Chapter 7: Activity‐Based Costing: A Tool to Aid Decision Making

The labor time required to assemble a product is an example of a:

Unit-level activity.

Batch-level activity.

Product-level activity.

Facility-level activity

Which of the following statements about Activity-Based Cost (ABC) is FALSE?

a. Activity-Based Cost differs from traditional costing systems in that products are not cross-subsidized.

b. In Activity-Based Costing, cost drivers are usually what cause costs to be incurred.

c. Activity-Based Costing is more likely to result in major differences from traditional costing systems if
the firm manufactures only one product rather than multiple products.

d. Activity-Based Costing is useful for allocating marketing and distribution costs

ABC costing helps an organization implement its strategy through all of the following means except:

A. Providing relatively accurate cost information.

B. Identifying the most profitable products and customers.

C. Helping improve cycle time.

D. Identifying value added and non-value added activities.

E. None of the above

Sheen Co. manufacturers laser printers. It has outlined the following overhead cost drivers:

Overhead Costs Pool Cost Driver Overhead Cost Budgeted Level for Cost Driver

Quality control Number of inspections $64,800 1,080

Machine operation Machine hours 132,000 1,100

Materials handling Number of batches 900 30

Miscellaneous overhead cost Direct labor hours 48,000 4,000

Sheen Co. has an order for 1,000 laser printers that has the following production requirements:

Number of inspections 175

Machine hours 180

Number of batches 5

Direct labor hours 650

Using activity-based costing, applied miscellaneous factory overhead for the 1,000 laser printers order
based on direct labor hours is:

A. $7,800.

B. $10,000.

C. $10,500.

D. $150.

E. $21,600.
1. $48,000 ÷ 4,000 direct labor hours = $12 per labor hour
2. $12 × 650 labor hours = $7,800

What is the total overhead cost per unit of the laser printers order using activity-based costing (rounded
to the nearest cent)?

A. $39.55.

B. $40.05.

C. $42.25.

D. $50.65.

E. $58.30.

($10,500 + $21,600 + $150 + $7,800) ÷ 1,000 = $40.05

Using activity-based costing, applied quality control factory overhead for the baseball cleat order is:

A. $28,450.

B. $30,220.

C. $24,375.

D. $21,150.

E. $19,600.

1. $78,000 ÷ 1,200 = $65 per inspection

2. $65 × 375 = $24,375

National Inc. manufactures two models of CMD that can be used as cell phones, MPX, and digital
camcorders.

Model Annual Sales in Units

High F 10,000

Great P 16,000

National uses a volume-based costing system to apply factory overhead based on direct labor dollars. The
unit prime costs of each product were as follows:

High F Great P

Direct materials $38.00 $25.40

Direct labor $17.52 $13.14

Budget factory overhead:

Engineering and Design 2,409 engineering hours $404,712

Quality Control 12,848 inspection hours 269,808

Machinery 33,726 machine hours 539,616

Miscellaneous Overhead 26,400 direct labor hours 134,904

Total $1,349,040

National's controller had been researching activity-based costing and decided to switch to it. A special
study determined National's two products have the following budgeted activities:
 High F Great P

Engineering and design hours 969 1,440

Quality control inspection hours 5,648 7,200

Machine hours 20,286 13,440

Labor hours 12,000 14,400

Using activity-based costing, total overhead per unit of Great P model is (rounded to the nearest cent):

A. $42.61.

B. $45.99.

C. $61.32.

D. $66.73.

E. $168.00.

If a costing system uses a single base to allocate overhead costs that are results of several production
activities:

A. Products that use relatively more of this base tend to be undercosted.

B. Products that use relatively less of this base tend to be overcosted.

C. Products that use relatively more of this base tend to be overcosted.

D. Products may be over- or under-costed, depending on the activity level.

E. Products may be over- or under-costed, depending on the overhead rate.

Which of the following is not normally associated with activity-based costing?

A. Activity cost pools.

B. Multiple cost drivers.

C. Reduction of non-value-adding costs.

D. High direct labor costs relative to manufacturing overhead costs.

E. Improved decision-making and pricing.

Chapter 8: Master Budgeting

Budgeting for production (i.e., units to be produced in an upcoming budget period):

A. Is simply an extension of the sales forecast.

B. Is prepared after the materials purchases budget is prepared.

C. Involves the sales budget and both beginning and ending finished goods inventory amounts.

D. Is not needed under a JIT production philosophy.

E. Is normally the first major step in the master budgeting process.

Unless properly controlled, a "bottom-up" budgeting process can lead to:

A. Excessively tight (i.e., difficult-to-achieve) budgets.

B. Easy budget targets.

C. Excessive downward communication.

D. Reduced incentives for participation.

E. Reduced levels of "budgetary slack."

Berol Company plans to sell 200,000 units of finished product in July and anticipates a growth rate in sales
of 5% per month. The desired monthly ending inventory in units of finished product is 80% of the next
month's estimated sales. There are 150,000 finished units in inventory on June 30.
Berol Company's production requirement in units of finished product for the three-month period ending
September 30 is:

A. 712,025 units

B. 630,500 units

C. 664,000 units

D. 665,720 units

1
Unit sales of 200,000 × 105% = 210,000
2
Unit sales of 210,000 × 105% = 220,500
3
Unit sales of 210,000 × 80% = 168,000
4
Unit sales of 220,500 × 80% = 176,400
5
Unit sales of 220,500 × 105% × 80% = 185,220

The Johann's Professional Service Company expects 70% of sales for cash and 30% on credit. The
company collects 80% of its credit sales in the month following sale, 15% in the second month following
sale, and 5% are not collected (that is, they are "bad debts"). Expected sales for June, July, and August
are $48,000, $54,000, and $44,000, respectively. What are the company's expected total cash receipts in
August?

A. $45,920.

B. $61,400.

C. $87,600.

D. $50,400

E. $15,120
Doanne Food Processing expects to have 36,000 pounds of raw materials inventory on hand on March
31, the end of the current year. The company budgets the following production (in units) for April
through July, inclusive:

April 120,000

May 130,000

June 140,000

July 120,000

At the end of each month the firm desires its ending raw material inventory to be 10% of the next
month's production needs. Each finished unit requires three pounds of raw materials.

Doanne's budgeted purchases (in pounds) of raw materials for June would be:

A. 414,000.

B. 420,000.

C. 426,000.

D. 456,000.

E. 498,000.

Worton Distributing expects its September sales to be 25% higher than its August sales of $150,000.
Purchases were $100,000 in August and are expected to be $120,000 in September. All sales are on
credit and are expected to be collected as follows: 30% in the month of the sale and 70% in the
following month. Purchases are paid 25% in the month of purchase and 75% in the following month. The
cash balance on September 1 is $10,000. The ending cash balance on September 30 is estimated to be:

A. $56,250.

B. $56,500.

C. $65,250.

D. $66,250.

E. $76,250.
1. Beginning-of-month cash balance (given) = $10,000

2. Cash receipts in September from credit sales made in August ($150,000 × 0.70) = $105,000

3. Cash receipts in September from credit sales made in September ([$150,000 × 1.25] × 0.30) = $56,250

4. Cash disbursements in September from purchases made in August ($100,000 × 0.75) = $75,000

5. Cash disbursements in September from purchases made in September ($120,000 × 0.25) = $30,000

6. Ending cash balance = Beginning cash balance + Cash receipts from credit sales made in August +
Cash receipts from credit sales made in September - Cash disbursements from purchases made in
August - Cash disbursements for purchases made in September = $10,000 + $105,000 + $56,250 -
$75,000 - $30,000 = $66,250

87. Graham Corporation's budgeted production schedule, by quarters, for the coming year is as
follows:

Quarter 1 = 22,500 units

Quarter 2 = 19,000 units

Quarter 3 = 17,000 units

Quarter 4 = 24,000 units

Each unit of product requires three pounds of direct material. The company's policy is to begin each
quarter with 30% of that quarter's direct materials production requirements.

Graham expects to have 50,000 pounds of direct materials on hand at the beginning of Quarter 1.

What would be Graham's budgeted direct materials purchases (in pounds) for the third quarter?

A. 19,100 pounds.

B. 44,700 pounds.
C. 51,000 pounds.

D. 57,300 pounds.

E. 72,600 pounds.

1. Estimated beginning inventory of direct materials, Quarter 3 = 17,000 units × 3 lbs./unit × 0.30 =
15,300 lbs.

2. Desired ending inventory of direct materials, Quarter 3 = [(24,000 units × 3 lbs./unit) × 0.30] = 21,600
lbs.

3. Lbs. of direct materials needed for Quarter 3 production = 17,000 units × 3 lbs./unit = 51,000 lbs.

4. Required purchases of direct materials, Quarter 3 = Production requirements + Desired ending

inventory - Beginning inventory = 51,000 lbs. + 21,600 lbs. - 15,300 lbs. = 57,300 lbs.

The practice of managers knowingly including a higher amount of expenditures (or lower amount of
revenue) in the budget than they actually believe will occur is called:

A. Goal congruency.

B. Resource capacity planning.

C. Participative budgeting.

D. Budgetary slack.

E. Kaizen budgeting.

Chapter 9: Flexible Budgets and Performance Analysis

The purpose of a flexible budget is to:

reduce the total time in preparing the annual budget.

compare actual and budgeted results at virtually any level of production.

eliminate cyclical fluctuations in production reports by ignoring variable costs.

allow management some latitude in meeting goals.

Chapter 10: Standard Costs and Variances

A materials usage variance can be caused by all of the following except:

A. Actual output volume of the period (i.e., units produced).

B. Performance of the workers in using the materials.

C. Quality of the materials.

D. Skill level of the workers using the materials.

E. Inadequate employee supervision.

Which of the following statements about processing cycle efficiency (PCE) is not true?

A. It is defined as the ratio of processing time to non-processing time.

B. It is a measure of operating process efficiency.

C. It is based on the relationship between actual processing time and total production time.

D. It incorporates notions of "value-added" and "non-value-added," as discussed in the

development of activity-based cost (ABC) systems.

E. The optimum value of PCE is 1.

Norio Manufacturing uses powdered plastics (PPS) to manufacture a high-pressure board used in a digital
equipment product, Flex 10. Information concerning its operation in June is as follows:

Budgeted units of Flex 10 for June 5,000

45,000
Budgeted usage of PPS
pounds

Number of units of Flex 10 manufactured 4,000

43,200
PPS purchased
pounds

39,000
PPS used
pounds

Total actual cost of PPS used $224,640

Direct materials usage variance—

$21,600
unfavorable

The standard cost per pound of PPS (to two decimal places) is:

A. $5.20.

B. $5.76.

C. $6.24.

D. $6.84.

E. $7.20.

Direct materials usage variance = (AQ - SQ) × SP = ((39,000) - [4,000 × (45,000 ÷ 5,000)]) × SP = $21,600;
therefore, SP = $21,600 ÷ 3,000 pounds = $7.20/pound

The direct materials purchase-price variance (rounded to a whole number) is:

A. $51,840 favorable.

B. $56,160 favorable.

C. $62,208 favorable.

D. $64,840 favorable.

E. $72,000 favorable.

1. Direct materials quantity variance = (AQ - SQ) × SP (or, equivalently: (AQ × SP) - (SQ × SP)).

2. Standard cost per pound, SP: = (AQ × SP) - (SQ × SP) = (39,000 × SP) - ([4,000 × (45,000 ÷ 5,000)] × SP) =
$21,600; therefore, SP = $21,600 ÷ 3,000 pounds = $7.20 per pound.

3. Purchase-price variance = (AP - SP) × AQ = ($5.76 - $7.20)/pound × 43,200 pounds purchased = $62,208
favorable.

In a standard cost system, an unfavorable production-volume variance would result if:

A. There is an unfavorable labor efficiency variance.

B. There is an unfavorable labor rate variance.

C. Actual production is less than the "denominator volume" (that is, the volume level used to establish the
fixed overhead application rate).

D. There is an unfavorable manufacturing overhead spending variance.

E. Actual fixed overhead costs are greater than budgeted fixed overhead costs.

The following information for the past year is available from Thinnews Co., a company that uses machine
hours to apply factory overhead:

Actual total factory overhead cost $24,000

Actual fixed overhead cost $10,000

Budgeted fixed overhead cost $11,000

Actual machine hours 5,000

Standard machine hours for the units manufactured 4,800

Denominator volume—machine hours 5,500

Standard variable overhead rate per machine hour $3

The variable overhead spending variance is:
A. $600 unfavorable.

B. $1,000 favorable.

C. $1,400 unfavorable.

D. $1,500 favorable.

E. $2,100 favorable.

1. Variable overhead spending variance = actual variable overhead cost incurred - flexible budget for
variable overhead cost, based on inputs (i.e., actual machine hours worked).
2. Actual variable overhead cost = $14,000 (Actual variable overhead cost incurred = Actual total overhead
cost - actual fixed overhead cost incurred = $24,000 - $10,000 = $14,000).
3. Flexible budget for variable overhead cost = 5,000 machine hours × $3.00/machine hour = $15,000.
4. Variable overhead spending variance = actual variable overhead cost - Flexible budget for variable
overhead cost = $14,000 - $15,000 = $1,000 favorable

The variable factory overhead efficiency variance is:

A. $600 unfavorable.

B. $1,000 favorable.

C. $1,400 unfavorable.

D. $1,500 favorable.

E. $2,100 favorable.

1. Variable overhead efficiency variance = FB for variable overhead cost based on inputs - FB for variable
overhead cost based on outputs (i.e., based on standard allowed machine hours).

2. FB based on inputs = 5,000 actual machine hours × $3.00/machine hour = $15,000.

3. FB based on outputs = 4,800 allowed machine hours × $3.00/machine hour = $14,400.

4. Variable overhead efficiency variance = $15,000 - $14,400 = $600 unfavorable

A standard is:
unrelated to budgeting since standards are used for control purposes only.

normally set at the ideal rather than the practical level of cost, efficiency, or quantity.

normally not applied to the variable portion of overhead.

the budgeted cost for one unit of product

Kennedy Inc. has the following data for its operation in August:

Increase in direct materials inventory 100 Sets

Direct materials purchased (AQ) 1,600 Sets

Finished goods manufactured 700 Units

Direct materials purchase-price variance $400 Favorable

Budgeted

Finished goods to manufacture 800 Units

Direct materials purchases 2,000 Sets

Direct materials per unit of finished goods 2 Sets

Direct materials price per set (SP) $3.60

What was the actual purchase price (AP) per set of direct materials purchased (to two decimal places)?

A. $3.35.

B. $3.40.

C. $3.72.

D. $3.80.

E. $3.85.

Actual price paid per set of direct materials purchased (AP) = (total standard cost of materials purchased
- favorable materials purchase-price variance) ÷ number of sets purchased = [(1,600 sets (given) ×
$3.60/set (given)) - $400 favorable purchase price variance (given)] ÷ 1,600 sets purchased (given) =
$3.35/set
What was the direct materials usage (quantity) variance in August?

A. $180 unfavorable.

B. $360 unfavorable.

C. $540 favorable.

D. $540 unfavorable.

E. $720 unfavorable.

1. Direct materials usage variance = (AQ - SQ) × SP

2. Actual quantity of direct materials used, AQ = 1,600 sets purchased - 100 sets increase in inventory =
1,500 sets
3. Standard quantity of direct materials allowed for actual output, SQ = 700 units (given) × 2 sets/unit =
1,400 sets
4. Direct materials usage variance = (AQ - SQ) × SP = (1,500 - 1,400) sets × $3.60/set (given) = $360
unfavorable

Chapter 11: Performance Measurement in Decentralized Organizations

Which of the following would be most appropriate for evaluating a cost center?

Return on investment

Contribution margin percentage

A static budget

A standard costing system

Which of the following is an advantage of decentralization?

A. Promote coordination among divisions of company.

B. Limits conflicts among divisions of company.

C. Motivates managers.

D. Offers qualitative method of performance evaluation.

Bonniwell Corporation has two divisions: the Delta Division and the Alpha Division. TheDelta Division has
sales of $620,000, variable expenses of $359,600, and traceable fixed expenses of $229,200. The Alpha
Division has sales of $820,000, variable expenses of $541,200, and traceable fixed expenses of $172,900.
The total amount of common fixed expenses not traceable to the individual divisions is $122,000. What
is the company's net operating income?

A. $539,200

B.$15,100

C. $137,100

D. $417,200

Return on investment (ROI) is a term often used to express income earned on capital invested in a
division (investment center). A division's ROI would increase if:

A. Sales increased by the same dollar amount as expenses and total assets increased.

B. Sales remained the same and expenses were reduced by the same dollar amount that total
assets increased.

C. Sales decreased by the same dollar amount that expenses increased.

D. Sales and expenses increased by the same percentage that total assets increased.

E. Net profit margin on sales increased by the same percentage that total assets increased.

A company currently earning a profit can increase its return on investment (ROI) by:

A. Increasing sales revenue and operating expenses by the same dollar amount.

B. Decreasing sales revenues and operating expenses by the same percentage.

C. Increasing investment and operating expenses by the same dollar amount.

D. Increasing sales revenues and operating expenses by the same percentage.

E. Decreasing investment and sales by the same percentage.

Compared to return on investment (ROI), residual income (RI) may be a better measure of the financial
performance of an investment center because:

A. Problems associated with measuring the investment base are eliminated.

B. Of the fact that desirable investment opportunities will not be neglected by divisions currently
earning high rates of return.

C. Only the gross book value of assets needs to be calculated.

D. Returns do not increase as assets are depreciated.

E. The arguments over the implicit cost of capital (discount rate) are largely eliminated.

The following data pertain to the Whalen Division of Northern Industries.

The margin at Whalen was exactly the same in Year 2 as it was in Year 1.

The average operating assets for Year 2 amounted to:

A. $400,000

B. $800,000

C. $600,000

D. $500,000

Turnover = Sales ÷ Average operating assets

Average operating assets = Sales ÷ Turnover

= $600,000 ÷ 1.2 = $500,000

The return on investment in Year 1 was:

A. 48.00%

B. 32.50%

C. 7.58%

D. 1.92%
ROI = Margin × Turnover

Margin in Year 2 = ROI in Year 2 ÷ Turnover in Year 2

= 9.6% ÷ 1.2 = 8%

ROI in Year 1 = Margin in Year 1 × Turnover in Year 1

ROI in Year 1 = Margin in Year 2 × Turnover in Year 1

= 8% × 6 = 48%

The minimum required rate of return in Year 1 was:

A. 18%

B. 17%

C. 16%

D. 15%

Margin = Net operating income ÷ Sales

Net operating income = Sales × Margin

= $300,000 × 8% = $24,000

ROI = Margin × Turnover

Margin in Year 2 = ROI in Year 2 ÷ Turnover in Year 2

= 9.6% ÷ 1.2 = 8%

ROI in Year 1 = Margin in Year 1 × Turnover in Year 1

ROI in Year 1 = Margin in Year 2 × Turnover in Year 1

= 8% × 6 = 48%
ROI = Net operating income ÷ Average operating assets

48% = $24,000 ÷ Average operating assets

Average operating assets = $24,000 ÷ 48% = $50,000

Residual income = Net operating income - Average operating assets × Minimum required rate of return

$16,000 = $24,000 - $50,000 × Minimum required rate of return

$50,000 × Minimum required rate of return = $24,000 - $16,000

Minimum required rate of return = $8,000 ÷ $50,000 = 16%

Appendices 11A: Transfer Pricing

A company established a branch to sell automobile seat covers. The company purchases these covers and
stores them in a warehouse. The covers are then shipped from the warehouse to both the home office and
the new branch, FOB (Free On Board) destination. Home office management is responsible for setting the
transfer price of the covers charged to the branch. Per-unit costs of the covers are:

$60.00 purchase price

$2.50 shipping cost to warehouse

$3.00 handling cost, including $1 allocated administrative overhead

$3.50 shipping cost to branch, paid by home office

According to the general transfer-pricing formula given in the text, the minimum transfer price that home
office should charge the branch is:

A. $62.50.

B. $63.50.

C. $66.00.

D. $68.00.

E. $69.00.

Minimum Transfer Price = Incremental Cost = Out-of-Pocket Cost + Opportunity Cost = $68.00 = [$60.00
+ $2.50 + $3.50 + ($3.00 - $1.00)] + $0; note—while not asked, the maximum amount to be charged
would be the external market price (if such existed).
An appropriate transfer price between two divisions of The Stark Company can be determined from the
following data:

Fabricating Division:

Market price of the subassembly $50

Variable cost of the subassembly $20

Excess capacity (in units) 1,000

Assembly Division:

Number of units needed 900

What is the natural bargaining range (min and max transfer price) for the two divisions?

A. Between $20 and $50.

B. Between $50 and $70.

C. Any amount less than $50.

D. $50 is the only acceptable price.

E. $20 is the only acceptable price.

Chapter 12: Differential Analysis: The Key to Decision Making

The Talbot Company produces wheels that are used in the production of bicycles. Talbot's costs to
produce 100,000 wheels annually are:

Direct materials $ 30,000

Direct labor 50,000

Variable overhead 20,000

Fixed overhead 70,000

Total $170,000

An outside supplier has offered to sell Talbot similar wheels for $1.25 per wheel. If the wheels were
purchased from the outside supplier, $15,000 of annual fixed factory overhead could be avoided.

What is the highest price that Talbot could pay the outside supplier for the wheel and still be
economically indifferent between making or buying the wheels?

$1.70

$1.15

$1.00

$ .80

Management accountants are frequently asked to analyze various decision situations including the
following:

I. The cost of a special device that is necessary if a special order is accepted.

II. The cost proposed annually for the plant service for the grounds at corporate headquarters.

III. Joint production costs incurred, to be considered in a sell-or-process-further decision.

IV. The costs associated with alternative uses of plant space, to be considered in a make/buy decision.

V. The cost of obsolete inventory acquired several years ago, to be considered in a keep-versus-disposal
decision.

The costs described in situations III and V above are examples of:

A. Prime costs.
B. Sunk costs.

C. Discretionary costs.

D. Relevant costs.

E. Opportunity costs.

United Industries manufactures three products in its highly automated factory. The products are all
popular, with demand far exceeding the company's ability to supply the marketplace. To maximize
(short-term) operating income, management should focus on each product's:

A. Gross margin per unit.

B. Gross margin ratio.

C. Contribution margin per unit.

D. Contribution margin ratio.

E. Contribution per machine hour.

In situations when management must decide on accepting or rejecting one-time-only special orders,
where there is sufficient capacity, which one of the following would not be relevant to the decision?

A. Absorption (that is, full product) cost.

B. Differential costs.

C. Direct costs.

D. Variable costs.

E. Incremental costs.

Regis Company manufactures plugs at a cost of $36 per unit, which includes $8 of fixed overhead. Regis
needs 30,000 of these plugs annually (as part of a larger product it produces). Orlan Company has
offered to sell these units to Regis at $33 per unit. If Regis decides to purchase the plugs, $60,000 of the
annual fixed overhead cost will be eliminated, and the company may be able to rent the facility
previously used for manufacturing the plugs.

If the plugs are purchased and the facility rented, Regis Company wishes to realize $100,000 in net
savings annually. To achieve this goal, the minimum annual rent on the facility must be:
A. $10,000.

B. $40,000.

C. $70,000.

D. $190,000.

E. $280,000.

1. Relevant cost to purchase (without considering rental income) = $33/unit.

2. Relevant cost to make = Avoidable (i.e., incremental) cost = $36 - Unavoidable fixed cost/unit = $36 -
([($8/unit × 30,000 units) - $60,000] ÷ 30,000 units) = $36 - ($180,000 ÷ 30,000 units) = $36 - $6 =
$30/unit.

3. Difference = $33 - $30 = $3 per unit in favor of making the parts rather than purchasing the parts
from an external supplier.

4. Therefore, cost disadvantage of purchasing externally rather than making the parts = $3/unit ×
30,000 units = $90,000.

5. If a net benefit of $100,000 is desired, then the facility needs to be rented annually for an amount
equal to the cost disadvantage of purchasing externally (to recoup this cost) + targeted (desired) net
benefit from the decision = $90,000 + $100,000 (given) = $190,000.

A truck, costing $25,000 and uninsured, was wrecked the very first day it was used. It can either be
disposed for $5,000 cash and replaced with a similar truck costing $27,000, or it can be rebuilt for
$20,000 and be brand new as far as operating characteristics and looks are concerned. The better
decision choice provides a net cost savings of:

A. $2,000.

B. $5,000.

C. $7,000.

D. $12,000.

E. Some amount other than these choices.

40. Plainfield Company manufactures part G for use in its production cycle. The full cost per unit for
each of 10,000 units of part G are as follows:

Direct materials $3
Direct labor 15

Variable overhead 6

Fixed overhead 8

$32

Verona Company has offered to sell Plainfield 10,000 units of part G for $30 per unit. If Plainfield
accepts Verona's offer, the released facilities could be used to save $45,000 in relevant costs in the
manufacture of part H. In addition, $5 per unit of the fixed overhead applied to part G would be
eliminated. Which alternative is more desirable and by what amount?

Alternative Amount

A) Manufacture $10,000

B) Manufacture $15,000

C) Buy $35,000

D) Buy $65,000

E) Buy $10,000

1. Relevant cost to manufacture = Incremental (i.e., avoidable) variable cost per unit × number of units =
(direct materials cost/unit + direct labor cost/unit + variable overhead cost/unit) × 10,000 units = ($3 +
$15 + $6)/unit × 10,000 units = $24/unit × 10,000 units = $240,000

2. Relevant cost to buy = external purchase cost less avoidable fixed costs = ($30/unit × 10,000 units) -
$45,000 - ($5/unit × 10,000 units) = $205,000

3. Buy has lower cost: $240,000 - $205,000 = $35,000

Note: the relevant cost to make could also be defined as incremental variable cost + incremental fixed
cost = $240,000 + ($45,000 + [$5/unit × 10,000 units]) = $240,000 + $95,000 = $335,000. Relevant cost
to purchase = $30/unit × 10,000 units = $300,000. Difference = $335,000 - $300,000 = $35,000 in favor
of purchasing externally.

Products A, B, and C are produced from a single raw material input. The raw material costs $90,000,
from which 5,000 units of A, 10,000 units of B, and 15,000 units of C can be produced each period.
Product A can be sold at the split-off point for $2 per unit, or it can be processed further at a cost of
$12,500 and then sold for $5 per unit. Product A should be:

A. sold at the split-off point, since further processing would result in a loss of $0.50 per unit.

B. processed further, since this will increase profits by $2,500 each period.

C. sold at the split-off point, since further processing will result in a loss of $2,500 each period.

D. processed further, since this will increase profits by $12,500 each period.