Chapter 12, Relevant Costs for ...

1. Foster Company makes 20,000 units per year of a part that it uses in the products it manufactures. The
unit product cost of this part is computed as follows:

Direct Materials $24.70

Direct Labour $16.30
Variable Manufacturing Overhead $ 2.30
Fixed Manufacturing Overhead $13.40
Unit Product Cost $56.70

An outside supplier has offered to sell the company all the parts that Foster needs for $51.80 a unit. If
the company accepts this offer, the facilities now being used to make the part could be used to make
more units of a product that is in high demand. The additional contribution margin on this other
product would be $44,000 per year.

If the part were purchased from the outside supplier, all of the direct labour cost of the part would be
avoided. However, $5.10 of the fixed manufacturing overhead cost that is being applied to the part
would continue, even if the part were purchased from the outside supplier. This fixed manufacturing
overhead cost would be applied to the company's remaining products.

Required:

a) How much of the unit product cost of $56.70 is relevant in the decision of whether to make or buy
the part?
b) What is the net total dollar advantage (disadvantage) of purchasing the part rather than making it?
c) What is the maximum amount the company should be willing to pay an outside supplier per unit for
the part if the supplier commits to supplying all 20,000 units required each year?
Ans: a) Relevant cost per unit:
Direct Materials $24.70
Direct Labour $16.30
Variable Manufacturing Overhead $ 2.30
Fixed Manufacturing Overhead ($13.40 - $5.10) $ 8.30
Relevant Manufacturing Cost $51.60

b) Net advantage (disadvantage):

Manufacturing Cost Savings ($51.60 x 20,000) $ 1,032,000
Additional Contribution Margin $ 44,000
Cost of Purchasing the Part ($51.80 x 20,000) ($1,036,000)
Net Advantage (Disadvantage) $ 40,000

c) Maximum acceptable purchase price:

Manufacturing Cost Savings $1,032,000
Additional Contribution Margin $ 44,000
Total Benefit $1,076,000
Number of Units 20,000
Benefit per Unit $ 53.80
Difficulty: Hard

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2. The Hyatt Company is trying to decide whether it should purchase new equipment and continue to
make its subassemblies internally or if production should be discontinued and the subassembly
purchased from an outside supplier.

New equipment for producing the subassemblies can be purchased at a cost of $400,000. The
equipment would have a five-year useful life (the company uses straight-line depreciation) and a
$50,000 salvage value.

Alternatively, the subassemblies could be purchased from an outside supplier. The supplier has offered
to provide the subassemblies for $9 each under a five-year contract.

Hyatt Company's present costs per unit of producing the subassemblies internally (with the old
equipment) are given below. The costs are based on a current activity level of 40,000 subassemblies
per year:

Direct Materials $ 3.00

Direct Labour $ 4.20
Variable Overhead $ 0.60
Fixed Overhead ($0.80 supervision, $0.90 depreciation,
and $2 general company overhead) $ 3.70
Total Cost per Unit $11.50

The new equipment would be more efficient and would reduce direct labour costs and variable
overhead costs by 25%. Supervision cost ($30,000 per year) and direct materials cost per unit would
not be affected by the new equipment. The company has no other use for the space now being used to
produce the subassemblies. The company's total general company overhead would not be affected by
this decision. Assume direct labour is a variable cost.

Required:
Assume that 40,000 subassemblies are needed each year. Prepare an analysis of the two alternatives
and make a recommendation to the management of the company of the appropriate course of action.

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Ans: The $2.00 per unit general overhead cost is not relevant to the decision. This cost will continue
regardless of which alternative the company selects. The depreciation of $0.90 per unit is not a
relevant cost because it represents a sunk cost (in addition to the fact that the old equipment is
worn out and must be replaced). The cost of the new equipment is relevant because the new
equipment will not be purchased if the company decides to accept the outside supplier's offer.
The cost of supervision is relevant because this cost can be avoided by purchasing the
subassemblies.

At the level of 40,000 subassemblies per year, the company should purchase the subassemblies
from the outside supplier.
Difficulty: Medium

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3. Benjamin Signal Company produces products R, J, and C from a joint production process. Each
product may be sold at the split-off point or be processed further. Joint production costs of $92,000 per
year are allocated to the products based on the relative number of units produced. Data for Benjamin's
operations for the current year are as follows:

Product R can be processed beyond the split-off point for an additional cost of $26,000 and can then be
sold for $105,000. Product J can be processed beyond the split-off point for an additional cost of
$38,000 and can then be sold for $117,000. Product C can be processed beyond the split-off point for
an additional cost of $12,000 and can then be sold for $57,000.

Required:
Which products should be processed beyond the split-off point?
Ans:

Products R and J should be processed beyond the split-off point. Product C should be sold at
split-off. Joint production costs are not relevant to the decision to sell at split-off or to process
further.
Difficulty: Medium

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4. Bowen Company produces products P, Q, and R from a joint production process. Each product may be
sold at the split-off point or be processed further. Joint production costs of $81,000 per year are
allocated to the products based on the relative number of units produced. Data for Bowen's operations
for the current year are as follows:

Product P can be processed beyond the split-off point for an additional cost of $10,000 and can then be
sold for $50,000. Product Q can be processed beyond the split-off point for an additional cost of
$35,000 and can then be sold for $65,000. Product R can be processed beyond the split-off point for an
additional cost of $6,000 and can then be sold for $25,000.

Required:
Which products should be processed beyond the split-off point?
Ans:

Products P and R should be processed beyond the split-off point. Product Q should be sold at
split-off. Joint production costs are not relevant to the decision to sell at split-off or to process
further.
Difficulty: Medium

Difficulty: Medium

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5. Juett Company produces a single product. The cost of producing and selling a single unit of this
product at the company's normal activity level of 70,000 units per month is as follows:

Direct Materials $29.60

Direct Labour $ 5.80
Variable Manufacturing Overhead $ 2.50
Fixed Manufacturing Overhead $17.20
Variable Selling & Administrative Expense $ 1.80
Fixed Selling & Administrative Expense $ 6.70

The normal selling price of the product is $72.90 per unit.

An order has been received from an overseas customer for 2,000 units to be delivered this month at a
special discounted price. This order would have no effect on the company's normal sales and would not
change the total amount of the company's fixed costs. The variable selling and administrative expense
would be $1.10 less per unit on this order than on normal sales.

Direct labour is a variable cost in this company.

Required:
a) Suppose there is ample idle capacity to produce the units required by the overseas customer, and the
special discounted price on the special order is $66.10 per unit. By how much would this special order
increase (decrease) the company's net operating income for the month?
b) Suppose the company is already operating at capacity when the special order is received from the
overseas customer. What would be the opportunity cost of each unit delivered to the overseas
customer?
c) Suppose there is not enough idle capacity to produce all of the units for the overseas customer, and
accepting the special order would require cutting back on production of 1,300 units for regular
customers. What would be the minimum acceptable price per unit for the special order?

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Ans: a)
Variable cost per unit on normal sales:
Direct Materials $29.60
Direct Labour $ 5.80
Variable Manufacturing Overhead $ 2.50
Variable Selling & Administrative Expense $ 1.80
Variable Cost per Unit on Normal Sales $39.70

Variable cost per unit on special order:

Normal Variable Cost per Unit $39.70
Reduction in Variable Selling & Administrative $ 1.10
Variable Cost per Unit on Special Order $38.60

Selling Price for Special Order $ 66.10

Variable Cost per Unit on Special Order $ 38.60
Unit Contribution Margin on Special Order $ 27.50
Number of Units in Special Order 2,000
Increase (Decrease) in Net Operating Income $55,000

b) The opportunity cost is just the contribution margin on normal sales:

Normal Selling Price per Unit $72.90
Variable Cost per Unit on Normal Sales $39.70
Unit Contribution Margin on Normal Sales $33.20

c) Minimum acceptable price:

Unit Contribution Margin on Normal Sales $ 33.20
Displaced Normal Sales 1,300
Lost Contribution Margin Displaced Sales $ 43,160
Total Variable Cost on Special Order ($38.60 x 2,000) $ 77,200
$120,360
Number of Units in Special Order 2,000
Minimum Acceptable Price on Special Order $ 60.18
Difficulty: Hard

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6. When Mr. Ding L. Berry, president and chief executive of Berry, Inc., first saw the segmented income
statement below, he flew into his usual rage: "When will we ever start showing a real profit? I'm
starting immediate steps to eliminate those two unprofitable lines!"

*These traceable expenses could be eliminated if the product lines to which they are traced were
discontinued.

Required:
Recommend which segments, if any, should be eliminated. Prepare a report in good form to support
your answer.
A segmented income report, without the allocation of common fixed expenses, will provide the
basis for deciding which segments to drop.

The only segment that possibly should be eliminated is segment W, which shows a negative
segment margin of $2,000.Ans:
Difficulty: Medium

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7. Northern Stores is a retailer in British Columbia. The most recent monthly income statement for
Northern Stores is given below:

Northern is considering closing Store I. If Store I is closed, one-fourth of its traceable fixed expenses
would continue to be incurred. Also, the closing of Store I would result in a 20% decrease in sales in
Store II. Northern allocates common fixed expenses on the basis of sales dollars and none of these
costs would be saved if a store were shut down.

Required:
Compute the overall increase or decrease in the net income of Northern Stores if Store I is closed.
Ans:
Loss in contribution if Store I is closed:
Store I contribution margin lost ($418,000)
Store II contribution margin lost (20% x 422,000) ($ 84,400)
Total lost contribution ($502,400)
Fixed costs avoided if Store I is closed (0.75 x 231,000) $ 173,250
Net decrease in income if Store I is closed ($329,150)
Difficulty: Medium

Difficulty: Medium

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8. Kramer Company makes 4,000 units per year of a part called an axial tap for use in one of its products.
Data concerning the unit production costs of the axial tap follow:

Direct Materials $35

Direct Labour $10
Variable Manufacturing Overhead $ 8
Fixed Manufacturing Overhead $20
Total Manufacturing Cost per Unit $73

An outside supplier has offered to sell Kramer Company all of the axial taps it requires. If Kramer
Company decided to discontinue making the axial taps, 40% of the above fixed manufacturing
overhead costs could be avoided. Assume that direct labour is a variable cost.

Required:

a) Assume Kramer Company has no alternative use for the facilities presently devoted to production of
the axial taps. If the outside supplier offers to sell the axial taps for $65 each, should Kramer Company
accept the offer? Fully support your answer with appropriate calculations.
b) Assume that Kramer Company could use the facilities presently devoted to production of the axial
taps to expand production of another product that would yield an additional contribution margin of
$80,000 annually. What is the maximum price Kramer Company should be willing to pay the outside
supplier for axial taps?
Ans: a) The analysis of the alternatives follows below:

* 40% x $20

The company should make the part rather than buy it from the outside supplier because it costs
$4 less under that alternative.

b) The maximum acceptable price is $81 because that is the cost to the company of making the
part itself when the opportunity cost is included:

Total cost of making the part internally $61

Opportunity cost per unit ($80,000 ÷ 4,000) $20
Total $81
Difficulty: Hard

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9. Glocker Company makes three products in a single facility. These products have the following unit
product costs:

Additional data concerning these products are listed below.

The mixing machines are potentially a constraint in the production facility. A total of 5,900 minutes are
available per month on these machines.

Direct labour is a variable cost in this company.

Required:
a) How many minutes of mixing machine time would be required to satisfy demand for all four
products?
b) How much of each product should be produced, rounded to the nearest whole unit, to maximize net
operating income?
c) Up to how much should the company be willing to pay, rounded to the nearest whole cent, for one
additional hour of mixing machine time if the company has made the best use of the existing mixing
machine capacity?

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Ans: a) Demand on the mixing machine:

Total time required for all products: 6,500 minutes

b) Optimal production plan:

c) The company should be willing to pay up to the contribution margin per minute for the
marginal job, which is $13.95.
Difficulty: Hard

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10. Holt Company makes three products in a single facility. Data concerning these products follow:

The mixing machines are potentially a constraint in the production facility. A total of 25,800 minutes
are available per month on these machines.

Direct labour is a variable cost in this company.

Required:
a) How many minutes of mixing machine time would be required to satisfy demand for all four
products?
b) How much of each product should be produced, rounded to the nearest whole unit, to maximize net
operating income?
c) Up to how much should the company be willing to pay, rounded to the nearest whole cent, for one
additional hour of mixing machine time if the company has made the best use of the existing mixing
machine capacity?

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Ans: a) Demand on the mixing machine:

Total time required for all products: 26,700 minutes

b) Optimal production plan:

c) The company should be willing to pay up to the contribution margin per minute for the
marginal job, which is $5.15.
Difficulty: Medium

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11. Redner, Inc. produces three products. Data concerning the selling prices and unit costs of the three
products appear below:

Fixed costs are applied to the products on the basis of direct labour hours.

Demand for the three products exceeds the company's productive capacity. The grinding machine is the
constraint, with only 2,400 minutes of grinding machine time available this week.

Required:
a) Given the grinding machine constraint, which product should be emphasized? Support your answer
with appropriate calculations.
b) If there is still unfilled demand for the product that the company should emphasize in part a) above,
up to how much should the company be willing to pay for an additional hour of grinding machine
time?
Ans: a) The product to emphasize can be determined by computing the contribution margin per unit of
the scarce resource, which in this case is grinding machine time.

Product L should be emphasized because it has the greatest contribution margin per unit of the
scarce resource.

b) If additional grinding machine time is used to produce more of Product L, the time would be
worth 60 x $5 = $300 per hour.
Difficulty: Hard

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12. Iaci Company makes two products from a common input. Joint processing costs up to the split-off
point total $42,000 a year. The company allocates these costs to the joint products on the basis of their
total sales values at the split-off point. Each product may be sold at the split-off point or processed
further. Data concerning these products appear below:

Required:
a) What is the net monetary advantage (disadvantage) of processing Product X beyond the split-off
point?
b) What is the net monetary advantage (disadvantage) of processing Product Y beyond the split-off
point?
c) What is the minimum amount the company should accept for Product X if it is to be sold at the split-
off point?
d) What is the minimum amount the company should accept for Product Y if it is to be sold at the split-
off point?
Ans: a) & b)

c) & d)

Minimum selling price at split-off

Product X $29,200
Product Y $28,900
Difficulty: Hard

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13. Harris Corp. manufactures three products from a common input in a joint processing operation. Joint
processing costs up to the split-off point total $200,000 per year. The company allocates these costs to
the joint products on the basis of their total sales value at the split-off point. Each product may be sold
at the split-off point or processed further. The additional processing costs and sales value after further
processing for each product (on an annual basis) are:

The "Further Processing Costs" consist of variable and avoidable fixed costs.

Required:
Which product or products should be sold at the split-off point, and which product or products should
be processed further? Show computations.
Ans:

Product K should be sold after further processing beyond the split-off point. Products J and L
should be sold at the split-off point without any further processing.
Difficulty: Medium

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