CH APTE R 7

Use of Cost Information in Management Decision-Making

Summary of Questions by Objectives and Bloom’s Taxonomy
TRUE-FALSE

1. Incremental revenue is the additional revenue received as a result of selecting one

decision alternative over another.

2. Sunk costs are not incremental costs.

3. Differential costs are also incremental costs.

4. In deciding whether to sell or process further, the costs that have been incurred to process
the product to this point are incremental costs.

5. In a make or buy decision, direct materials and direct labor are usually incremental costs.

6. In a make or buy decision, the original purchase price of the equipment which is currently
used in the manufacturing process is usually a relevant cost.

7. Fixed costs that are avoidable are incremental costs in a make or buy decision.

8. Avoidable costs are not relevant.

9. Chief resource officer is another title for the person who is responsible for the company’s
financial accounting system.

10. The proper way to analyze the decision to drop a product line is to compare sunk costs to
incremental costs.

11. Common costs are fixed costs that are not directly traceable to an individual product line.

12. If a department is eliminated, the company will avoid the fixed costs that have been
allocated to that department.

13. When deciding whether to eliminate a segment, the segment should generally be kept if
its contribution margin less avoidable fixed costs is positive.

14. Opportunity costs represent the benefits foregone by selecting one alternative over
another.

15. Avoidable costs are always incremental costs.

16. Fixed costs are always sunk costs.

7-2 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

17. Two or more products which result from common inputs are called joint products.

18. The best way to allocate the cost of common inputs to joint products is based on the
physical quantities of the outputs.
 Chapter 7 The Use of Cost Information in Management Decision Making 7-3

19. Allocating joint costs to products based on physical quantities will make the products
have the same contribution margin ratio if they are sold at the split-off point.

20. The stage of production at which individual products are identifiable is referred to as the
spin-off point.

21. A disadvantage of using an outside supplier is the associated loss of control over the
production process.

22. The qualitative aspects of a decision must receive the same careful attention as the
quantitative aspects.

23. The primary benefit of using an outside supplier is that the adverse effect of a downturn
in business is less severe.

*24. When applying the theory of constraints, management attempts to improve throughput in
all areas of the factory.

*25. Improving performance in areas which are not bottlenecks will not improve overall
output.

*26. According to the theory of constraints, everything else should be subordinate to the
binding constraint.

*27. The binding constraint is the process that limits throughput.

Material from the appendix to the chapter is marked with an asterisk (*).

Answers

1 T 6 F 11 T 16 F 21 T 26 T
2 T 7 T 12 F 17 T 22 T 27 T
3 T 8 F 13 T 18 F 23 T
4 F 9 F 14 T 19 F 24 F
5 T 10 F 15 T 20 F 25 T
7-4 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

MULTIPLE CHOICE

28. Which of the following is often not a differential cost?

A. Direct labor
B. Direct material
C. Variable manufacturing overhead
D. Fixed manufacturing overhead

29. Which of the following is never considered in incremental analysis?

A. Incremental revenue
B. Sunk costs
C. Incremental profit
D. Differential costs

30. Which of the following is not a term used to describe the additional costs incurred as a
result of selecting one decision alternative over another?
A. Differential costs
B. Relevant costs
C. Sunk costs
D. Incremental costs

31. When deciding between two alternatives, the preferred alternative always has
A. no opportunity costs.
B. greater revenues than the other alternatives.
C. less expense than the other alternatives.
D. greater incremental profit than the other alternatives.

32. Costs that were incurred in the past which are never incremental costs are called
A. sunk costs.
B. opportunity costs.
C. differential costs.
D. relevant costs.

33. A company is trying to decide whether to sell partially completed goods in their current
state or incur additional costs to finish the goods and sell them as complete units. Which
of the following is not relevant to the decision?
A. The selling price of the completed units.
B. The costs incurred to process the units to this point.
C. The selling price of the partially completed units.
D. The costs that will be incurred to finish the units.
 Chapter 7 The Use of Cost Information in Management Decision Making 7-5

34. A company is trying to decide whether to keep or drop the sporting goods department in
its department store. If the segment is dropped, the manager will be fired. The manager's
salary, in relation to the decision to keep or drop the sporting goods department, is
A. avoidable and therefore relevant.
B. not avoidable and therefore relevant.
C. sunk and therefore not relevant.
D. the same for all alternatives and therefore not relevant.

35. Which of the following is not normally relevant in a make or buy decision?
A. direct materials
B. supervisory salaries
C. incremental revenues
D. opportunity costs

36. A company is currently making a necessary component in house (the company is

producing the component for its own use). The company has received an offer to buy the
component from an outside supplier. A machine is being rented to make the component.
If the company were to buy the component, the machine would no longer be rented. The
rent on the machine, in relation to the decision to make or buy the component, is:
A. sunk and therefore not relevant.
B. avoidable and therefore not relevant.
C. avoidable and therefore relevant.
D. unavoidable and therefore relevant.

37. Fixed costs that will be eliminated if a particular course of action is undertaken are called
A. optional costs.
B. opportunity costs.
C. direct costs.
D. avoidable costs.

38. The value of benefits foregone by selecting one decision alternative over another is a(n)
A. sunk cost.
B. incremental benefit.
C. differential revenue.
D. opportunity cost.

39. A product line should be dropped when

A. it has a negative contribution margin.
B. its avoidable fixed costs are greater than its contribution margin.
C. there will be a positive change in income if the product line is dropped.
D. All of the above.
7-6 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

40. Common costs

A. are fixed costs that are not directly traceable to an individual product line.
B. normally not avoidable.
C. Both A and B are true.
D. Neither A nor B is true.

41. Which of the following is a direct cost of a specific department in a retail store?
A. Company president’s salary.
B. Rent on the store.
C. Utilities for the store.
D. Cost of the department’s inventory.

42. When a department or product line is dropped, the common fixed costs which had been
allocated to that department
A. are eliminated.
B. become variable costs.
C. are allocated to the remaining departments or product lines.
D. become sunk costs.

43. You have tickets to go to Mexico (Cancun specifically) over spring break. Just this week
your best friend informs you that s/he is getting married over spring break and would like
you to be in the wedding as an attendant. Which of the following is a sunk cost that
should not be relevant to your decision as to whether be in the wedding or go on the trip
to Mexico?
A. The cost of the airline tickets to Mexico.
B. The amount of refund you could get on the airline tickets to Mexico.
C. The cost of the clothing you will have to buy/rent to be in the wedding.
D. The fact that you have never been anywhere for Spring Break and were really
looking forward to going to Mexico.

44. Which of the following statements regarding opportunity costs is true?

A. Opportunity costs are recorded with two debits, rather than a debit and a credit.
B. Opportunity costs are always incremental costs.
C. Opportunity costs are a key factor in financial accounting.
D. The same decision will be reached whether or not opportunity costs are
considered in the analysis.
 Chapter 7 The Use of Cost Information in Management Decision Making 7-7

45. Robin Company currently produces 8,000 units of part B13. Current costs for part B13
are as follows:

Direct materials $12

Direct labor 9
Factory rent 7
Administrative 10
General factory overhead 7
Total $45

If the company decides to buy part B13, 50% of the administrative costs would be
avoided. All of the Robin Company items, including part B13, are manufactured in the
same rented production facility. The company has an offer from a wholesaler that wishes
to sell the part to Robin for $31 per unit. What effect will occur if the company decides to
accept the offer?
A. The cost for this part will increase by $5 per unit.
B. The cost for this part will be the same.
C. The cost for this part will decrease by $14 per unit.
D. The cost for this part will decrease by $10 per unit.

46. Walter Jewelry Company produces a bracelet which normally sells for $79.95. The
company produces 1,500 units annually but has the capacity to produce 2,000 units. A
special order for manufacturing and selling 200 bracelets at $49.95 has been received
which would not disrupt current operations. Current costs for the bracelet are as follows:

Direct materials $17.00

Direct labor 14.50
Variable overhead 4.00
Fixed overhead 5.00
Total $40.50

In addition, the customer would like to add a monogram to each bracelet which would
require an additional $2 per unit in additional labor costs and Walter Jewelry would also
have to purchase a piece of equipment to create the monogram which would cost $1,600.
This equipment would not have any other uses. With regard to this special order, only
A. incremental revenues will exceed incremental costs by $2,490.
B. incremental revenues will exceed incremental costs by $890.
C. incremental revenues will exceed incremental costs by $2,890
D. incremental revenues will exceed incremental costs by $1,290
7-8 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

47. NY Memorabilia Company produces a souvenir plate which normally sells for $79.95.
The company produces 1,500 plates annually but has the capacity to produce 2,000
plates. A special order for manufacturing and selling 200 plates at $49.95 has been
received which would not disrupt current operations. Current costs for the plate are as
follows:

Direct materials $17.00

Direct labor 14.50
Variable overhead 4.00
Fixed overhead 5.00
Total $40.50

In addition, the customer would like to add a date to each plate which would require an
additional $2 per plate in additional labor costs and NY Memorabilia Company would
also have to purchase a piece of equipment to create the date which would cost $1,200.
This equipment would not have any other uses. Which statement is true with regard to
this special order?
A. Incremental revenues will exceed incremental costs by $2,490.
B. Incremental revenues will exceed incremental costs by $890.
C. Incremental revenues will exceed incremental costs by $2,890.
D. Incremental revenues will exceed incremental costs by $1,290.

48. Rockwell Company owns a single restaurant which has a cantina primarily used to seat
patrons while they wait on their tables. The company is considering eliminating the
cantina and adding more dining tables. Segmented contribution income statements are as
follows and fixed costs applicable to both segments are allocated on the basis of sales.

Restaurant Cantina Total

Sales $800,000 $200,000 $1,000,000
Variable costs 475,000 160,000 635,000
Direct fixed costs 50,000 15,000 65,000
Allocated fixed costs 212,500 37,500 250,000
Net Income $ 62,500 ($12,500) $50,000

What financial effect will occur to profit if Rockwell eliminates the cantina but no more
dining customers are served?
A. Net income will increase by $12,500
B. Net income will decrease to $37,500.
C. Net income will decline by $25,000
D. Net income will be $25,000
 Chapter 7 The Use of Cost Information in Management Decision Making 7-9

49. Hydra Company has two locations, downtown and at a suburban mall. During March, the
company reported total net income of $337,000 and sales of $1.2 million. The
contribution margin in the downtown store was $320,000 (40% of sales). The
contribution margin in the mall store is $200,000. Total fixed costs are $90,000 in the
downtown store and $93,000 in the mall location. How much are sales at the mall
location?
A. $400,000
B. $800,000
C. $666,667
D. Not enough information is provided to answer.

50. Collegebooks Company has two locations, downtown and on campus. During March, the
company reported net income of $164,000 and sales of $1.2 million. The contribution
margin in the downtown store was $320,000 (32% of sales). The contribution margin in
the campus store is $110,000. Direct fixed costs are $90,000 in the downtown store and
$93,000 in the campus location. How much are total variable costs?
A. $410,000
B. $3,750,000
C. $192,000
D. $853,000

51. Ricket Company has 1,500 obsolete calculators that are carried in inventory at a cost of
$13,200. If these calculators are upgraded at a cost of $9,500, they could be sold for
$22,500. Alternatively, the calculators could be sold “as is” for $9,000. What is the net
advantage or disadvantage of reworking the calculators?
A. $13,000 advantage
B. $4,000 advantage
C. $9,200 disadvantage
D. $200 disadvantage

52. BigByte Company has 12 obsolete computers that are carried in inventory at a cost of
$13,200. If these computers are upgraded at a cost of $7,500, they could be sold for
$15,300. Alternatively, the computers could be sold “as is” for $9,000. What is the net
advantage or disadvantage of reworking the computers?
A. $6,300 advantage
B. $1,200 disadvantage
C. $5,400 disadvantage
D. $3,000 advantage
7-10 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

53. The following are production and cost data for two products, buckets and pails.

Buckets Pails
Contribution margin per unit $450 $280
Machine set-ups needed per unit 20 14

The company can only perform 14,000 set-ups each period yet there is unlimited demand
for each product. What is the maximum contribution margin for the year?
A. $315,000
B. $35,000
C. $280,000
D. $595,000

54. The following are production and cost data for two products, A and B.

Product A Product B
Contribution margin per unit $450 $340
Machine set-ups needed per unit 25 20

The company can only perform 12,000 set-ups each period yet there is unlimited demand
for each product. What is the maximum contribution margin for the year?
A. $216,000
B. $204,000
C. $420,000
D. $18,050,000

55. Central Apparel Company owns two stores and management is considering eliminating
the east store due to declining sales. Contribution income statements are as follows and
common fixed costs are allocated on the basis of sales.
West East Total
Sales $420,000 $90,000 $510,000
Variable costs 210,000 45,000 255,000
Direct fixed costs 50,000 25,000 75,000
Allocated fixed costs 110,000 35,000 145,000
Net Income $ 50,000 ($15,000) $35,000

Central’s management feels that if they eliminate the east store, that sales in the west
store will increase by 20%. If the east store is closed, what effect will occur to the overall
company net income?
A. Increase by $25,000
B. Increase by $22,000
C. Increase by $12,000
D. Increase by $15,000
 Chapter 7 The Use of Cost Information in Management Decision Making 7-11

56. Explorer Company manufactures two products, hard-tops and covers for its convertible
vehicles. Data for each follows:

Hard-top Covers
Direct labor hours required per unit 4 8
Contribution margin per unit $240 $390

Only 4,200 direct labor hours are available per month. How many units of each product
should Explorer make in order to maximize profits?
Hard-tops Covers
A. 4,200 400
B. 1,050 0
C. 1,050 250
D. 0 250

57. Urban Athletics Company has two store locations, north and south. During October, the
company reported net income of $192,000 on sales of $905,000. Sales in the north store
were $680,000 and variable costs in the south store were 60% of sales. The contribution
margin in the north store was $204,000. If total direct costs are $50,000, how much will
allocated fixed costs be?
A. $102,000
B. $2,000
C. $52,000
D. $30,000

58. The Abbott Company currently makes 10,000 units annually of a part it utilizes in the
products it manufactures. Current costs for the part are as follows:

Direct materials $16.25

Direct labor 11.85
Variable manufacturing overhead 6.30
Fixed manufacturing overhead 10.20
Total $44.60

If the company decides to buy the part the empty warehouse space could be rented for
$35,000 annually. In addition, half of the fixed manufacturing overhead costs would be
avoided if the company decides to buy the part. The company has an offer from a
manufacturer to produce the part for $42 per unit. If the company decides to accept the
offer the net advantage or disadvantage to the company’s annual net income would be:
A. An advantage of $10,000.
B. An advantage of $35,000.
C. A disadvantage of $25,000.
D. An advantage of $26,000.
7-12 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

59. Manor Homes plans to discontinue a segment which last year generated a contribution
margin of $65,000 and incurred $40,000 in fixed costs. If the segment is discontinued,
half of the fixed costs will not be avoided. If Manor Homes decides to discontinue this
segment the overall effect on profits will be:
A. a decrease of $65,000.
B. a decrease of $25,000.
C. a decrease of $45,000.
D. an increase of $45,000.

60. Rumper Company has 2,000 obsolete ratchers in its inventory which have a cost of $22
each. If the ratchers are reworked they could be sold for $37 each. If sold as-is, the
revenue would be only $10 each. If Rumper Company decides to rework the ratchers,
how much should the company be willing to invest to ensure that no additional loss
occurs on the sale of the ratchers?
A. $44,000
B. $54,000
C. $20,000
D. $22,000

61. Wester Company sells product Z for $23 per unit. Unit product costs are as follows:

Direct materials $4
Direct labor 5
Manufacturing overhead 12
Total $21

A special order to purchase 20,000 units was recently received. There is enough capacity
to fill the order and filling this order would not disrupt current operations. Wester
Company would incur an additional $3 per unit for shipping costs. Half of the
manufacturing overhead costs are fixed and would be incurred no matter how many units
are produced. In negotiating a price, how much is the minimum acceptable selling price?
A. $18
B. $19
C. $22
D. $15
 Chapter 7 The Use of Cost Information in Management Decision Making 7-13

62. Rogertree Company manufactures a number of products from the same raw material.
Joint processing costs total $10,000 per month. Product A could be sold at the cut-off
point for $18,000 per month or it can be further processed at a cost of $9,000 per month
and then sold for $35,000. Rogertree Company should:
A. Further process product A because its incremental revenues will exceed
incremental costs by $8,000.
B. Further process product A because its incremental revenues will exceed
incremental costs by $26,000.
C. Sell as-is because the incremental loss is $2,000 if processed further.
D. Further process product A because its incremental revenues will exceed
incremental costs by $16,000.

63. Tilma Company sells product X for $23 per unit. Unit product costs are as follows:

Direct materials $4
Direct labor 5
Manufacturing overhead 12
Total $21

A special order to purchase 20,000 units was recently received. There is enough capacity
to fill the order and filling this order would not disrupt current operations. Tilma
Company would incur an additional $3 per unit for shipping costs. 40% of the
manufacturing overhead costs are fixed and would be incurred no matter how many units
are produced. In negotiating a price, how much is the minimum acceptable selling price?
A. $19.20
B. $19.00
C. $16.80
D. $12.00

64. Meadows Company manufactures a number of products from the same raw material.
Joint processing costs total $10,000 per month. Product Z could be sold at the cut-off
point for $18,000 per month or it can be further processed at a cost of $9,000 per month
and then sold for $26,000. Meadows Company should:
A. further process product Z because its incremental revenues will exceed
incremental costs by $7,000.
B. further process product Z because its incremental revenues will exceed
incremental costs by $17,000.
C. sell product Z at the split-off point because its incremental costs will exceed
incremental revenues by $1,000.
D. sell product Z at the split-off point because its incremental costs will exceed
incremental revenues by $7,000.
7-14 Test Bank to accompany Jiambalvo Managerial Accounting, 4th Edition

Answers

28 D 46 B 64 C
29 B 47 D
30 C 48 C
31 D 49 A
32 A 50 A
33 B 51 B
34 A 52 B
35 B 53 A
36 C 54 A
37 D 55 B
38 D 56 B
39 D 57 C
40 C 58 A
41 D 59 C
42 C 60 B
43 A 61 A
44 B 62 A
45 A 63 A