ANSWER KEY:

DO IT YOURSELF (ENABLING ACTIVITY 1)

The total unit variable costs of production (which includes direct materials, direct labor, and variable
overhead) is P800 (P50 + P500 + P250). Below is the relevant costs analysis:

Make
Buy
Purchase costs (10,000 x P1,100)
P11,000,000
Variable mfg. Costs (10,000 x P800) P 8,000,000
Avoidable fixed overhead 2,500,000
Total relevant costs P10,500,000
11,000,000
Less: Cost to make 10,500,000 Net advantage of making
P 500,000

DO IT YOURSELF (ENABLING ACTIVITY 2)

In make or buy decisions, the relevant costs of manufacturing includes variable production costs,
avoidable fixed costs, and all other incremental cost of manufacturing. Given the data in this problem, the
relevant cost of manufacturing is P15 computed as follows:

Direct materials P2
Direct labor 5
Variable overhead (P20 x 40%) 8
Relevant manufacturing unit cost P15

DO IT YOURSELF (ENABLING ACTIVITY 3)

To decide whether to make or buy a part, the net relevant costs of making and buying should be tabulated
and compared. The alternative that results to lower relevant costs would be the better alternative. In this
case, the relevant cost analysis, shall be:
Relevant costs of making (15,000 x P78) P1,170,000
Relevant costs of buying 1,260,000
Net advantage of making P 90,000

DO IT YOURSELF (ENABLING ACTIVITY 4)

The differential cost of purchasing the component.

The unit variable cost is P30. The avoidable fixed overhead is P2 (i.e., P 5 – P3). The relevant costs of
making and buying are as follows:

Make
Buy

Purchase price (12,000 x P37)

P444,000
Variable production costs (12,000 x P30) P360,000
Avoidable fixed overhead (12,000 x P2) 24,000
Rental income
( 40,000)
Net relevant costs P384,000
P404,000
Savings (P404,000 – P384,000) P 20,000

DO IT YOURSELF (ENABLING ACTIVITY 5)

Answer: Only the direct materials and direct labor costs are relevant in this decision. To make the
decision, we must compute the average direct materials and direct labor cost per unit.

Direct materials ................................................................ $614,400 Direct

labor ....................................................................... 256,000
Total .................................................................................. $870,400 Current monthly
production ............................................. 12,800 Average direct materials and direct labor cost per unit ....
$68 Since price on the special order is $61 per trophy and the relevant cost is $68, the company would
suffer a loss of $7 per trophy. Therefore, the special order should not be accepted.

DO IT YOURSELF (ENABLING ACTIVITY 6)

Accept or reject a special sales order.

The special sales order should be accepted if it would increase the operating profit of the business. Based
on the data given, the incremental contribution margin (ergo, incremental profit) is P185,000 as shown
below: Unit CM [P600 – (P100 + P150 + P75 + P90)] P 185 Incremental CM (1,000 units x P185)
P185,000 It is, therefore, advisable for the business to accept the special sales order and increase profit by
P185,000.

DO IT YOURSELF (ENABLING ACTIVITY 7)

SOLUTION:

ANSWER LETTER D.
The expected income after the appropriate product is discontinued. The segment margin of each product
should be computed to determine which must be discontinued as follows:

C J F
Sales 200,000.00 150,000.00 125,000.00
Variable costs (95,000.00) (75,000.00) (50,000.00)
Separate (direct) fixed costs (60,000.00) (35,000.00) (40,000.00)
Segment Margin 45,000.00 40,000.00 35,000.00

Product P gives the lowest profit and shall be eliminated inasmuch as only two products shall now be
produced by the company as they move to a smaller facility. With products C and J remaining, the
operating profit of the business shall be:
Segment margin (P45,000 + P 40,000) P 85,000
- Allocated fixed costs [(P35,000 + P40,000 + P25,000) x 60%] 60,000
Operating income (loss) P 25,000
DO IT YOURSELF (ENABLING ACTIVITY 8)

Answer: Product C J R
Sales value after further processing ................. $100,000 $115,000 $ 55,000
Sales value after split-off ................................. 75,000 70,000 46,500
Added sales value from processing ................. 25,000 45,000 8,500
Added processing costs ................................... 20,000 36,000 10,000
Net gain (loss) from further processing ........... $ 5,000 $ 9,000 $ (1,500)

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

DO IT YOURSELF (ENABLING ACTIVITY 9)

Answer Letter A
The product to be produced and sold given a limitation in machine hours.  The product to be produced
and sold should give the higher contribution margin per machine hour, calculated as follows:

Product A Product
B
Unit contribution margin P 80 P 120
/ Machine hours per unit 4 hours 5 hours
Contribution margin per hour P 20 P 24
Priority (1)
(2)

Product B should be prioritized over that of product A because it gives a higher contribution margin per
hour, and expectedly a higher profit to the company.

DO IT YOURSELF (ENABLING ACTIVITY 10)

ANSWER LETTER B
The most profitable product for the manufacturer.  The most profitable product gives the highest
contribution margin per resource constraint, in this case is machine hours, determined as follows:
A B C
D
Unit contribution margin (USP – UVC) P(2) P7 P10
P9
x No. of units per machine hour 3 4 2
3
Contribution margin per machine hour P(6) P28 P20
P27
Rank of priority (4) (1)
(3) (2)
Product B must be prioritized in production over the other products because it has the highest rate of
profitability per machine hour.
True/False Questions
1. Fixed costs are sunk costs and are therefore irrelevant in decisions. Answer: False
2. Future costs that do not differ between the alternatives in a decision are avoidable costs.
Answer: False
3. The book value of an old machine is always considered a sunk cost in a decision. Answer:
True
4. In a special order situation that involves using existing idle capacity, opportunity costs are
zero. TRUE
5. When a company has a production constraint, the product with the highest contribution margin
per unit of the constrained resource should be given highest priority. Answer: True Level: Easy
LO: 5
6. Lumber produced in a lumber mill results in several different products being produced from
each log; such products are called joint products. Answer: True Level: Easy LO: 6
7. In a sell or process further decision, an avoidable fixed production cost incurred after the split-
off point is relevant to the decision. Answer: True Level: Medium LO: 6
8. Joint processing after the split-off point is profitable if the incremental revenue from such
processing exceeds the incremental processing costs. Answer: True Level: Easy LO: 6
9. A differential cost is a cost that differs between or among the various decision alternatives. A cost must
be differential to be relevant. TRUE
10. Incremental cost is the additional cost of producing or selling a contemplated quantity of output.
Incremental costs can be either variable or fixed. Most variable costs are relevant while most fixed costs
are not relevant. TRUE

11. Cost relevant to an insourcing vs. outsourcing decision include variable manufacturing costs
as well as
A. Avoidable fixed costs. C. Property taxes.
B. Factory depreciation. D. Factory management costs
ANSWER: A

12. In considering a special order situation that will enable a company to make use of presently
idle capacity, which of the following costs would be irrelevant?
A. Depreciation. C. Materials.
B. Variable overhead. D. Direct labor.
ANSWER: A
13. When only differential manufacturing costs are taken into account for special-order pricing,
an essential assumption is that
A. Manufacturing fixed and variable costs are linear.
B. Selling and administrative fixed and variable costs are linear.
C. Acceptance of the order will not affect regular sales.
D. Acceptance of the order will not cause unit selling and administrative variable costs to
increase.
ANSWER: C
14. Production of a special order will increase gross profit when the additional revenue from the
special order is greater than
A. The direct materials and labor cost in producing the order.
B. The fixed costs incurred in producing the order.
C. The indirect costs of producing the order.
D. The marginal cost of producing the order
ANSWER: D
15. When considering a special order that will enable a company to make use of currently idle
capacity, which of the following cost is irrelevant?
A. Materials. C. Direct Labor.
B. Depreciation. D. Variable overhead.
ANSWER: B

16. When a multi-product plant operates at full capacity, quite often decisions must be made as
to which products to emphasize. These decisions are frequently made with a short-run focus. In
making such decisions, manager should select products with the
A. Highest sales price per unit.
B. Highest individual unit contribution margin.
C. Highest volume potential.
D. Highest contribution margin per unit of the constraining resource.
ANSWER: D

17. In the manufacturing process of Drigo Company, an output called substance “pooz” is
disposed of as waste. Recently, the Research Department has discovered a process to convert this
waste to detergent. The following data are available:
1. Cost of disposal is P20.00 per liter.
2. Additional processing cost will be P6.00 per liter.
3. Selling price of the new detergent is P14.00 per liter.
4. Joint costs to manufacture all products is P1.5 billion, of which P250,000 can be allocated to
“pooz”.
Which of the amounts are relevant in the decision to dispose or sell “pooz” as detergent?
A. P20, P6, P14, P250,000. C. P1.5 billion, P250,000
B. P20, P6, P14. D. P20, P14, P1.5 billion, P250,000
ANSWER: B

18. Buff Corp. is considering replacing an old machine with a new machine. Which of the
following items is relevant to Buff's decision? (Ignore income tax considerations.)
Book value Disposal value
of old machine of new machine
A) Yes No
B) No Yes
C) No No
D) Yes Yes
Answer: B Level: Medium LO: 1 Source: CPA, adapted

19. Which one of the following is most relevant to a manufacturing equipmentreplacement

decision?
A. Original cost of the old equipment.
B. Disposal price of the old equipment.
C. Gain or loss on the disposal of the old equipment.
D. A lump-sum write-off amount from the disposal of the old equipment.
Answer: B Level: Medium LO: 1 Source: CPA, adapted

20. Relevant or differential cost analysis

A. Takes all variable and fixed cost into account to analyze decision alternatives.
B. Considers only variable cost as they change with each decision alternative.
C. Considers the change in reported net income for each alternative to arrive at the optimum
decision for the company.
D. Considers all variable and fixed cost as they change with each decision alternative
Answer: D Level: Medium LO: 1 Source: CPA, adapted