Download Chapter 13 Solution Manual for Managerial Accounting Garrison and more Exercises Management Accounting in PDF only on Docsity!
Solutions Manual, Chapter 13 711
Chapter 13
Relevant Costs for Decision Making
Solutions to Questions
13-1 A relevant cost is a cost that differs in total between the alternatives in a decision.
13-2 An incremental cost (or benefit) is the change in cost (or benefit) that will result from some proposed action. An opportunity cost is the benefit that is lost or sacrificed when reject- ing some course of action. A sunk cost is a cost that has already been incurred and that cannot be changed by any future decision.
13-3 No. Variable costs are relevant costs only if they differ in total between the alterna- tives under consideration.
13-4 No. Not all fixed costs are sunk—only those for which the cost has already been irrev- ocably incurred. A variable cost can be a sunk cost, if it has already been incurred.
13-5 No. A variable cost is a cost that varies in total amount in direct proportion to changes in the level of activity. A differential cost is the difference in cost between two alternatives. If the level of activity is the same for the two al- ternatives, a variable cost will not be affected and it will be irrelevant.
13-6 No. Only those future costs that differ between the alternatives under consideration are relevant.
13-7 Only those costs that would be avoided as a result of dropping the product line are rele- vant in the decision. Costs that will not differ regardless of whether the product line is re- tained or discontinued are irrelevant.
13-8 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 discon-
tinued 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 re- tained if its presence promotes the sale of other products. 13-9 Allocations of common fixed costs can make a product line (or other segment) appear to be unprofitable, whereas in fact it may be profitable. 13-10 If a company decides to make a part internally rather than to buy it from an outside supplier, then a portion of the company’s facili- ties have to be used to make the part. The company’s opportunity cost is measured by the benefits that could be derived from the best al- ternative use of the facilities. 13-11 Any resource that is required to make products and get them into the hands of cus- tomers could be a constraint. Some examples are machine time, direct labor time, floor space, raw materials, investment capital, supervisory time, and storage space. While not covered in the text, constraints can also be intangible and often take the form of a formal or informal poli- cy that prevents the organization from furthering its goals. 13-12 Assuming that fixed costs are not af- fected, profits are maximized when the total contribution margin is maximized. A company can maximize its contribution margin by focusing on the products with the greatest amount of contribution margin per unit of the constrained resource. 13-13 Joint products are two or more products that are produced from a common input. Joint costs are the costs that are incurred up to the
712 Managerial Accounting, 12th Edition
split-off point. The split-off point is the point in the manufacturing process where joint products can be recognized as individual products.
13-14 Joint costs should not be allocated among joint products. If joint costs are allocated among the joint products, then managers may think they are avoidable costs of the end prod- ucts. However, the joint costs will continue to be incurred as long as the process is run regardless of what is done with one of the end products. Thus, when making decisions about the end products, the joint costs are not avoidable and are irrelevant.
13-15 As long as the incremental revenue from further processing exceeds the incremental costs
of further processing, the product should be processed further. 13-16 Most costs of a flight are either sunk costs, or costs that do not depend on the num- ber of passengers on the flight. Depreciation of the aircraft, salaries of personnel on the ground and in the air, and fuel costs, for example, are the same whether the flight is full or almost empty. Therefore, adding more passengers at reduced fares at certain times of the week when seats would otherwise be empty does little to increase the total costs of making the flight, but can do much to increase the total contribution and total profit.
714 Managerial Accounting, 12th Edition
- No, the housekeeping program should not be discontinued. It is actually generating a positive program segment margin and is, of course, provid- ing a valuable service to seniors. Computations to support this conclu- sion follow: Contribution margin lost if the housekeeping pro- gram is dropped ............................................... $(80,000) Fixed costs that can be avoided: Liability insurance ............................................. $15, Program administrator’s salary ........................... 37,000 52, Decrease in net operating income for the organi- zation as a whole .............................................. $(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 adminis- trative overhead is allocated and none of it would be avoided if the pro- gram were dropped; thus it is not relevant to the decision. The same result can be obtained with the alternative analysis below:
Current Total
Total If House- keeping Is Dropped
Difference: Net Operat- ing Income Increase or (Decrease) Revenues .................................... $900,000 $660,000 $(240,000) Variable expenses........................ 490,000 330,000 160, Contribution margin..................... 410,000 330,000 (80,000) Fixed expenses: Depreciation* ........................... 68,000 68,000 0 Liability insurance ..................... 42,000 27,000 15, Program administrators’ salaries 115,000 78,000 37, General administrative overhead 180,000 180,000 0 Total fixed expenses .................... 405,000 353,000 52, Net operating income (loss) ......... $ 5,000 $(23,000) $ (28,000) *Includes pro-rated loss on disposal of the van if it is donated to a chari- ty.
Solutions Manual, Chapter 13 715
Exercise 13-2 (continued)
- To give the administrator of the entire organization a clearer picture of the financial viability of each of the organization’s programs, the general administrative overhead should not be allocated. It is a common cost that should be deducted from the total program segment margin. Fol- lowing the format introduced in Chapter 12 for a segmented income statement, a better income statement would be:
Total
Home Nursing
Meals on Wheels
House- keeping Revenues ............................ $900,000 $260,000 $400,000 $240, Variable expenses................ 490,000 120,000 210,000 160, Contribution margin............. 410,000 140,000 190,000 80, Traceable fixed expenses: Depreciation ..................... 68,000 8,000 40,000 20, Liability insurance ............. 42,000 20,000 7,000 15, Program administrators’ salaries .......................... 115,000 40,000 38,000 37, Total traceable fixed expens- es .................................... 225,000 68,000 85,000 72, Program segment margins ... 185,000 $ 72,000 $105,000 $ 8, General administrative over- head ................................ 180, Net operating income (loss). $ 5,
Solutions Manual, Chapter 13 717
Only the incremental costs and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are rele- vant overhead costs in this situation. The other manufacturing overhead costs are fixed and are not affected by the decision.
Per Total Unit 10 bracelets Incremental revenue ............................ $349.95 $3,499. Incremental costs: Variable costs: Direct materials............................... 143.00 1,430. Direct labor..................................... 86.00 860. Variable manufacturing overhead ..... 7.00 70. Special filigree ................................ 6.00 60. Total variable cost ............................. $242.00 2,420. Fixed costs: Purchase of special tool ................... 465. Total incremental cost .......................... 2,885. Incremental net operating income ......... $ 614.
Even though the price for the special order is below the company's regular price for such an item, the special order would add to the company's net operating income and should be accepted. This conclusion would not nec- essarily follow if the special order affected the regular selling price of bracelets or if it required the use of a constrained resource.
718 Managerial Accounting, 12th Edition
1. A B C
(1) Contribution margin per unit ................................. $18 $36 $ (2) Direct labor cost per unit ...................................... $12 $32 $ (3) Direct labor rate per hour ..................................... 8 8 8 (4) Direct labor-hours required per unit (2) ÷ (3) ........ 1.5 4.0 2. Contribution margin per direct labor-hour (1) ÷ (4) $12 $ 9 $
- The company should concentrate its labor time on producing product A:
A B C Contribution margin per direct labor-hour .. $12 $9 $ Direct labor-hours available ....................... × 3,000 × 3,000 × 3, Total contribution margin .......................... $36,000 $27,000 $30, Although product A 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 compa- ny’s constraint, this measure should guide management in its production decisions.
- The amount Banner Company should be willing to pay in overtime wag- es for additional direct labor time depends on how the time would be used. If there are unfilled orders for all of the products, Banner would presumably use the additional time to make more of product A. Each hour of direct labor time generates $12 of contribution margin over and above the usual direct labor cost. Therefore, Banner should be willing to pay up to $20 per hour (the $8 usual wage plus the contribution margin per hour of $12) for additional labor time, but would of course prefer to pay far less. The upper limit of $20 per direct labor hour signals to man- agers how valuable additional labor hours are to the company.
720 Managerial Accounting, 12th Edition
Product X Product Y Product Z Sales value after further processing .. $80,000 $150,000 $75, Sales value at split-off point ............. 50,000 90,000 60, Incremental revenue ........................ 30,000 60,000 15, Cost of further processing ................ 35,000 40,000 12, Incremental profit (loss)................... $(5,000) 20,000 3,
Products Y and Z should be processed further, but not Product X.
Solutions Manual, Chapter 13 721
- The relevant costs of a fishing trip would be:
Fuel and upkeep on boat per trip..... $ Junk food consumed during trip*..... 8 Snagged fishing lures ..................... 7 Total .............................................. $
- The junk food consumed during the trip may not be completely relevant. Even if Steve were not going on the trip, he would still have to eat. The amount by which the cost of the junk food ex- ceeds 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.
- 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 doesn’t 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.
- In a decision of whether to give up fishing altogether, nearly all of the costs listed by Steve’s 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.
Contribution margin lost if the Bath Department is dropped:
- Solutions Manual, Chapter
- Lost from the Bath Department $700,
- Lost from the Kitchen Department (10% × $2,400,000) 240,
- Total lost contribution margin 940,
- Less avoidable fixed costs ($900,000 – $370,000) 530,
- Decrease in overall net operating income $410,
724 Managerial Accounting, 12th Edition
Relevant Costs Item Make Buy Direct materials (60,000 @ $4.00) ............. $240, Direct labor (60,000 @ $2.75) ................... 165, Variable manufacturing overhead (60,000 @ $0.50) ................................... 30, Fixed manufacturing overhead, traceable (1/3 of $180,000)................................... 60, Cost of purchasing from outside supplier (60,000 @ $10) ..................................... $600, Total cost ................................................. $495,000 $600,
The two-thirds of the traceable fixed manufacturing overhead costs that cannot be eliminated, and all of the common fixed manufacturing overhead costs, are irrelevant.
The company would save $105,000 per year by continuing to make the parts itself. In other words, profits would decline by $105,000 per year if the parts were purchased from the outside supplier.
726 Managerial Accounting, 12th Edition
The company should accept orders first for Product Z, second for Product X, and third for Product Y. The computations are:
Product X
Product Y
Product Z (a) Direct materials required per unit .... $24.00 $15.00 $9. (b) Cost per pound ............................... $3.00 $3.00 $3. (c) Pounds required per unit (a) ÷ (b)... 8 5 3 (d) Contribution margin per unit ........... $32.00 $14.00 $21. Contribution margin per pound of materials used (d) ÷ (c) ............... $4.00 $2.80 $7.
Since Product Z uses the least amount of material per unit of the three products, and since it is the most profitable of the three in terms of its use of this constrained resource, some students will immediately assume that this is an infallible relationship. That is, they will assume that the way to spot the most profitable product is to find the one using the least amount of the constrained resource. The way to dispel this notion is to point out that Product X uses more material (the constrained resource) than does Product Y, but yet it is preferred over Product Y.The key factor is not how much of a constrained resource a product uses, but rather how much con- tribution margin the product generates per unit of the constrained re- source.
Solutions Manual, Chapter 13 727
Merifulon should be processed further:
Sales value after further processing .................. $60, Sales value at the split-off point ....................... 40, Incremental revenue from further processing .... 20, Cost of further processing ................................ 13, Profit from further processing .......................... $ 7,
The $10,000 in allocated common costs (1/3 × $30,000) will be the same regardless of which alternative is selected, and hence is not relevant to the decision.
Solutions Manual, Chapter 13 729
No, the overnight cases should not be discontinued. The computations are:
Contribution margin lost if the cases are dis- continued ..................................................... $(260,000) Less fixed costs that can be avoided if the cas- es are discontinued: Salary of the product line manager.............. $ 21, Advertising ................................................ 110, Insurance on inventories ............................ 9,000 140, Net disadvantage of dropping the cases............ $(120,000)
The same solution can be obtained by preparing comparative income statements:
Keep Overnight Cases
Drop Overnight Cases
Difference: Net Operating Income Increase or (Decrease) Sales ............................................ $450,000 $ 0 $(450,000) Variable expenses: Variable manufacturing expenses 130,000 0 130, Sales commissions ..................... 48,000 0 48, Shipping .................................... 12,000 0 12, Total variable expenses ................. 190,000 0 190, Contribution margin ...................... 260,000 0 (260,000) Fixed expenses: Salary of line manager................ 21,000 0 21, General factory overhead ............ 104,000 104,000 0 Depreciation of equipment .......... 36,000 36,000 0 Advertising—traceable ................ 110,000 0 110, Insurance on inventories............. 9,000 0 9, Purchasing department ............... 50,000 50,000 0 Total fixed expenses ..................... 330,000 190,000 140, Net operating loss ......................... $ (70,000) $(190,000) $(120,000)
730 Managerial Accounting, 12th Edition
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 Costs 20,000 Units Make Buy Make Buy Cost of purchasing ....................... $23.50 $470, Cost of making: Direct materials ......................... $ 4.80 $ 96, Direct labor ............................... 7.00 140, Variable manufacturing overhead 3.20 64, Fixed manufacturing overhead ... 4.00 * 80, Total cost .................................. $19.00 $23.50 $380,000 $470,
- The remaining $6 of fixed manufacturing overhead cost would not be relevant, since it will continue regardless of whether the company makes or buys the parts.
The $150,000 rental value of the space being used to produce part R- represents an opportunity cost of continuing to produce the part internally. Thus, the completed analysis would be:
Make Buy Total cost, as above ........................................... $380,000 $470, Rental value of the space (opportunity cost) ........ 150, Total cost, including opportunity cost .................. $530,000 $470,
Net advantage in favor of buying ........................ $60,
Profits would increase by $60,000 if the outside supplier’s offer is accepted.
