Exercise 2: Accept or Reject a Special Order

Laguna Manufacturing Company produces a product “Print”, and sells them in Metro Manila. The following information thereon is
given:
Sales volume per year………………………………………… 35,000 units
Practical Capacity………………………………………………. 50,000 units
Unit selling price…………………………………………………. P50
Direct Materials……………………………. 12
Direct Labor…………………………………… 6
Variable Factory Overhead………………. 9
Fixed Factory Overhead per annum…………………………. 100,000
Variable Operating Expenses per unit………………………. 5
Fixed Operating Expenses per annum……………………….. 50,000
An order fro 5,000 units has been received from Cebu City at P46, FOB – shipping point.
Instructions:
1. Determine the relevant costs in accepting or rejecting the order from Cebu City and give your recommendation.
2. Compute the cut-off sales price for the special order.
3. What would be the effect on operating income if the order is accepted?
Answer:

a. Relevant costs:
Variable manufacturing costs
Direct materials (5,000 u. X P12) P 60,000
Direct Labor (5,000 u x P6) 30,000
Variable FOH (5,000 u x P9) 45,000
135,000
b. BEP sales price
Total relevant costs of P135,00 / 5,000 units P 27

c. Operating income would increase by P95,000 if the order is accepted.

(5,000 u x (P46 – 27) = P95,000
Exercise 3. Continue making of buy

Use the data given in exercise 2. Assume that another manufacturer, CBX Manufacturing Company
has offered to manufacture for the company its product for P25 per unit. If the offer is accepted,
savings in fixed factory overhead are estimated at 30%.
Questions:
1. What are the relevant costs in the decision problem?
2. If the offer of CBX Manufacturing Company is accepted, what would be the effect on the
operating income of Laguna Manufacturing Company?
3. How much is the cut off purchase price?
Answer:
a. Relevant costs:
Incremental costs in manufacturing
Variable manufacturing costs
Direct materials (35, 000 u. x P12) P420,000
Direct labor (35, 000 u. x P6) 210,000
Variable FOH (35, 000 u. x P9) 315,000
Total variable mfg. costs P945, 000
Foregone savings in fixed factory overhead (30% x P100, 000 30,000
Total incremental costs in manufacturing P975, 000

b. The operating income of Laguna Mfg. Co. may be expected to increase by P100,000 if the offer of CBX
Mfg. Co. is accepted.
Purchase costs (35, 000 u x P25) P875, 000
Total relevant cost (a) 975, 000
Differential cost P100,000
Or:
Buy Make Difference
Sales (35, 000 u x P50) P 1, 750, 000 P 1, 750, 000 -
Less –
Variable costs of sales
Purchase cost (35,000 x P25) P 875, 000
Var. mfg. cost (35, 000 x P27) P 945, 000 P (70,000)
Fixed FOH (70%) 70, 000 100, 000 (30, 000)
Var. operating exp. (@ P5) 175, 000 175, 000 -
Fixed operating exp. 50, 000 50, 000
P 1, 170, 000 P 1, 270, 000
Operating income P 580, 000 P 480, 000 100,000

C. Cut- off purchase price =

Total relevant cost of P975, 000/ 35, 000 units = P27.86
Exercise 4: Sell or process further

The manager of Diamond Manufacturing Company is determining which of the three products of the company
should be processed further in as much as they can be sold in semi processed form. The following data are given
below.

Semi Processed After Processing Further

Product Sales Value Accumulated Cost Sales Value Additional Cost
M 70,000 55,000 90,000 20,000
O 30,000 12,000 43,000 18,000
P 40,000 22,000 65,000 10,000

Questions:
1.What would be your recommendation?
2.If there are 20,000 units of Product P, how much would be the relevant cost per unit?
3.Are the accumulated costs in semi processing relevant?
Answer
a. Product P should be processed further because the additional
processing will increase operating income by P15,000.
Increase in Additional cost Incremental
sales value Income
Product M (P90,000 – 70,000) P 20, 000 P 20, 000 P -
Product O (P43,000 – 30,000) 13, 000 18, 000 (5, 000)
Product P (P65,000 – 40,000) 25, 000 10, 000 15, 000

b. Relevant unit cost of Product P is the additional cost of P10,000

divided by 20, 000 units or P.50.
c. No. The accumulated costs in semi-processing are not relevant
because they have to be incurred jut the same. Once the goods are
already semi-processed, the related costs are already considered as
sunk (or past) cost.
Exercise 5. Obsolete Inventory

The Underground River Corporation has 50 pairs of “flared pants” costing P100 each. In as much as
they are no longer saleable, the company has two options: to sell them as they are for P50 a pair or
have them reprocessed at a cost of P20 per pair so they can be sold at approximately P80 each.
Questions:
1. Is the accumulated cost of the flared pants relevant?
2. What item(s) of cost is (are) relevant? Why?
3. Which option would result in incremental cash flow?
Answer
a. No. the accumulated costs of the flared pants is not relevant because
it is past cost. It will not be affected by whatever decision management
makes.
b. The relevant cost is the reprocessing cost of P20 per pair of pants
because it may not be incurred depending on the option management
chooses.
c. Reprocessing the pants would result in an incremental cash inflow of
P500:
Sell as is Process further
Sales revenue from sale of pants
(50 prs. X P50) P 2, 500
(50 prs. X P80) P 4, 000
Incremental cost (50 prs x P20) (1, 000)
Net proceeds P 2, 500 P 3, 000
 Exercise 6. Optimum Product Mix
• The management of Siboney Manufacturing Company is determining the optimum product mix
from the following data:
Product Selling price per unit Variable cost per unit Hours to process Estimated Market Share
D 120 90 3 5,000 units
E 62 30 4 10,000 units
F 30 10 30 minutes 100,000 units
• Theoretical or maximum capacity is 80,000 units. Allowance for unavoidable interruptions (such
as oiling and cleaning and brown outs) is 15%.

• Required:
Optimum Product Mix
Answer
Operating product mix:
CM per hour Rank
Product D: (P120 – 90) / 3 hrs P 10 2nd
Product E: (P62 – 30) / 4 hrs 8 3rd
Product F: (P30 – 10) / (1/2 hr.) 40 1st

Practical capacity (80,000 hrs. x 1-15%) 68, 000

Reserve for product F (100, 000 u. x ½ hr)(50,000)
Reserve for product D ( 5, 000 u. x 3 hrs) (15,000)
Available for product E 3, 000

No. of units that can be produced of product E:

(3, 000 hrs. / 4 hrs. ) 750

Optimum product mix:

Product F100, 000
Product D 5,000 units
Product E 750
Exercise 7. Retention or Closure of an organizational segment
The results of operations of Sunshine Traders are being reviewed. The following income statements have been presented.

Division A Division B Division C

Sales 500,000 300,000 200,000
Less: Cost of Sales 200,000 120,000 90,000
Gross profit on sales 300,000 180,000 110,000
Less: Operating expenses
Directly related to sales 50,000 60,000 40,000
Not directly related to sales 70,000 50,000 30,000
Allocated expenses 100,000 60,000 40,000
220,000 170,000 110,000
Operating Income 80,000 10,000 0

A proposal was made to effect that Division C be closed for it has no contribution to company profit.
Questions.
1. What are the relevant items in the problem?
2. Do you agree with the proposal?
Answer:
a. Relevant items in the problem are the avoidable costs and expenses in
each division which, in the absence of any additional information, are
presumed to be each division’s direct costs and expenses. For Division C
they are:
Cost of sales P 90, 000
Operating expenses
Directly related to sales 40, 000
Not directly related to sales 30,000
Total avoidable costs and expenses P 160, 000

b. No, Division C should not be closed based on its zero contribution to profit
per the given income statements because its closure would reduce the
company’s income from P90, 000 to P50, 000 or by P40, 000 which is the
division’s contribution to recovery of allocated expenses. This is arrived at by
deducting the total avoidable costs and expenses of P160, 000 from Division
C’s sales of P200, 000. The following pro-forma statement prove this:
Pro-forma income statement (based on the assumption that Division C
is closed):
Sales (P500, 000 + 300,000) P 800, 000
Less – Cost of sales (P200, 000 + 120, 000) 320, 000
Gross profit on sales P 480, 000
Less –
Operating expenses
Directly related to sales (P50,000 + 60,000) P 110, 000
Not directly related to sales (70,000 + 50,000) 120, 000
Allocated expenses (P100,000 + 60,000 + 40,000) 200,000
P 430,000
Operating income P 50,000
Exercise 8. Temporary Shutdown

An underpass is to be constructed beside the main sales outlet of Batangsas Corp. and
operations are expected to suffer a 70% decline in sales volume for three months. Management is
therefore determining whether it would be advisable to close the sales outlet temporarily and then
resume after three months. The following data are given on the sales outlet:
Fixed costs and expenses per quarter P30, 000
Unit selling price of the product 80
Variable costs and expenses per unit 48
Current sales volume: 2, 000 units/quarter

A shutdown for three moths is expected to reduce a fixed costs and expenses by 60% but
additional costs of security and maintenance of P2,000 have to be incurred aside from re-starting
costs of P3,000.
a. Compute for shutdown point.
b. Which would result in bigger operating loss: continuing operations during the three-month
period or having a shutdown? How much would be the difference?
Answer
a. Shutdown point= Fixed costs – Shutdown costs
CM per unit
= P30, 000 – [(P30, 000 x 40%) + 2, 000 + 3,000
P80 – 48
= 406. 25 units
b. A shutdown would result I bigger operating loss even if sales volume declines by 70% or to 600
units (that is , 2, 000 units x 30%) because it is still higher that sales volume at shutdown point
of 406. 25 units. The difference would be P6, 200, that is [(600 – 406. 25units) x CM per unit of
(P80 – P40)]
Proof:

Operate Shutdown
Sales (600 units x P80) P48, 000
Variable costs and expenses (600 x P48) (28, 000)
Fixed costs and expenses (30, 000)
Shutdown costs (17,000)
Net income (loss) (P 10, 800) (P17, 000)
Difference P 6, 200
 Asynchronous Activity to be submitted on
or before 9PM tonight.
1. The Poison Chemical Company produces two joint products, Alash
and Pottum from the same process. Joint processing costs of $150,000
are incurred up to split-off point, when 100,000 units of Alash and
50,000 units of Pottum are produced. The selling prices at split-off point
are $1.25 per unit for Alash and $2.00 per unit for Pottum.
The units of Alash could be processed further to produce 60,000 units
of a new chemical, Alashplus, but at an extra fixed cost of $20,000 and
variable cost of 30c per unit of input. The selling price of Alashplus
would be $3.25 per unit. Should the company sell Alash or Alashplus?
2. Brent fashion store comprises three department – Men’s Wear,
Ladies’ Wear and Unisex. The store budget is as follows:
Men’s Ladies’ Unisex Total
Sales 40,000 60,000 20,000 120,000

Direct cost of sales 20,000 36,000 15,000 71,000

Department costs 5,000 10,000 3,000 18,000
Apportioned store costs 5,000 5,000 5,000 15,000
Profit/(loss) 10,000 9,000 (3,000) 16,000

It is suggested that Unisex be closed to increase the size of Men’s and

Ladies’ Wear. What information is relevant or required?
3. Ann Ltd manufactures special purpose gauges to customers’ specifications. The
highly-skilled labour force is always working to full capacity and the budget for the
next year is as follows:
Sales 40,000
Direct materials 4,000
Direct wages (3,200 hours @ $5) 16,000
Fixed overhead 10,000 30,000
Profit 10,000

An enquiry is received from XY Ltd for a gauge which would use $60 of direct
materials and 40 labour hours.

Required:
(a) What is the minimum price to quote to XY Ltd?
(b) Would the minimum price be different if spare capacity was available but
materials were subject to a quota of $4,000 per year?
4. Claire Ltd makes four components, W, X, Y and Z for which costs in the forthcoming year are expected to be as
follows.
W X Y Z
Production (units) 1,000 2,000 4,000 3,000
Unit marginal costs $ $ $ $
Direct materials 4 5 2 4
Direct labor 8 9 4 6
Variable production overheads 2 3 1 2
14 17 7 12

Directly attributable fixed costs per annum and committed fixed costs:

Incurred as a direct consequence of making W 1,000

Incurred as a direct consequence of making X 5,000
Incurred as a direct consequence of making Y 6,000
Incurred as a direct consequence of making Z 8,000
Other fixed costs (committed) 30,000
50,000
A sub-contractor has offered to supply units of W, X, Y and Z for $12, $21, $10 and $14 respectively. Should
Claire Ltd make or buy the components?