chapter 19 - answer
Post on 18-Sep-2015
57 Views
Preview:
DESCRIPTION
TRANSCRIPT
CHAPTER 17
MANAGEMENT ACCOUNTING - Solutions Manual
Chapter 19 Relevant Costs for Decision MakingRelevant Costs for Decision Making Chapter 19
CHAPTER 19
RELEVANT COSTS FOR DECISION MAKING
I.Questions1.Quantitative factors are those which may more easily be reduced in terms of pesos such as projected costs of materials, labor and overhead. Qualitative factors are those whose measurement in pesos is difficult and imprecise; yet a qualitative factor may be easily given more weight than the measurable cost savings. It can be seen that the accountants role in making decisions deals with the quantitative factors.
2.Relevant costs are expected future costs that will differ between alternatives. In view of the definition of relevant costs, historical costs are always irrelevant because they are not future costs. They may be helpful in predicting relevant costs but they are always irrelevant costs per se.
3.The differential costs in any given situation is commonly defined as the change in total cost under each alternative. It is not relevant cost, but it is the algebraic difference between the relevant costs for the alternatives under consideration.
4.Analysis:
Future costs:Replace Rebuild
New TruckP10,200
Less: Proceeds from
disposal, net 1,000
P 9,200P8,500
Advantage of rebuildingP700
The original cost of the old truck is irrelevant but its disposal value is relevant. It is recommended that the truck should be rebuilt because it will involve lesser cash outlay.
5.No. Variable costs are relevant costs only if they differ in total between the alternatives under consideration.
6.Only those costs that would be avoided as a result of dropping the product line are relevant in the decision. Costs that will not differ regardless of whether the product line is retained or discontinued are irrelevant.
7.Not necessarily. An apparent loss may be the result of allocated common costs or of sunk costs that cannot be avoided if the product line is dropped. A product line should be discontinued only if the contribution margin that will be lost as a result of dropping the line is less than the fixed costs that would be avoided. Even in that situation the product line may be retained if its presence promotes the sale of other products.8.Allocations of common fixed costs can make a product line (or other segment) appear to be unprofitable, whereas in fact it may be profitable.9.In cost-plus pricing, prices are set by applying a markup percentage to a products cost.
10.The price elasticity of demand measures the degree to which a change in price affects unit sales. The unit sales of a product with inelastic demand are relatively insensitive to the price charged for the product. In contrast, the unit sales of a product with elastic demand are sensitive to the price charged for the product.
11.The profit-maximizing price should depend only on the variable (marginal) cost per unit and on the price elasticity of demand. Fixed costs do not enter into the pricing decision at all. Fixed costs are relevant in a decision of whether to offer a product or service, but are not relevant in deciding what to charge for the product or service. Because price affects unit sales, total variable costs are affected by the pricing decision and therefore are relevant.
12.The markup over variable cost depends on the price elasticity of demand. A product whose demand is elastic should have a lower markup over cost than a product whose demand is inelastic. If demand for a product is inelastic, the price can be increased without cutting as drastically into unit sales.
II.ExercisesExercise 1 (Identifying Relevant Costs)
Case 1Case 2
ItemRelevantNot RelevantRelevantNot Relevant
a.Sales revenue
XX
b.Direct materials
XX
c.Direct labor
XX
d.Variable manufacturing overhead
XX
e.Book value Model E7000 machine
XX
f.Disposal value Model E7000 machine
XX
g.Depreciation Model E7000 machine
XX
h.Market value Model F5000 machine (cost)
XX
i.Fixed manufacturing
overhead
XX
j.Variable selling expense
XX
k.Fixed selling expense
XX
l.General administrative overhead
XX
Exercise 2 (Identification of Relevant Costs)
Requirement 1
Fixed cost per mile (P3,500* 10,000 miles)
P0.35
Variable operating cost per mile
0.08
Average cost per mile
P0.43
*Depreciation
P2,000
Insurance
960
Garage rent
480
Automobile tax and license
60
Total
P3,500
Requirement 2
The variable operating costs would be relevant in this situation. The depreciation would not be relevant since it relates to a sunk cost. However, any decrease in the resale value of the car due to its use would be relevant. The automobile tax and license costs would be incurred whether Ingrid decides to drive her own car or rent a car for the trip during summer break and are therefore irrelevant. It is unlikely that her insurance costs would increase as a result of the trip, so they are irrelevant as well. The garage rent is relevant only if she could avoid paying part of it if she drives her own car.
Requirement 3
When figuring the incremental cost of the more expensive car, the relevant costs would be the purchase price of the new car (net of the resale value of the old car) and the increases in the fixed costs of insurance and automobile tax and license. The original purchase price of the old car is a sunk cost and is therefore irrelevant. The variable operating costs would be the same and therefore are irrelevant. (Students are inclined to think that variable costs are always relevant and fixed costs are always irrelevant in decisions. This requirement helps to dispel that notion.)Exercise 3 (Make or Buy a Component)
Requirement 1
Per Unit Differential Costs15,000 units
MakeBuyMakeBuy
Cost of purchasing
P200P3,000,000
Direct materials
P60P900,000
Direct labor
801,200,000
Variable manufacturing overhead
10150,000
Fixed manufacturing overhead, traceable1
20300,000
Fixed manufacturing overhead, common
0 0 0 0
Total costs
P170P200P2,550,000P3,000,000
Difference in favor of continuing to make the parts
P30P450,000
1Only the supervisory salaries can be avoided if the parts are purchased. The remaining book value of the special equipment is a sunk cost; hence, the P3 per unit depreciation expense is not relevant to this decision. Based on these data, the company should reject the offer and should continue to produce the parts internally.
Requirement 2
MakeBuy
Cost of purchasing (part 1)
P3,000,000
Cost of making (part 1)
P2,550,000
Opportunity costsegment margin forgone on a potential new product line
650,000
Total cost
P3,200,000P3,000,000
Difference in favor of purchasing from the outside supplier
P200,000
Thus, the company should accept the offer and purchase the parts from the outside supplier.
Exercise 4 (Evaluating Special Order)
Only the incremental costs and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are relevant overhead costs in this situation. The other manufacturing overhead costs are fixed and are not affected by the decision.
PerTotal
Unit10 bracelets
Incremental revenue
P3,499.50P34,995.00
Incremental costs:
Variable costs:
Direct materials
1,430.00 14,300.00
Direct labor
860.00 8,600.00
Variable manufacturing overhead
70.00 700.00
Special filigree
60.00 600.00
Total variable cost
P2,420.00 24,200.00
Fixed costs:
Purchase of special tool
4,650.00
Total incremental cost
28.850.00
Incremental net operating income
P 6.145.00
Even though the price for the special order is below the companys regular price for such an item, the special order would add to the companys net operating income and should be accepted. This conclusion would not necessarily follow if the special order affected the regular selling price of bracelets or if it required the use of a constrained resource.
Exercise 5 (Utilization of a Constrained Resource)
Requirement 1
XYZ
(1)Contribution margin per unit
P18P36P20
(2)Direct labor cost per unit
P12P32P16
(3)Direct labor rate per hour
888
(4)Direct labor-hours required per unit (2) (3)
1.54.02.0
Contribution margin per direct labor-hour (1) (4)
P12P9P10
Requirement 2
The company should concentrate its labor time on producing product X:
XYZ
Contribution margin per direct labor-hour
P12P9P10
Direct labor-hours available
3,0003,0003,000
Total contribution margin
P36,000P27,000P30,000
Although product X has the lowest contribution margin per unit and the second lowest contribution margin ratio, it has the highest contribution margin per direct labor-hour. Since labor time seems to be the companys constraint, this measure should guide management in its production decisions.
Requirement 3
The amount Jaycee Company should be willing to pay in overtime wages for additional direct labor time depends on how the time would be used. If there are unfilled orders for all of the products, Jaycee would presumably use the additional time to make more of product X. Each hour of direct labor time generates P12 of contribution margin over and above the usual direct labor cost. Therefore, Jaycee should be willing to pay up to P20 per hour (the P8 usual wage plus the contribution margin per hour of P12) for additional labor time, but would of course prefer to pay far less. The upper limit of P20 per direct labor hour signals to managers how valuable additional labor hours are to the company.
If all the demand for product X has been satisfied, Jaycee Company would then use any additional direct labor-hours to manufacture product Z. In that case, the company should be willing to pay up to P18 per hour (the P8 usual wage plus the P10 contribution margin per hour for product Z) to manufacture more product Z.
Likewise, if all the demand for both products X and Z has been satisfied, additional labor hours would be used to make product Y. In that case, the company should be willing to pay up to P17 per hour to manufacture more product Y.Exercise 6 (Sell or Process Further)
Product AProduct BProduct C
Sales value after further processing
P80,000P150,000P75,000
Sales value at split-off point
50,00090,00060,000
Incremental revenue
30,00060,00015,000
Cost of further processing
35,00040,00012,000
Incremental profit (loss)
P(5,000)20,0003,000
Products B and C should be processed further, but not Product A.Exercise 7 (Identification of Relevant Costs)
Requirement 1
The relevant costs of a fishing trip would be:
Fuel and upkeep on boat per trip
P25
Junk food consumed during trip*
8
Snagged fishing lures
7
Total
P40
*The junk food consumed during the trip may not be completely relevant. Even if Shin were not going on the trip, he would still have to eat. The amount by which the cost of the junk food exceeds the cost of the food he would otherwise consume would be the relevant amount.
The other costs are sunk at the point at which the decision is made to go on another fishing trip.
Requirement 2
If he fishes for the same amount of time as he did on his last trip, all of his costs are likely to be about the same as they were on his last trip. Therefore, it really doesnt cost him anything to catch the last fish. The costs are really incurred in order to be able to catch fish and would be the same whether one, two, three, or a dozen fish were actually caught. Fishing, not catching fish, costs money. All of the costs are basically fixed with respect to how many fish are actually caught during any one fishing trip, except possibly the cost of snagged lures.
Requirement 3
In a decision of whether to give up fishing altogether, nearly all of the costs listed by Shins wife are relevant. If he did not fish, he would not need to pay for boat moorage, new fishing gear, a fishing license, fuel and upkeep, junk food, or snagged lures. In addition, he would be able to sell his boat, the proceeds of which would be considered relevant in this decision. The original cost of the boat, which is a sunk cost, would not be relevant.
These three requirements illustrate the slippery nature of costs. A cost that is relevant in one situation can be irrelevant in the next. None of the costs are relevant when we compute the cost of catching a particular fish; some of them are relevant when we compute the cost of a fishing trip; and nearly all of them are relevant when we consider the cost of not giving up fishing. What is even more confusing is that CG is correct; the average cost of a salmon is P167, even though the cost of actually catching any one fish is essentially zero. It may not make sense from an economic standpoint to have salmon fishing as a hobby, but as long as Shin is out in the boat fishing, he might as well catch as many fish as he can.
Exercise 8 (Dropping or Retaining a Segment)
Requirement 1
No, the housekeeping program should not be discontinued. It is actually generating a positive program segment margin and is, of course, providing a valuable service to seniors. Computations to support this conclusion follow:
Contribution margin lost if the housekeeping program is dropped
P(80,000)
Fixed costs that can be avoided:
Liability insurance
P15,000
Program administrators salary
37,00052,000
Decrease in net operating income for the organization as a whole
P(28,000)
Depreciation on the van is a sunk cost and the van has no salvage value since it would be donated to another organization. The general administrative overhead is allocated and none of it would be avoided if the program were dropped; thus it is not relevant to the decision.
The same result can be obtained with the alternative analysis below:
Current TotalTotal If House-keeping Is DroppedDifference: Net Operating Income Increase or (Decrease)
Revenues
P900,000P660,000P(240,000)
Variable expenses
490,000330,000160,000
Contribution margin
410,000330,000(80,000)
Fixed expenses:
Depreciation*
68,00068,0000
Liability insurance
42,00027,00015,000
Program administrators salaries
115,00078,00037,000
General administrative overhead
180,000180,0000
Total fixed expenses
405,000353,00052,000
Net operating income (loss)
P5,000P(23,000)P (28,000)
*Includes pro-rated loss on disposal of the van if it is donated to a charity.
Requirement 2
To give the administrator of the entire organization a clearer picture of the financial viability of each of the organizations programs, the general administrative overhead should not be allocated. It is a common cost that should be deducted from the total program segment margin. Following the format for a segmented income statement, a better income statement would be:
TotalHome NursingMeals on WheelsHouse-keeping
Revenues
P900,000P260,000P400,000P240,000
Variable expenses
490,000120,000210,000160,000
Contribution margin
410,000140,000190,00080,000
Traceable fixed expenses:
Depreciation
68,0008,00040,00020,000
Liability insurance
42,00020,0007,00015,000
Program administrators salaries
115,00040,00038,00037,000
Total traceable fixed expenses
225,00068,00085,00072,000
Program segment margins
185,000P72,000P105,000P8,000
General administrative overhead
180,000
Net operating income (loss)
P5,000
Exercise 9 (Special Order)
Requirement 1
Monthly profits would be increased by P9,000:
Per UnitTotal for 2,000 Units
Incremental revenue
P12.00P24,000
Incremental costs:
Variable costs:
Direct materials
2.505,000
Direct labor
3.006,000
Variable manufacturing overhead
0.501,000
Variable selling and administrative
1.503,000
Total variable cost
P7.5015,000
Fixed costs:
None affected by the special order
0
Total incremental cost
15,000
Incremental net operating income
P9,000
Requirement 2
The relevant cost is P1.50 (the variable selling and administrative costs). All other variable costs are sunk, since the units have already been produced. The fixed costs would not be relevant, since they would not be affected by the sale of leftover units.
Exercise 10 (Make or Buy a Component)
The costs that are relevant in a make-or-buy decision are those costs that can be avoided as a result of purchasing from the outside. The analysis for this exercise is:
Per Unit Differential Costs20,000 Units
MakeBuyMakeBuy
Cost of purchasing
P23.50P470,000
Cost of making:
Direct materials
P4.80P96,000
Direct labor
7.00140,000
Variable manufacturing overhead
3.2064,000
Fixed manufacturing overhead
4.00*80,000
Total cost
P19.00P23.50P380,000P470,000
*The remaining P6 of fixed manufacturing overhead cost would not be relevant, since it will continue regardless of whether the company makes or buys the parts.
The P150,000 rental value of the space being used to produce part R-3 represents an opportunity cost of continuing to produce the part internally. Thus, the completed analysis would be:
MakeBuy
Total cost, as above
P380,000P470,000
Rental value of the space (opportunity cost)
150,000
Total cost, including opportunity cost
P530,000P470,000
Net advantage in favor of buying
P60,000
Profits would increase by P60,000 if the outside suppliers offer is accepted.
Exercise 11 (The Economists Approach to Pricing)
Requirement (1)
Cecile makes more money selling the ice cream cones at the lower price, as shown below:
P17.90 PriceP13.90 Price
Unit sales
8601,340
Sales
P15,394.00P18,626.00
Cost of goods sold @ P4.10
3,526.005,494.00
Contribution margin
11,868.0013,132.00
Fixed expenses
425.00425.00
Net operating income
P11,443.00P12,707.00
Requirement (2)
The price elasticity of demand is computed as follows:
Requirement (3)
The profit-maximizing price can be estimated using the following formulas:
This price is much lower than the prices Cecile has been charging in the past. Rather than immediately dropping the price to P9.60, it would be prudent to drop the price a bit and see what happens to unit sales and to profits. The formula assumes that the price elasticity is constant, which may not be the case.
Exercise 12 (Target Costing)
Sales (50,000 batteries P65 per battery)
P3,250,000
Less desired profit (20% P2,500,000)
500,000
Target cost for 50,000 batteries
P2,750,000
Target cost per battery= (P2,750,000 50,000 batteries)
= P55 per battery
Exercise 13 (Pricing a New Product)
The selling price of the new amaretto cappuccino product should at least cover its variable cost and its opportunity cost. The variable cost of the new product is P4.60 and its opportunity cost can be computed by multiplying the opportunity cost of P34 per minute of order filling time by the amount of time required to fill an order for the new product:
Hence, the selling price of the new product should at least cover both its variable cost of P4.60 and its opportunity cost of P25.50, for a total of P30.10.
III.Problems
Problem 1 (Accept or Reject an Order)
Product AProduct B
Selling price per unitP1.20P1.40
Less Variable costs/unit:
Materials0.500.70
Labor0.200.24
Factory overhead (25%) 0.10 0.14
0.80 1.08
Contribution margin/unitP0.40P0.32
Multiplied by number of units to be sold21,000 units30,000 units
Total contribution marginP8,400 P9,600
Product B should be accepted because its total contribution margin is higher than that of Product A.
Problem 2 (Eliminate or Retain a Product Line)
Requirement 1No, production and sale of the round trampolines should not be discontinued. Computations to support this answer follow:Contribution margin lost if the round trampolines
are discontinued
P(80,000)
Less fixed costs that can be avoided:
Advertising traceable
P41,000
Line supervisors salaries
6,000 47,000Decrease in net operating income for the
company as a whole
P(33,000)
The depreciation of the special equipment represents a sunk cost, and therefore it is not relevant to the decision. The general factory overhead is allocated and will presumably continue regardless of whether or not the round trampolines are discontinued; thus, it is not relevant.
Requirement 2
If management wants a clear picture of the profitability of the segments, the general factory overhead should not be allocated. It is a common cost and therefore should be deducted from the total product-line segment margin. A more useful income statement format would be as follows:Trampoline
TotalRoundRectangularOctagonal
Sales
P1,000,000P140,000P500,000P360,000
Less variable expenses
410,000 60,000 200,000 150,000
Contribution margin
590,000 80,000 300,000 210,000
Less fixed expenses:
Advertising traceable
216,00041,000110,00065,000
Depreciation of special equipment
95,00020,00040,00035,000
Line supervisors salaries
19,000 6,000 7,000 6,000
Total traceable fixed expenses
330,000 67,000 157,000 106,000
Product-line segment margin
260,000P 13,000P143,000P104,000
Less common fixed expenses
200,000
Net operating income (loss)
P 60,000
Problem 3 (Product Mix)
Requirement 1
Product Line
ABCD
Selling price per unitP30P25P10P8
Variable cost per unit 25 10 5 4
Contribution margin / unitP5 P15P 5P4
Divided by no. of hours required for each unit5 hrs.10 hrs.4 hrs.1 hr.
Contribution per hourP1P1.5P1.25P4
Product ranking:
1.D
2.B
3.C
4.A
Based on the above analysis, first priority should be given to Product D. The company should use 4,000 out of the available 96,000 hrs. to produce 4,000 units of product D. The remaining 92,000 hrs. should be used to produce 9,200 units of Product B. Hence, the best product combination is 4,000 units of Product D and 9,200 units of Product B.
Requirement 2
If there were no market limitations on any of the products, the company should use all the available 96,000 hours in producing 96,000 units of product D only.
The difference in profit between the two alternatives is computed as follows:
Contribution margin of combination (1)
Product D (4,000 x P 4.00)P 16,000
Product B (9,200 x P15.00) 138,000
Total contribution margin of D and BP154,000
Less contribution margin of D only
(96,000 x P4) 384,000
Difference, excess over profit in combination (1)P230,000
Problem 4 (Accept or Reject a Special Order)
Requirement 1
The company should accept the special order of 4,000 @ P10 each because this selling price is still higher than the additional variable cost to be incurred. Whether or not variable marketing expenses will be incurred, the decision is still to accept the order.
Supporting computations:
(a)Assume no additional variable marketing cost will be incurred.
Selling price per unit
P10.00
Less variable manufacturing costs:
Direct materialsP5.00
Direct labor3.00
Variable overhead 0.75 8.75
Contribution margin/unit
P 1.25
Multiplied by number of units of order
4,000units
Total increase in profit
P5,000
(b)Assume additional variable marketing cost will be incurred.
Selling price per unit
P10.00
Less variable costs (P8.75 + P0.25)
9.00
Contribution margin / unit
P 1.00
Multiplied by number of units of order
4,000units
Total increase in contribution margin
P4,000
Requirement 2
P8.75, the total variable manufacturing cost.
Requirement 3
Direct materialsP5.00
Direct labor
3.00
Variable factory overhead 0.75
Total cost of inventory under direct costingP8.75
Requirement 4
Present contribution margin
[10,000 units x (P15 - P9)]P60,000
Less proposed contribution margin
[(P14 - P9) x 11,000 units] 55,000
Decrease in contribution marginP 5,000
The company should not reduce the selling price from P15 to P14 even if volume will go up because total contribution margin will decrease.
Problem 5 (CVP Analysis used for Decision Making)
Requirement (a)Units sold per monthNo. of monthsProbability
4,000620%
5,0001550%
6,000 9 30%
30100%
Requirement (b)Production
4,000 units5,000 units6,000 units
Sales (4,000 x P40)P160,000P160,000P160,000
Less variable costs
Production cost @ P25100,000125,000150,000
Purchase cost @ P45
-
-
-
TotalP100,000P125,000P150,000
Contribution marginP 60,000P 35,000P 10,000
Sales (5,000 x P40)P200,000P200,000P200,000
Less variable costs
Production cost @ P25100,000125,000150,000
Purchase cost @ P45 45,000
-
-
TotalP145,000P125,000P150,000
Contribution marginP 55,000P 75,000P 50,000
Sales (6,000 x P40)P240,000P240,000P240,000
Less variable costs
Production cost @ P25100,000125,000150,000
Purchase cost @ P45 90,000 45,000 0
TotalP190,000P170,000P150,000
Contribution marginP 50,000P 70,000P 90,000
Requirement (c)Sales OrderContribution MarginProbabilityExpected Value
4,000P35,0000.20P 7,000
5,00075,0000.5037,500
6,00070,0000.30 21,000
Average Contribution MarginP65,500
Problem 6 (Pricing)
Requirement A:20052006Operating Result at Full Capacity
SalesP 100,000P 400,000P 480,000
Less Variable cost 130,000 520,000 624,000
Contribution margin(P 30,000)(P120,000)(P144,000)
Less Fixed cost 40,000 40,000 40,000
Net income (loss)(P 70,000)(P160,000)(P184,000)
The company had been operating at a loss because the product had been selling with a negative contribution margin. Hence, the more units are sold, the higher the loss will be.
Requirement B: P60.14
Requirement C: P74.29
Requirement D: P56.58
Problem 7 (Make or Buy)
Cost of MakingCost of Buying
Outside purchaseP90,000
Direct materialsP15,000
Direct labor30,000
Variable manufacturing overhead10,000
Fixed manufacturing overhead* 15,000
Total costP70,000P90,000
* 1/3 x P45,000 = P15,000
Therefore, the annual advantage to make the parts is P20,000.
Problem 8 (Close or Retain a Store)
Requirement 1
The simplest approach to the solution is:
Gross margin lost if the store is closed
P(228,000)
Less costs that can be avoided:
Direct advertising
P36,000
Sales salaries
45,000
Delivery salaries
7,000
Store rent
65,000
Store management salaries (new employee would not be hired to fill vacant position at another store)
15,000
General office salaries
8,000
Utilities
27,200
Insurance on inventories (2/3 P9,000)
6,000
Employment taxes*
9,000218,200
Decrease in company net operating income if the Ortigas Store is closed
P(9,800)
*Salaries avoided by closing the store:
Sales salaries
P45,000
Delivery salaries
7,000
Store management salaries
15,000
General office salaries
8,000
Total salaries
75,000
Employment tax rate
12%
Employment taxes avoided
P9,000
Requirement 2
The Ortigas Store should not be closed. If the store is closed, overall company net operating income will decrease by P9,800 per quarter.
Requirement 3
The Ortigas Store should be closed if P200,000 of its sales are picked up by the Makati Store. The net effect of the closure will be an increase in overall company net operating income by P76,200 per quarter:
Gross margin lost if the Ortigas Store is closed
P(228,000)
Gross margin gained at the Makati Store:P200,000 43%
86,000
Net loss in gross margin
(142,000)
Costs that can be avoided if the Ortigas Store is closed (part 1)
218,200
Net advantage of closing the Ortigas Store
P76,200
Problem 9 (Shutting Down or Continuing to Operate a Plant)
Requirement 1
Product KK-8 yields a contribution margin of P14 per gallon (P35 P21 = P14). If the plant closes, this contribution margin will be lost on the 22,000 gallons (11,000 gallons per month 2 = 22,000 gallons) that could have been sold during the two-month period. However, the company will be able to avoid certain fixed costs as a result of closing down. The analysis is:
Contribution margin lost by closing the plant for two months (P14 per gallon 22,000 gallons)
P(308,000)
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost (P60,000 2 months = P120,000)
P120,000
Fixed selling costs (P310,000 10% 2 months)
62,000182,000
Net disadvantage of closing, before start-up costs
(126,000)
Add start-up costs
(14,000)
Disadvantage of closing the plant
P(140,000)
No, the company should not close the plant; it should continue to operate at the reduced level of 11,000 gallons produced and sold each month. Closing will result in a P140,000 greater loss over the two-month period than if the company continues to operate. Additional factors are the potential loss of goodwill among the customers who need the 11,000 gallons of KK-8 each month and the adverse effect on employee morale. By closing down, the needs of customers will not be met (no inventories are on hand), and their business may be permanently lost to another supplier.
Alternative Solution:
Plant Kept OpenPlant ClosedDifferenceNet Operating Income Increase (Decrease)
Sales (11,000 gallons P35 per gallon 2)
P770,000P0P(770,000)
Less variable expenses (11,000 gallons P21 per gallon 2)
462,0000462,000
Contribution margin
308,0000(308,000)
Less fixed costs:
Fixed manufacturing overhead cost
(P230,000 2; P170,000 2)
460,000340,000120,000
Fixed selling cost (P310,000 2; P310,000 90% 2)
620,000558,00062,000
Total fixed cost
1,080,000898,000182,000
Net operating loss before start-up costs
(772,000)(898,000)(126,000)
Start-up costs
(14,000)(14,000)
Net operating loss
P(772,000)P(912,000)P(140,000)
Requirement 2
Ignoring the additional factors cited in part (1) above, Kristin Company should be indifferent between closing down or continuing to operate if the level of sales drops to 12,000 gallons (6,000 gallons per month) over the two-month period. The computations are:
Cost avoided by closing the plant for two months (see above)
P182,000
Less start-up costs
14,000
Net avoidable costs
P168,000
Verification:Operate at 12,000 Gallons for Two MonthsClose for Two Months
Sales (12,000 gallons P35 per gallon)
P420,000P0
Less variable expenses (12,000 gallons P21 per gallon)
252,0000
Contribution margin
168,0000
Less fixed expenses:
Manufacturing overhead (P230,000 and P170,000 2 months)
460,000340,000
Selling (P310,000 and P279,000 2 months)
620,000558,000
Total fixed expenses
1,080,000898,000
Start-up costs
014,000
Total costs
1,080,000912,000
Net operating loss
P(912,000)P(912,000)
Problem 10 (The Economists Approach to Pricing)
Requirement (1)
The postal service makes more money selling the souvenir sheets at the lower price, as shown below:
P500 PriceP600 Price
Unit sales
50,00040,000
Sales
P25,000,000P24,000,000
Cost of goods sold @ P60 per unit
3,000,0002,400,000
Contribution margin
P22,000,000P21,600,000
Requirement (2)
The price elasticity of demand, as defined in the text, is computed as follows:
=1.2239
Requirement (3)
The profit-maximizing price can be estimated using the following formulas:
This price is much lower than the price the postal service has been charging in the past. Rather than immediately dropping the price to P328, it would be prudent for the postal service to drop the price a bit and observe what happens to unit sales and to profits. The formula assumes that the price elasticity of demand is constant, which may not be true.
The critical assumption in the calculation of the profit-maximizing price is that the percentage increase (decrease) in quantity sold is always the same for a given percentage decrease (increase) in price. If this is true, we can estimate the demand schedule for souvenir sheets as follows:
Price*Quantity Sold
P60040,000
P50050,000
P41762,500
P34878,125
P29097,656
P242122,070
P202152,588
P168190,735
P140238,419
P117298,024
*The price in each cell in the table is computed by taking 5/6 of the price just above it in the table. For example, P500 is 5/6 of P600 and P417 is 5/6 of P500.
The quantity sold in each cell of the table is computed by multiplying the quantity sold just above it in the table by 50,000/40,000. For example, 62,500 is computed by multiplying 50,000 by the fraction 50,000/40,000.
The profit at each price in the above demand schedule can be computed as follows:
Price(a)Quantity Sold (b)Sales(a) (b)Cost of SalesP60 (b)Contribution Margin
P60040,000P24,000,000P2,400,000P21,600,000
P50050,000P250,00,000P3,000,000P22,000,000
P41762,500P26,062,500P3,750,000P22,312,500
P34878,125P27,187,500P4,687,500P22,500,000
P29097,656P28,320,200P5,859,400P22,460,800
P242122,070P29,540,900P7,324,200P22,216,700
P202152,588P30,822,800P9,155,300P21,667,500
P168190,735P32,043,500P11,444,100P20,599,400
P140238,419P33,378,700P14,305,100P19,073,600
P117298,024P34,868,800P17,881,400P16,987,400
The contribution margin is plotted below as a function of the selling price:
The plot confirms that the profit-maximizing price is about P328.
Requirement (4)
If the postal service wants to maximize the contribution margin and profit from sales of souvenir sheets, the new price should be:
Profit-maximizing price = 5.4663 P70 = P383
Note that a P100 increase in cost has led to a P55 (P383 P328) increase in the profit-maximizing price. This is because the profit-maximizing price is computed by multiplying the variable cost by 5.4663. Since the variable cost has increased by P100, the profit-maximizing price has increased by P100 5.4663, or P55.
Some people may object to such a large increase in price as unfair and some may even suggest that only the P10 increase in cost should be passed on to the consumer. The enduring popularity of full-cost pricing may be explained to some degree by the notion that prices should be fair rather than calculated to maximize profits.
Problem 11 (Ranking Alternatives and Managing with a Constraint)
Requirement (1)
This problem can be solved by first computing the profitability index of each customer and then ranking the customers based on that profitability index:
CustomerIncremental Profit(A)Ji Euns TimeRequired(B)Profitability Index(A) (B)
Lalaine
P1,4004P350
Emily
1,2404P310
Anna
1,6005P320
Catherine
9603P320
Gee Ann
1,9005P380
Lily
2,8808P360
Lourdes
9303P310
Ma. Cecilia
1,3604P340
Sheila Raya
2,3406P390
Jane
2,0406P340
CustomerProfitability IndexJi Euns TimeRequiredCumulative Amount of Ji Euns Time Required
Sheila Raya
P39066
Gee Ann
P380511
Lily
P360819
Lalaine
P350423
Jane
P340629
Ma. Cecilia
P340427
Anna
P320538
Catherine
P320341
Emily
P310445
Lourdes
P310348
Given that Ji Eun should not be asked to work more than 33 hours, the four customers below the line in the above table should be told that their reservations have to be cancelled.
Requirement (2)
The total profit on wedding cakes for the weekend after canceling the four reservations would be:
Sheila Raya
P2,340
Gee Ann
1,900
Lily
2,880
Lalaine
1,400
Jane
2,040
Ma. Cecilia
1,360
Total
P11,920
Notes:
Both Ji Euns time and the cakes would have to be very carefully scheduled to make sure that all cakes are completed on time. We have assumed that the 33 hours of Ji Euns time that are available for cake decorating do not include hours that have been set aside as a buffer to provide protection from inevitable disruptions in the schedule.If the cumulative amount of Ji Euns time required did not exactly consume the total amount of time available, some adjustment might be required in which reservations are cancelled to ensure that the most profitable plan is selected.
Requirement (3)
To avoid disappointing customers, reservations should probably not be accepted for any particular weekend after 33 hours of Ji Euns time have been committed for that weekends cakes. To ensure that only the most profitable cake reservations are accepted, a reservation for any cake with a profitability index of less than P340 should probably not be accepted. This was the cutoff point for the cakes in the first weekend in June. This cutoff may need to be adjusted upward or downward over timethe cakes that were reserved for the first weekend in June may not be representative of the cakes that would be reserved for other weekends. If too many reservations are turned down and Ji Euns time is not fully utilized, then the cutoff should be adjusted downward. If too few reservations are turned down and Ji Euns time is once again overbooked or profitable cake orders are turned away, then the cutoff should be adjusted upward.
Requirement (4)
Ms. Hye Young should consider changing the way prices are set so that they include a charge for Ji Euns time. On average, the prices may be the same, but they should be based not only on the size of the cakes, but also on the amount of cake decorating that the customer desires. The charge for Ji Euns time should be her hourly rate of pay (including any fringe benefits) plus the opportunity cost of at least P340 per hour. Because Ji Eun will not be working more than 33 hours per week, if another cake reservation is accepted, some other cake reservation will have to be cancelled. Ms. Hye Young would have to give up at least P34 profit per hour to accept another cake reservation.
Requirement (5)
Making Ji Eun happy involves not asking her to work more than 33 hours per week decorating cakes. Making customers happy involves not canceling their reservations, not raising prices, and providing top quality wedding cakes. Ms. Hye Young can accomplish both of these objectives and increase her profits by clever management of the constraintJi Euns time. The possibilities include:
Ms. Hye Young should make sure that none of Ji Euns time is wasted on unnecessary tasks. For example, Ji Eun should not be asked to cream butter by hand for frostings if a machine could do the job as well with less labor time.
Ms. Hye Young should make sure that none of Ji Euns time is wasted on tasks that can be done by other persons. For example, an assistant can be assigned to prepare frosting and to clean up, relieving Ji Eun of those tasks. As long as the cost of the assistants time is less than P34 per hour, the result will be higher profits and more pleased customers.
Ms. Hye Young should consider assigning an apprentice to Ji Eun. The apprentice could relieve Ji Eun of some of her workload while learning the skills to eventually expand the companys cake decorating capacity.
Ms. Hye Young might consider subcontracting some of the less demanding cake decorating to another baker. This would be profitable as long as the charge is less than P340 per hour.
IV.Multiple Choice Questions1. C11. D21. D31. A
2. C12. A22. A32. D
3. B13. D23. D33. C
4. B14. A24. E34. A
5. A15. D25. B35. C
6. B16. C26. D
7. C17. A27. D
8. B18. C28. C
9. A19. B29. A
10. B20. C30. A
Supporting computations for nos. 16 - 29:16.Sales [(100,000 x 90%) x (P5.00 x 120%)]P540,000
Less: Variable costs (P300,000 x 90%) 270,000
Contribution marginP270,000
Less: Fixed costs 150,000
Operating incomeP120,00017.Direct materialsP 4
Direct labor5
Overhead2
Selling cost 3
Minimum selling price per unitP1418.Relevant cost to make (10,000 x P24)P240,000
Purchase cost P300,000
Less: Savings in manufacturing costP45,000
Avoidable fixed overhead 50,000 95,000
Net purchase price
P205,000
Difference in favor of buy alternative
P 35,000
19.Increase in sales (60,000 x P3)
P180,000
Less: Increase in variable cost (60,000 x P2.50)
150,000
Net increase in income
P 30,00020.RST
Sales (10,000 x P20)P200,000P200,000P200,000
Less: Variable costs
R (P12 x 10,000)120,000
S (P 8 x 10,000)80,000
T (P 4 x 10,000)
40,000
Contribution marginP 80,000P120,000P160,000
21.RST
Sales (P16 x 15,000)P240,000P240,000P240,000
Less: Variable costs
R (P12 x 15,000)180,000
S (P 8 x 15,000)120,000
T (P 4 x 15,000)
60,000
Contribution marginP 60,000P120,000P180,000
Less: Fixed costs 40,000 80,000 120,000
Operating incomeP 20,000P 40,000P 60,000
22.Old operating income:
Contribution margin
P80,000
Less: Fixed cost
40,000
P40,000
New operating income
20,000
Difference - decrease
P20,000
23.Sales
P1,200,000
Less: Variable costs
Direct materialsP300,000
Direct labor400,000
Factory overhead80,000
Marketing expenses70,000
Administrative expenses 50,000 900,000
Contribution margin
P 300,000
Less: Fixed costs
Factory overheadP 50,000
Marketing expenses30,000
Administrative expenses20,000
Increase in fixed costs 10,000 110,000
Profit
P 190,00024.Sales
P1,200,000
Less: Variable costs
Direct materialsP275,000
Direct labor375,000
Factory overhead80,000
Marketing expenses70,000
Administrative expenses 50,000 850,000
Contribution margin
P 350,000
Less: Fixed costs
Factory overheadP 50,000
Marketing expenses30,000
Administrative expenses20,000
Decrease in fixed costs
(P25,000 ( 4) (6,250) 93,750
Profit
P 256,25025.Direct materials (P2 x 5,000)
P10,000
Direct labor(P8 x 5,000)
40,000
Variable overhead(P4 x 5,000)
20,000
Total variable costs
P70,000
Add: Avoidable fixed overhead
10,000
Total
P80,00026.Avoidable fixed overhead
P 4
Direct materials
4
Direct labor
16
Variable overhead
18
Total
P42
Multiplied by: Number of units to be produced
20,000
Total relevant costs to make the part
P840,000
27.Purchase cost (P1.25 x 10,000)
P12,500
Variable costs to make
10,000
Savings of making the blade
P 2,50028.Selling price per unit
P17
Less: Variable costs of goods sold per unit
([P320,000 - P80,000] ( 20,000 units)
12
Contribution margin per unit
P 5
Multiplied by units to be sold under Special Order
2,000
Increase in operating income
P10,00029.Budgeted operating income:
Contribution margin (P2,000,000 x 30%)
P600,000
Less fixed costs
400,000
Net operating income
P200,000
Operating income under the proposal:
SalesP2,000,000
Less Variable costs
([70% x P2,000,000] x 80%) 1,120,000
Contribution margin P 880,000
Less fixed costs 520,000 360,000
Increase in budgeted operating profit
P160,000
Net avoidable costs
Contribution margin per gallon
=
P168,000
P14 per gallon
=12,000 gallons
(d
=
In(1 + % change in quantity sold)
In(1 + % change in price)
=
1,340 860
860
In(1 +
)
)
In(1 +
13.90 17.90
17.90
In(1 + 0.55814)
In(1 0.22346)
=
In(1.55814)
In(0.77654)
=
0.44349
0.25291
=
= 1.75
Profit-maximizing
markup on variable cost
1
1 + (d
=
= 1.333
1
1 + (1.75)
=
=
Profit-maximizing
price
Profit-maximizing
markup on variable cost
1 +
x
Variable cost
per unit
(1 + 1.3333) x P4.10 = P9.60
=
(1 + 4.4663) x P60 = P328
0.2231
0.1823
=
In(0.8000)
In(1.2000)
=
In(1 0.2000)
In(1 + 0.2000)
=
)
In(1 +
600.00 500.00
500.00
)
In(1 +
40,000 50,000
50,000
=
In(1 + % change in quantity sold)
In(1 + % change in price)
=
(d
=
Variable cost
per unit
x
1 +
Profit-maximizing
markup on variable cost
=
Profit-maximizing
price
= 4.4663
1
1 + (1.2239)
=
1
1 + (d
=
Profit-maximizing
markup on variable cost
Selling price of
the new product
Variable cost of the new product
(
+
Opportunity cost
per unit of the
constrained resource
Amounts of the constrained
resource required by a unit
of the new product
x
+
45 seconds
60 seconds per minute
P34 per minute
+
(
P4.60
Selling price of
the new product
P34 per minute
+
0.75 minute
+
(
P4.60
Selling price of
the new product
=
P25.50
P30.10
+
(
P4.60
Selling price of
the new product
19-119-3219-33
_1303835509.xlsChart2
21600000
22000000
22291666.6666667
22439236.1111111
22397641.7824074
22110173.7316744
21505552.0642442
20494268.1007752
18964010.1472918
16773944.9979928
Price
Selling Price
Contribution Margin
PA-5
PriceQuantity SoldSalesCost of SalesContribution Margin
$600.0040,000$24,000,000$2,400,000$21,600,000
$500.0050,000$25,000,000$3,000,000$22,000,000
$416.6762,500$26,041,667$3,750,000$22,291,667
$347.2278,125$27,126,736$4,687,500$22,439,236
$289.3597,656$28,257,017$5,859,375$22,397,642
$241.13122,070$29,434,392$7,324,219$22,110,174
$200.94152,588$30,660,826$9,155,273$21,505,552
$167.45190,735$31,938,360$11,444,092$20,494,268
$139.54238,419$33,269,125$14,305,115$18,964,010
$116.28298,023$34,655,338$17,881,393$16,773,945
PA-5
21600000
22000000
22291666.6666667
22439236.1111111
22397641.7824074
22110173.7316744
21505552.0642442
20494268.1007752
18964010.1472918
16773944.9979928
Price
Selling Price
Contribution Margin
PA-7
Selling price$4,950
Unit sales100
Variable selling cost$650
Required ROI15%
Investment$600,000
Purchase priceROI
$3,00021.7%
$3,10020.0%
$3,20018.3%
$3,30016.7%
$3,40015.0%
$3,50013.3%
$3,60011.7%
$3,70010.0%
$3,8008.3%
$3,9006.7%
$4,0005.0%
PA-7
0.2166666667
0.2
0.1833333333
0.1666666667
0.15
0.1333333333
0.1166666667
0.1
0.0833333333
0.0666666667
0.05
ROI
Purchase price
Realized ROI
PA-10
Change in price-5.00%
Change in quantity8.00%
Elastiticity-1.50
Optimal multiple of variable cost3.00
Variable cost per unit$6.00
Profit-maximizing price$17.99
Current selling price$25.00
Current unit sales50,000
Demand curve intercept15.65
Unit sales at profit-maximizing price81,919.47
Fixed cost$960,000
Selling priceUnit salesSalesVariable costFixed CostNet Operating Income
$25.0050,000$1,250,000$300,000$960,000-$10,000
$23.7554,000$1,282,500$324,000$960,000-$1,500
$22.5658,320$1,315,845$349,920$960,000$5,925
$21.4362,986$1,350,057$377,914$960,000$12,143
$20.3668,024$1,385,158$408,147$960,000$17,012
$19.3473,466$1,421,173$440,798$960,000$20,374
$18.3879,344$1,458,123$476,062$960,000$22,061
$17.4685,691$1,496,034$514,147$960,000$21,887
$16.5992,547$1,534,931$555,279$960,000$19,652
$15.7699,950$1,574,839$599,701$960,000$15,138
PA-10
-10000
-1500
5925.0000000002
12143.3700000001
17011.7632200001
20374.1479117202
22060.7609132647
21886.9766653168
19652.0849043867
15137.9697053342
Unit sales
Selling price
Net operating income
top related