SHORT-TERM NON-ROUTINE DECISIONS

MANAGEMENT ACCOUNTING PART 2

Relevant Cost – expected future costs and revenues that differ among alternative courses of action

The following are relevant:

a. Differential cost – costs that are present in one alternative in a decision making cases but are absent
in whole or in part in another alternative
b. Avoidable cost – costs that can be eliminated in whole or in part when one alternative is chosen over
another in a decision making case
c. Opportunity cost – refers to the contribution to income that is foregone or lost when one action is
taken over the best alternative course of action

The following are irrelevant:

a. Sunk cost (past cost) – cost that has already been incurred and therefore cannot be avoided
regardless of the alternative taken by decision maker
b. Future costs that do not differ between or among the alternative under consideration.

WARM-UP:

Miss Patricia Baldemor, a graduate of Cebu State University, is going to Manila to review for the CPA Board
Examination. She is considering to stay in a dormitory that is just a stone’s throw away from the review
school during her 5-month stay in manila. Her aunt, however, is offering her a room in her house which is
about three (3) kilometres away from the school. She told her aunt that she would first conduct differential
analysis before making her decisions on where to stay. She listed the following costs and costs estimates:

If she will stay in

Her aunt's House A dormitory
Plane ticket: Cebu-Manila-Cebu ₱ 8,000.00 ₱ 8,000.00
Tuition fee* 1,000.00 1,000.00
Board and lodging fee - 25,000.00
Share in food and household expenses 10,000.00 -
Transportation (Aunt -School- Aunt) 1,700.00 -
Snacks etc while in school 4,000.00 4,000.00
Books used in college to be used during the review 10,000.00 10,000.00
New review books to be purchased 2,000.00 2,000.00
Clothes to be brought to Manila 6,000.00 6,000.00
Personal supplies while in Manila * 400.00 2,000.00
Other expenses (for contingencies and gimmick) 3,000.00 5,000.00

TUITION FEE – Being a honor graduate, Patricia has to pay the miscellaneous fee of only P1, 000 for the
whole review term.
PERSONAL SUPPLIES – Her aunt will shoulder some of her personal supplies if she will stay in her (Aunt’s)
house.

Patricia is currently working as an accounting clerk in a Cebu-based firm, earning P8, 000 per month. She
could have stayed in Cebu and continue working but she wants to review in Manila and fulfil her dream of
becoming a CPA.

She informed her boss of her decision to review in Manila. She filed a five-month study leave (without pay)
which her boss approved.

QUESTIONS:

1. If the alternative are whether to stay in her Aunt’s or in a dormitory, the relevant costs are.
2. Opportunity cost of reviewing in Manila
3. Irrelevant future cost
4. Sunk cost/past costs
ANSWERS:

1.
Aunt's House Dormitory
Board and lodging fee 25,000.00
Share in food and household expenses 10,000.00
Transportation (Aunt -School- Aunt) 1,700.00
Personal supplies while in Manila * 400 2,000.00
Other expenses (for contingencies and
3,000.00 5,000.00
gimmick)
15,100.00 32,000.00

2. P40, 000. Patricia is currently working as an accounting clerk in a Cebu-based firm, earning P8, 000 per
month. She could have stayed in Cebu and continue working but she wants to review in Manila and fulfil
her dream of becoming a CPA.

3.
Plane ticket: Cebu-Manila-Cebu ₱8,000.00
Tuition fee* 1,000.00
Snacks etc while in school 4,000.00
New review books to be purchased 2,000.00
Opportunity Cost 40,000
₱55,000.00
4.
Books used in college to be used during the review 10,000.00
Clothes to be brought to Manila 6,000.00
P 16,000

MAKE OR BUY
PROBLEM 1. Toblerone Corporation manufactures part X-24 for use in its production cycle. The cost per
unit for 10,000 units of part X-24 are as follows:

Direct Materials P 6.00

Materials handling costs (20%) 1.20
Direct Labor 20.00
Variable Overhead 5.00
Fixed Overhead 11.00
TOTAL P 43.20

Ferrero Company has offered to sell Toblerone Corporation 10,000 units of part X-24 for P40 per unit.
If Toblerone accepts Ferrero’s offer, P4.00 of the fixed overhead per unit could be eliminated. The materials
handling costs pertain to the cost of receiving and inspecting incoming materials and other components
which are not included in the overhead.

If the part is outsourced from an outside supplier, one-half of the released facilities could be used to
produce a new product, Citrus, which is expected to generate a contribution margin of P90, 000 per year.
Additionally, a savings of P15, 000 is expected if the parts are purchased outside. The other half of the
released facilities could be rented out for P60, 000 per annum.

The outside supplier required that an equipment be leased to meet the order of the company. The
equipment rental cost of P80,000 shall be charged to the company.

REQUIRED:
1. What alternative is better, make or buy the part and by how much is its advantage?

Cost to Make Cost to Buy

Purchase price 400,000.00
DM 60,000.00
Materials Handling costs (20%) 12,000.00 80,000.00
DL 200,000.00
Variable-Overhead 50,000.00
Avoidable fixed overhead 40,000.00
Savings if made from released facilities (15,000.00)
Rental income from released facilities (60,000.00)
Contribution Margin from new product (90,000.00)
Rental expense if the part is bought 80,000.00
Total relevant costs 362,000.00 395,000.00
SAVINGS 33,000.00

PROBLEM 2. Horseman Plastics manufactures plastic housings for air conditioners. One of the parts
required to manufacture an air conditioner plastic housing is currently produced by Horseman at a rate of
90,000 units annually. The management is considering purchasing the part from an external vendor, Heavy
Plaxtics, Inc. The cost per unit to manufacture:
Cost per unit to manufacture Cost per unit to buy
Direct Materials ₱ 20.00 Purchase price ₱ 60.00
Direct Labor ₱ 30.00 Freight Charges ₱ 5.00
Variable Overhead ₱ 13.00 Total Costs ₱ 65.00
Fixed Overhead ₱ 12.00
Total Costs ₱ 75.00

REQUIRED:
1. Assuming all of the Horseman’s internal production costs are all avoidable if it purchases
rather than make the parts, which alternative is better and by how much is its net advantage?

Cost per unit to manufacture 75.00

Cost per unit to buy (65.00)
Cost per unit advantage 10.00
Net advantage 900,000.00

ACCEPT OR REJECT SPECIAL ORDER

PROBLEM 1. The manufacturing capacity of Northwind Corporation’s facilities is 50,000 units of a product
a year. A summary of operating results for the year end December 31, 2o15 is as follows:

Total Per unit

Sales (38,000 units) 3,800,000.00 ₱ 100.00
Less: Variable Cost and Expenses 2,090,000.00 ₱ 55.00
Contribution Margin 1,710,000.00 ₱ 45.00
Less: Fixed Cost and Expenses 900,000.00
Operating income 810,000.00

A distributor has offered to buy 12,000 units at P90 per unit during 2016. Assume that all of the
corporation’s cost would be at the same level and rates in 2016 as to 2015.

REQUIRED: Should the company Accept or reject the special orders?

a. The corporation has no alternative use of its idle capacity.

Incremental Sales ( 12,000 X 90) 1,080,000.00

Incremental costs (12,000 X 55) 660,000.00

Incremental Profit 420,000.00

b. The corporation can rent out the idle capacity for P200,000.

Incremental Profit 420,000.00

Rent income if the facility is rented out (200,000.00)
Net advantage of accepting the special order 220,000.00

c. The corporation can use the idle capacity to produce a new product that could contribute a
P600,000 contribution margin,

Incremental Profit 420,000.00

CM from new product (600,000.00)

Net advantage of rejecting the special order (180,000.00)

d. If the special order is accepted, 2,000 units of regular sales is expected to be lost.

Incremental CM 420,000.00
CM lost from regular sales ( 2,000 x45) (90,000.00)
Net increase in profit from accepting the
special sales 330,000.00

e. Assuming a distributor has ordered 16,000 units and the corporation has to sacrifice some
of its regular customers to accommodate the special order.

Incremental CM (16,000X 35) 560,000.00

CM lost from regular sales ( 4,000 x45) (180,000.00)
Net increase in profit from accepting the
special sales 380,000.00
 CONTINUE OR DROP AN ORGANIZATION

PROBLEM 1. Espiritu Company plans to discontinue a division with a P200, 000 contribution to overhead.
Overhead allocated to the division is P500, 000 of which P50, 000 cannot be eliminated. Should Espiritu
Company discontinue the division?

Sales x
Less: Variable Cost x
Manufacturing Margin x
Less: Variable Expenses x
Contribution Margin x
Less: Controllable Direct fixed costs and expenses x
Controllable Margin x
Less: Non-controllable direct fixed cost and expenses x
FOCUS
SEGMENT (DIRECT) MARGIN x HERE!
Less: Indirect Fixed costs and expenses x
Operating Income x

CONTRIBUTION MARGIN x
Less: Avoidable fixed costs and expenses x
Controllable Segment Margin x

ANSWER: THE DIVISION SHOULD BE DISCONTINUED BECAUSE IT HAS NEGATIVE CONTROLLABLE

SEGMENT MARGIN.

200,00
CONTRIBUTION MARGIN
0.00
Less: Avoidable fixed costs and expenses(500,000 – (450,00
50,0000 0.00)
(250,
Controllable Segment Margin 000.00)

PROBLEM 2. The Gato Company manufactures and sells three products M, T, L. For the coming year, sales
are expected to be as follows:
PRODUCT Sales Price Quantity Total Sales
M ₱ 10.00 5000 ₱ 50,000.00
T ₱ 6.00 7000 42,000.00
L ₱ 15.00 3000 45,000.00
₱ 137,000.00
At the expected sales quantity and mix, the manufacturing cost per unit is as follows:
M T L
MATERIALS ₱ 2.00 ₱ 2.00 ₱ 4.00
DIRECT LABOR ₱ 2.00 ₱ 1.00 ₱ 3.00
FACTORY OVERHEAD
Variable ₱ 1.00 ₱ 1.00 ₱ 2.00
Fixed ₱ 1.00 ₱ 1.00 ₱ 3.00

Variable marketing expense is P1.00 per unit for M and T and P2.00 for L.
Budgeted fixed marketing expenses for the coming year are P3, 000 and budgeted fixed administrative
expenses are P6,000.

The sales manager has recommended dropping T from the product line and using the production capacity
currently committed to the production of T to produce more M.

The production manager reports that 4,000 additional units of M can be produced with the production
capacity now used in manufacturing T. To sell 4,000 additional units of M, the sales manager believes that
the advertising budget will have to be increased to P5, 000.
Should the manager’s proposal be accepted? Support your answer by computing the change in profitability
that would result from this action.

M T L
Sales price per
unit 10.00 6.00 15.00
Variable cost per
unit (5.00) (4.00) (9.00)
Variable expense
per unit (1.00) (1.00) (2.00)
UCM 4.00 1.00 4.00

M T
Contribution Margin -Product T 7,000.00
Contribution Margin -Product M new product ( 4,000 X 4) 16,000.00
Increase in advertising (5,000.00)
Incremental profit for each product 11,000.00 7,000.00
Net advantage of producing M 4,000.00

SELL-AS-IS OR PROCESS FUTHER

PROBLEM 1. Tarlac Corporation produces three main products. Its production and costs data are given
below:

X Y Z
Unit Sales after further processing ₱ 300.00 ₱ 550.00 ₱ 220.00
Unit Sales before further processing ₱ 250.00 ₱ 530.00 ₱ 190.00
Cost of separate (further processing) ₱ 120,000.00 ₱ 65,000.00 ₱ 190,000.00
Units produced and sold 2,000 4,000 7,500

TOTAL JOINT COSTS, P 1,400,000

Which of the products should be processed further?

X Y Z
550. 220.
300.00
Unit Sales after further processing 00 00
530. 190.
250.00
Unit Sales before further processing 00 00
20. 30.
50.00
Unit Sales advantage after further processing 00 00
4,0 7,5
2,000
Units sold 00 00

Incremental sales 100,000.00 80,000.00 225,000.00

(65,000. (190,000.
(120,000.00)
Incremental costs 00) 00)

Incremental profit (20,000.00) 15,000.00 35,000.00

Do not Process Process Process
further further further

PROBLEM 2. Cyclone Corporation produces three products at segregation point, KAH, MOOH, TEY.
Total Joint Cost in manufacturing these three products was P 3,000,000.

KAH MOOH TEY

40,000
Production and sales 10,000 units units 50,000 units
 ₱ ₱ ₱
Unit sales price at split-off point 80.00 100.00 200.00
₱ ₱ ₱
Unit Sales price after further processing 90.00 120.00 230.00
₱ ₱ ₱
Unit variable costs of subsequent processing 8.00 18.00 27.00

If product KAH is processed further, an equipment should be rented at a cost of P12, 000.
The company has no available space and manpower for MOOH subsequent processing, they will be
engaged to an outside contractor amounting to P90, 000. The total set-up cost of subsequently processing
product Tey is P120, 000, they will use idle machine and manpower time within the company for Product
Tey.

1. Which product should be processed further to maximize profit?

KAH MOOH TEY
80. 10 200
Unit sales price at split-off point
00 0.00 .00
90. 1 230
Unit Sales price after further processing
00 20.00 .00
(8. (1 (27.
Unit variable costs of subsequent processing
00) 8.00) 00)

unit CM after further processing 82.00 102.00 203.00

ADVANTAGE of Further processing per unit 2.00 2.00 3.00

Units sold 10,000 40,000 50,000

Incremental CM 20,000.00 80,000.00 150,000.00

Additional Costs after processing (12,000.00) (90,000.00) (120,000.00)

Incremental profit 8,000.00 (10,000.00) 30,000.00

Process Do not Process Process
further Further further

2. To maximize profit, what is the minimum sales price for product Kah that should be set
after it is processed further?

Unit sales price at split-off point 80

Unit variable costs of subsequent
processing 8
Additional cost (12000/10000) 1.2
Minimum Sales price of KAH 89.2

CONTINUE OPERATIONS OR SHUT DOWN

Loss from continuing = Loss from discontinuing At shutdown point:

(CM-FC)= (0 - Shutdown costs)
QS = FC- SDC
(CM – FC) = (0 – SDC) UCM
QS(UCM) – FC = (0- SDC) QS= quantity sold SDC= Shutdown cost
QS(UCM) = FC- SDC UCM = Unit contribution margin
PROBLEM 1. FAT Company produces and sells 140,000 units monthly except for the months of July and
August when the number of units sold normally decline to 10,000 units per month. Management
contemplates of temporarily shutting down operations in the months of July and August with the belief that
the business will be spared of more losses during the period.
If the business temporarily shuts down, security and maintenance amounting to P220, 000 per month
would still be incurred. Restarting the operations will cost the business P300, 000 for mobilization and
other cost. The business incurs a total of P24 million annual fixed during the months the operations are
shut down.
Other sales and costs data are as follows:
Unit sales price P 300.00
Unit variable production costs 140.00
Unit variable expenses 40.00
REQUIRED:
1. How much is the total shutdown cost?

Contribution Margin for two months 2,400,000.00

Fixed Cost 4,000,000.00
Allocated fixed cost 1,600,000.00
Security and Maintenance 440,000.00
Restart-up cost 300,000.00

Shutdown cost 2,340,000.00

2. What is the shutdown point? 13,833 units

3. Should the business continue or shut down?

Loss from continuing Loss from discontinuing
1,600,000.00 2,340,000.00
740,000.00

MINIMUM BID PRICE

PROBLEM 1. Continental Systems, Inc. manufactures truck engines for industrial users. The cost of a
particular jet engine the company manufactures is shown below:
Direct Materials 300,000.00
Direct Labor 190,000.00
Overhead:
Supervisor's Salary 40,000.00
Fringe benefits on Direct Labor 19,000.00
Depreciation 50,000.00
Rent 10,000.00
Total costs 609,000.00

If the production of this engine were discontinued, the production capacity would be idle and the
supervisor would be laid off. When asked to bid on the next contract for this engine, what should be the
minimum bid price?

Direct Materials 300,000.00

Direct Labor 190,000.00
Overhead:
Supervisor's Salary 40,000.00
Fringe benefits on Direct Labor 19,000.00
Minimum bid price 549,000.00

Fixed Costs are unavoildable.

PROBLEM 2. Frank Dean Company has its own cafeteria with the following annual costs:

Food 2,300,000.00
Labor 820,000.00
Overhead 550,000.00
Total 3,670,000.00
The overhead is 30% fixed. Of the fixed overhead, P72,000 go to the salary of the cafeteria supervisor. The
remainder of the fixed overhead has been allocated from total company overhead. Assuming the cafeteria
supervisor remains and that Frank Dean continues to pay the supervisor’s salary, what is the maximum
cost Frank Dean be willing to pay an outside firm to service the cafeteria?

Food 2,300,000.00
Labor 820,000.00
Overhead (550,000 X 70%) 385,000.00
Total 3,505,000.00

Salary of cafeteria is irrelevant, it will still be incurred.

OPTIMIZATION OF SCARCE RESOURCES

PROBLEM 1. Panay Corporation has 52,000 available machine hours and has fixed overhead rate of P4
per hour. It is considering to produce two popular products with the following production and costs data:
ANDROID 18 ANDROID 19
Cost if purchased from outside supplier ₱ 70.00 ₱ 105.00
Direct Materials ₱ 11.00 ₱ 22.00
Direct Labor ₱ 25.00 ₱ 38.00
Factory Overhead at P9 per hour ₱ 18.00 ₱ 27.00
Annual Demand in units 20,000.00 15,000.00

REQUIRED:
1. Assuming that there is no market limitation, which product should Panay Corporation
produce?

ANDROID 18 ANDROID 19
Number of hours per unit 2 hours 3 hours
(2 hours x 4 per unit) (3 hours x 4 per unit)
Fixed Overhead per unit 8.00 12.00
(18-10) (27-12)
Variable overhead per unit 10.00 15.00
UCM 24.00 30.00
No of hours per unit 2 3
CM per hour 12.00 10.00
RANK 1 2

2. Considering the market limits, how would Panay Corporation use its limited machine hours
to maximize profit?
Total
Rank Product Units Hrs Hours
40,000.
ANDROID 18
1 20,000.00 2 00
12,000.
ANDROID 19
2 4,000.00 3 00
52,000.
00
PROBLEM 2. Dragon Ball Corporation is considering to produce the following products and other relevant
information:
GOCO GOJAN GOTENG
Units sales price ₱ 100.00 ₱ 140.00 ₱ 210.00
Unit variable cost ₱ 60.00 ₱ 100.00 ₱ 100.00
Unit direct labor cost ₱ 10.00 ₱ 20.00 ₱ 40.00

The direct labor rate per hour is P5.00 and only 12,000 hours of the direct labor time are available.
REQUIRED:
1. Assuming the market for each product is unlimited, which product should the company
produce and how much should this product earn?

1) Goco Gojan Goteng

Unit sales price P100 P140 P210

Unit var costs ( 60) (100) (100)

Unit CM P 40 P 88 P110

Hrs per unit 2 hrs 4 hrs 8 hrs

CM per hr 40 40 110

 No. of hrs per unit

(Unit DL Costs/P5 hr) 2 hrs 4 hrs 8 hrs

CM per hour P 20 P 10 P13.75

Rank 1 3 2

2. Assuming that the demand for product Goco is 4,000 units and the other products have no
market limits, what is the optimum product mix to maximize profit?

2) Optimal Product Mix:

Rank Product Units Hrs/Unit Total Hrs

1 Goco 4,000 2 8,000

2 Goteng 500 8 4,000 (balance)

12,000

SELL NOW OR LATER

Tashima Corporation has 12,000 units of product Laos, a high end men’s wear, in storage. This product is
now out-of-fashion but is expected to regain market acceptance in the next 10 months. The total cost of
producing the product is P240,000, sixty percent of which is variable. It is now kept in a special storage of
which the company pays monthly rental of P18,000.

The product has a regular sales price of P20 per unit but is expected to be sold at P14.00 per unit when
fashion acceptability recovers. A merchandiser has offered to buy all 12,000 units of product Laos at a
price P8.00 per unit who will be picking up the products in the company’s storage.

Should the company sell now or sell the products later?

SELL NOW SELL LATER
Sales 96,000.00 168,000.00
Variable cost 144,000.00 144,000.00
CM (48,000.00) 24,000.00
Fixed Cost 180,000.00
Incremental profit (48,000.00) (156,000.00)
Net Advantage 108,000.00

REPLACE OR RETAIN AN EQUIPMENT

PROBLEM 1. Pink Industries, Inc. has an opportunity to acquire a new equipment to replace one of its
existing equipment. The following:

OLD NEW
Book value 700,000.00
Purchase price 1,200,000.00
Life in years 5 years 5 years
Salvage value-current 50,000.00
Salvage value after five years None None
Variable operating expenses 1,300,000.00 1,000,000.00

Expected Cash inflow of the new equipment to purchase is P300,000 per year.

Should the company retain or replace its old equipment? REPLACE.

Total Cash inflow for 5 years 1,500,000.00
Salvage value 50,000.00
Total expected cash inflow in purchasing new equipment 1,550,000.00
Less: Equipment cost (1,200,000.00)

Benefit in purchasing new equipment 350,000.00

PROBLEM 2. Boondat operates a cafeteria for its employee. The operations of the cafeteria requires fixed
costs of P980,000 per month and variable costs at 45% of sales. Cafeteria sales currently average
P2,200,000 per month. The company has the opportunity to replace the cafeteria with vending machines.
Gross customer spending at the vending machines is estimated to be 40% greater than the current sales
because the machines are available at all hours. By replacing the cafeteria with vending machines, the
company would receive 15% of the gross customer spending and avoid all cafeteria costs.

Should Boondat retain its cafeteria operations or sell using vending machines?

Cafeteria
Gross Sales* 2,200,000.00
Less: Variable cost (990,000.00)
Contribution Margin 1,210,000.00
Less: Fixed Cost (980,000.00)
Net Income from Cafeteria 230,000.00
Gross Sales from Vending Machine
(2,200,000 X 1.40) 3,080,000.00
Income from Vending machine 462,000.00
(3,080,000 X 15%)
Net Advantage of Vending Machine 232,000.00
(Replace cafeteria to vending machine)

SCRAP OR REWORK A DEFECTIVE UNIT

A company has 5,000 obsolete cutting supplies carried in inventory at a manufacturing cost of P40.00 per
unit. If the toys are reworked for P8.00 per unit, they could be sold for P12.00 per unit. If the toys are
scrapped, they could be sold for a total of P15,800.
REQUIRED:
1. Should the company sell the cutting supplies as scrape or rework it?

REWORK SCRAP
Sales 60,000.00
Cost (40,000.00)
Income 20,000.00 15,800.00

2. What is the sunk cost in the decision to be made? (40.00 X 5,000 = Php 200,000)

INDIFFERENCE POINT

Charms Motors employs 30 sales personnel to market an office equipment. The average equipment sells
for P350,000 and the company is currently paying 8% commission to its salespersons. It is considering a
scheme of paying its sales persons a flat rate of P7,000 per month plus 3% commission on sales made.

What is the amount of sales that would produce the same total compensation paid to sales
persons?