costs Final Sales Value
C P 100,000 P 80,000 P 250,000
I 200,000 40,000 200,000
T 50,000 . 60,000 . 100,000 .
P 350,000 P 180,000 P 550,000
REQUIRED:
A) Which product(s) should the company sell at split-off point?
B) If the company can only sell all the products at split-off point or process all the products further
beyond the split-off point, then which option is recommended?
8. SCRAP or REWORK
Argao Company has 5,000 obsolete truck parts that are carried in inventory at a cost of P 50,000. The
company is faced with a decision whether to scrap the parts or modify them:
➢ If the parts were junked, the company would realize only 10% of its cost.
➢ Should the company modify the parts, it will spend P 10,000 for materials, P 2,000 for direct labor,
and overhead equal to 40% of prime costs. The new parts will sell for P 25,000 in the market.
REQUIRED:
Should Argao Company modify or scrap the parts?

9. BEST PRODUCT COMBINATION

DMD Company produces products A, B and C. One machine is used to produce the products. The sales
demands, contribution margins and time on the machine (in hours) are as follows:

Market Limit Unit Contribution Margin Hours on Machine

A 100 units P 20 10 per unit
B 80 units P 18 5 per unit
C 150 units P 25 10 per unit
There are 2,400 hours available on the machine during the week. Total fixed cost is P 3,000.
REQUIRED:
A) What is the best product combination that maximizes the weekly contribution?
a. 90 units of A; 0 unit of B; 150 units of C
b. 50 units of A; 80 units of B; 150 units of C
c. 100 units of A; 80 units of B; 100 units of C
d. 100 units of A; 80 units of B; 150 units of C
B) How much is the profit associated with the best product combination?

10. LINEAR PROGRAMMING

A&S Company has an available 120 grams of Material 1 and 80 meters of Material 2 to produce its products
A and B:
Product A Product B
Unit Contribution Margin P3 P4
Required Materials:
Material 1 2 grams 5 grams
Material 2 4 meters 2 meters
REQUIRED:
A) Objective function - involving maximization of the company’s contribution margin.
B) Non-negativity constraint function
C) Constraint function for Material 1
D) Constraint function for Material 2 0 0
E) Optimal product mix
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
RELEVANT COSTING with LINEAR PROGRAMMING MS-44E
WRAP-UP EXERCISES
1. Identify the best description for relevant costs in decision-making process.
a. Past costs that are expected to be different under each alternative
b. Past costs that are expected to be the same under each alternative
c. Future costs that are expected to be different under each alternative
d. Future costs that are expected to be the same under each alternative
2. A cost incurred in the past and hence irrelevant for current decision making is a:
a. Sunk cost c. Direct cost
b. Fixed cost d. Discretionary cost
3. Which of the following costs is generally considered irrelevant in decision-making process?
a. Direct labor c. Fixed factory overhead
b. Direct materials d. Variable factory overhead
4. Which of the following cost classification schemes is most relevant to decision making?
a. Fixed vs. variable c. Joint vs. common
b. Direct vs. common d. Avoidable vs. unavoidable
5. The salary that you would otherwise earn by working rather than attending the CPA review is a good
example of a (an):
a. Sunk cost c. Opportunity cost
b. Joint cost d. Unavoidable cost
6. An opportunity cost is usually:
a. Relevant and part of traditional accounting records
b. Relevant, but not part of traditional accounting records
c. Irrelevant, but part of traditional accounting records
d. Irrelevant and not part of traditional accounting records
7. In a make-or-buy decision
a. Only variable costs are relevant
b. Only conversion costs are relevant
c. Fixed costs that can be avoided in the future are relevant
d. Fixed costs that will continue regardless of the decision are relevant
8. In a make-or-buy decision, the cost to buy is compared with the
a. Total cost to make c. Variable manufacturing costs
b. Relevant cost to make d. Variable selling & administrative expenses
9. What is the opportunity cost of making a component part in a factory given that there is no alternative
use of the capacity?
a. Zero c. Variable costs of the component
b. Fixed costs of the component d. Total manufacturing costs of the component
10. In an accept-or-reject decision, which cost is usually considered to be irrelevant?
a. Fixed cost of the product c. Direct fixed costs associated with the order
b. Variable cost of the product d. Opportunity costs of the temporary idle capacity
11. If there is an excess capacity, then the minimum acceptable price for a special order must cover
a. Usual fixed manufacturing costs
b. Variable and usual fixed manufacturing costs
c. Variable and incremental fixed costs associated with the special order
d. Variable manufacturing costs plus contribution margin foregone on lost regular units.
12. If a company is operating at maximum or full capacity, the minimum special-order price must cover
a. Variable costs associated with the special order
b. Variable and incremental fixed costs associated with the special order
c. Variable and fixed manufacturing costs associated with the special order
d. Variable costs and incremental fixed costs associated with the special order plus
contribution margin foregone on regular units not produced.
13. If the margin lost by dropping a product line is higher than avoidable fixed costs, then the product line
a. Operates at a loss c. Shall be continued
b. Shall be shutdown d. Has no impact on company profit
14. Assuming there is a material amount of shutdown costs, then the shutdown point must be
a. Nil or zero c. Above its break-even point
b. Below its break-even point d. Equal to its break-even point
15. Which is usually considered irrelevant in ‘sell or process further’ decision making?
a. Joint costs c. Sales value at the split-off point
b. Further processing costs d. Sales value after further processing
16. A company that has a limited number of labor hours and abundant machine hours should produce first
the product that has the highest
a. Demand in units c. Contribution margin per labor hour
b. Contribution margin per unit d. Contribution margin per machine hour
17. In linear programming, the expression “Maximize Z = 50 X + 100 Y” is most likely a (an)
a. Objective function c. Cost function
b. Constraint function d. Restriction function
18. The term ‘constraints’ in a linear programming model generally refers to:
a. Committed costs c. Scarce resources
b. Inefficiencies 0 0d. Decision variables
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
RELEVANT COSTING with LINEAR PROGRAMMING MS-44E
SELF-TEST QUESTIONS - with suggested answers
( Sources: CMA/CIA/RPCPA/AICPA/Various test banks)

1. In the development of the accounting data for decision-making purposes, a relevant cost is defined as:
B a. Changes in variable cost under each alternative course of action.
b. Future costs which will differ under each alternative course of action.
c. Historical costs which are the best available basis for estimating future costs.
d. Standard costs which are developed by time-and-motion-study techniques because of their
relevance to managerial control.
2. In a decision analysis situation, which one of the following costs is generally NOT relevant to the decision?
D a. Incremental cost c. Avoidable cost
b. Differential cost d. Historical cost
3. The relevance of a particular cost to a decision is determined by the
C a. Size of the cost c. Potential effects on the decision
b. Risk level of the decision d. Accuracy and verifiability of the cost
4. The kind of cost that can be ignored in short-term decision making is a(n):
C a. Differential cost c. Sunk cost
b. Incremental cost d. Relevant cost
5. In determining whether to manufacture a part or buy it from an outside vendor, a cost that is irrelevant to the short-run
decision is
D a. Prime costs
b. Variable overhead
c. Fixed overhead that will be avoided if the part is bought from an outside vendor
d. Fixed overhead that will continue even if the part is bought from an outside vendor
6. In a make-or-buy decision, the relevant costs include variable manufacturing costs as well as
C a. Factory management costs c. Avoidable fixed costs
b. General office costs d. Depreciation costs
7. Turkey Technology manufactures a particular computer component. Currently, the costs per unit are as follows:
Direct materials, P 50; direct labor, P 500; variable overhead, P 250; fixed overhead, P 400.
Pakistan Inc. has obtained Turkey with an offer to sell 10,000 units of the component for P 1,100 per unit. If Turkey
accepts the proposal, P 2,500,000 of the fixed overhead will be eliminated. Should Turkey make or buy the component?
D a. Make due to savings of P 3,000,000 c. Buy due to savings of P 1,000,000
b. Buy due to savings of P 2,500,000 d. Make due to savings of P 500,000
8. Saudi, Inc. is operating at 70% capacity and considers making Part A5 now being purchased from outside suppliers for
P 110 each, which is projected to increase in the near future. Saudi has the equipment and labor force required to
manufacture Part A5. The design engineer estimates that each part requires P 40 of direct materials and P 30 of direct
labor. The plant overhead is 200% of direct labor peso cost, and 40% of the overhead is fixed cost. A decision to
manufacture Part A5 will result in a gain or (loss) for each component of:
D a. P 26 c. (P 20)
b. P 16 d. P 4
9. The Blade Division of Baghdad Corporation produces hardened steel blades. One-third of the Blade Division’s output is
sold to the Lawn Products Division of Baghdad; the remainder is sold to outside customers. The Blade Division’s
estimated sales and cost data for the fiscal year are as follows:
Lawn Products Outsiders
Sales P 15,000 P 40,000
Variable costs (10,000) (20,000)
Fixed costs (3,000) (6,000)
Profit P2,000 P 14,000
Unit sales 10,000 units 20,000 units
The Lawn Products Division has an opportunity to purchase 10,000 identical quality blades from an outside supplier at a
cost of P 1.25 per unit. Assume that the Blade Division cannot sell any additional products to outside customers. Should
Baghdad allow its Lawn Products Division to purchase the blades from the outside supplier?
D a. Yes, because buying the blades would save Baghdad Company P 500
b. No, because making the blades would save Baghdad Company P 1,500
c. Yes, because buying the blades would save Baghdad Company P 2,500
d. No, because making the blades would save Baghdad Company P 2,500
10. Cairo Manufacturing uses 10 units of Part Number KJ45 each month in the production of radar equipment. The unit cost
to manufacture one unit of KJ45 is presented below.
Direct materials P 1,000
Materials handling (20% of direct material cost) 200
Direct labor 8,000
Manufacturing overhead (150% of direct labor) 12,000
Materials handling represents the direct variable costs of the Receiving Department that are applied to direct materials
and purchased components on their cost. This is a separate charge in addition to manufacturing overhead. Cairo’s
annual manufacturing overhead budget is one-third variable and two-thirds fixed. Egypt Suppliers, one of Cairo’s
reliable vendors, has offered to supply Part KJ45 at a unit price of P 15,000. If Cairo purchases the KJ45 units from
Scott, the capacity Cairo used to manufacture these parts would be idle. Should Cairo decide to purchase the parts
from Egypt, the unit cost of KJ45 would:
A a. Increase by P 4,800 c. Decrease by P 3,200
b. Decrease by P 6,200 0 0
d. Increase by P 1,800
NOTE: The relevant cost to buy must include 20% handling cost. (P 15,000 + P 3,000)