chapter 19 - answer

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


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


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


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


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


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


Purchase cost @ P45 45,000

-

-

TotalP145,000P125,000P150,000


Sales (6,000 x P40)P240,000P240,000P240,000

Less variable costs


Purchase cost @ P45 90,000 45,000 0

TotalP190,000P170,000P150,000


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


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



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


Administrative expenses20,000

Increase in fixed costs 10,000 110,000

Profit

P 190,00024.Sales

P1,200,000



Direct labor375,000

Factory overhead80,000


Administrative expenses 50,000 850,000

Contribution margin

P 350,000

Less: Fixed costs

Factory overheadP 50,000


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


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


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


=

Profit-maximizing

price

= 4.4663

1

1 + (1.2239)

=

1

1 + (d

=

Profit-maximizing


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


chapter 19 - answer

Documents

irrelevant costs

future costs

variable costs

historical costs

sunk costs

differential costs

definition of relevant

decision makingrelevant