Handout #7 LGM

Relevant Cost
 
Make or Buy Decision

*avoidable costs
*opportunity costs

Problem A. MOB Company is currently producing its own face masks. Manufacturing costs under the normal
capacity of 10,000 facemasks are as follows:
Total Per unit
Variable costs 350,000 35
Fixed costs 1,500,000 150

A third party company has offered to sell MOB Company its annual demand of 10,000 units of facemasks at a
price of P95 per unit.

Case A.1: (1) Should MOB make or but its own facemasks?
(2) What is the maximum price in which MOB would be better off buying than making?

Case A.2: Assuming that upon halting the production, P800,000 of the fixed cost will no longer be incurred,
(1) should MOB make or buy its own facemasks?
(2) what is the maximum price in which MOB would be better off buying than making?

Case A.3: Assuming that the facilities freed up upon halting productions will be rented out for an annual
fee of P600,000,
(1) should MOB make or buy its own facemasks?
(2) what is the maximum price in which MOB would be better off buying than making?

Problem B. MOB Company manufactures Part A11, which will be used in its production cycle. The cost per unit of
10,000 units of Part A11 are as follows:
Direct materials P6.00
Materials handling (20%) 1.20
Direct labor 20.00
Variable overhead 5.00
Fixed overhead 11.00
Total manufacturing cost per unit 43.20

The materials handling cost pertain to the cost of receiving and inspecting incoming materials and other
components which are not included in the overhead.

A third party company has offered to sell MOB Company its annual demand of 10,000 units of Part A11 for P40.00
per unit. If MOB accepts the offer:
 P4 of the fixed overhead per unit could be eliminated
 One half of the released facilities could be used to produce a new product, Product Z99, which is
expected to generate a contribution margin of P90,000 per year
 A savings of P15,000 is expected
 The other half of the released facilities could be rented out for P60,000 per annum

The outside supplier requires that an equipment be leased to meet the order of the company, the equipment
rental cost of P80,000 shall be charged annually to the company.

1. Should MOB make or buy Part A11? How much is the net advantage of your decision?

Problem C. The monthly unit cost to manufacture and market a product is as follows:
Manufacturing cost Marketing cost
DM 2.00 Variable 2.50
DL 2.40 Fixed 1.50
Variable 1.60
Fixed 1.00

The company must decide to continue making the product or buy it from an outside supplier. The supplier has
offered to make the product at a level of quality that the company prescribes. Fixed marketing costs would be
unaffected, but variable marketing cost would continue at 30% if the company were to accept the proposal.

1. How much is the maximum amount per unit that the company can pay the supplier without decreasing
its operating income?
Handout #7 LGM
Relevant Cost
 
Accept or Reject a Special Offer

*incremental costs
*opportunity costs

**minimum price = IC + OC

Problem A. AOR Corporation normally sells 20,000 bottles of alcohol in a year, but it can produce a maximum of
22,000 bottles. The following cost data were collected from its normal capacity:
Total Per unit
Variable manufacturing 700,000 35
Variable selling 300,000 15
Fixed manufacturing 3,000,000 150
Fixed selling 2,000,000 100

AOR sells one bottle of alcohol for P500.

A customer makes requests a special order for 2,000 bottles this year and requests AOR to reduce the sales price
to P200. The customer will not accept partial delivery of the order.

Case A.1: In a typical year, should AOR accept the special order? What is the minimum price for this
special order?

Case A.2: If regular sales are forecasted to be 22,000 this year, should AOR accept the special order?
What is the minimum price for this special order?

Case A.3: If regular sales are forecasted to be 20,500 this year, should AOR accept the special order?
What is the minimum price for this special order?

Problem B. AOR Corporation has a manufacturing capacity of 50,000 units. A summary of the operations of for
the year ended December 31, 2020 are as follows:
Total Per unit
Sales 3,800,000 100
Variable costs (2,090,000) (55)
Contribution margin 1,710,000 45
Fixed cost (900,000)
Operating income 810,000

A customer has offered to buy 12,000 units at P90 per unit during 2021. Assume that all of AOR’s 2021 costs are at
the same levels and rates as its 2020 costs.

Case B.1: If AOR has no alternative use for the idle capacity, should it accept or reject the special order?

Case B.2: If AOR can rent out the idle capacity for P200,000, should it accept or reject the special order?

Case B.3: If AOR can use the idle capacity to produce a new product that could provide a P600,000
contribution margin, should it accept or reject the special order?

Case B.4: If the special order is accepted, 2,000 units of regular sales is expected to be lost, should AOR
accept or reject the special order?

Case B.5: If the special order customer had ordered 16,000 units instead of 12,000 units, and AOR has to
sacrifice some of its regular customers to accommodate this special order, should AOR accept or reject
the special order?

Problem C. AOR Company received a request for special order from SPC for 15,000 units of its products at P22.50
per unit. AOR usually sells these products at P39 per unit, with a cost of P29 per unit. Further analysis reveals that
AOR will not be paying sales commission of P2.50 per unit of sales and will save an additional P1.50 per unit for
packaging. However, a special design is needed for this order which will cost AOR P30,000. Also, total fixed cost
of P400,000 for the production of 50,000 units will remain unchanged. AOR decided to accept the special order,
but JLS, a regular customer who normally buys 2,000 units, also wants to pay P22.50 after hearing of this.

1. The decision to accept the special order increased/(decreased operating profit by __________.
Handout #7 LGM
Relevant Cost
 
Prioritizing Constrained/Scarce Resources

Problem A. PCR Corporation manufactures three different products – PPP, CCC, and RRR. The production
department had met all demand requirements for the current month and has the opportunity to produce
additional units of products with its excess capacity. Unit selling prices and costs are as follows:
PPP CCC RRR
Selling price P58 P65 P80
DM 16 20 19
DL (P10 per DL hour) 10 15 20
VOH 8 12 16
FxOH 15 10 20

Variable overhead is applied on the basis of direct labor cost, while fixed overhead is applied on the basis of
machine hours (P5 per machine hour). There is sufficient demand for the additional production of any model in
the product line.

Case A.1: If there is excess capacity, and no limitation in resources, wo which product/s should PCR
devote its excess production?

Case A.2: If it has excess machine capacity but a limited amount of labor time, to which product/s should
PCR devote its excess production?

Case A.3: If it has excess amount of labor time but limited machine capacity, to which product/s should
PCR devote its excess production?

Problem B. PCR Corporation manufactures two different products – SSS and RRR. The following information are
available:
SSS RRR
Revenue P130 P80
Variable cost (70) (38)

Total demand for SSS is 16,000 units and for RRR is 8,000 units. Machine hours is a scarce resource. Only 42,000
machine hours are available during the year. SSS requires 6 machine hours per unit while RRR requires only 3
machine hours per unit.

1. How many units of SSS and RRR should the company produce?

Problem C. PCR Corporation compiled the following information pertaining to its two products – PPP and BBB:
PPP BBB
DM P6 P11
DL 4 9
OH (@16 per hour) 16 32

Cost if purchased from an outside supplier P20 P38

Annual demand 20,000 units 28,000 units

Past experience has shown that the fixed manufacturing overhead component included in the cost per machine
hour averages P10. The company has a policy of filling all sales order, even if it means purchasing units from an
outside supplier

1. If 50,000 machine hours are available, and the company desires to follow an optimal strategy, how many
units of each product should it produce/buy?
Handout #7 LGM
Relevant Cost
 
Continue or Discontinue/ Keep or Drop a Division Line

*avoidable costs
*financial impact on the other division lines

**allocated common costs are unavoidable costs

Problem A. COD Corporation has three product lines – KKK, OOO, and DDD. Due to concerns regarding its
profitability, COD is considering dropping OOO. The following are the segmented income statements of the three
product lines:
KKK OOO DDD Total
Sales P300,000 P200,000 P250,000 P750,000
Variable costs (90,000) (100,000) (100,000) (290,000)
Contribution margin 210,000 100,000 150,000 460,000
Direct/Traceable fixed costs (50,000) (60,000) (70,000) (180,000)
Segment margin 160,000 40,000 80,000 180,000
Allocated common cost (90,000) (60,000) (75,000) (225,000)
Operating income P70,000 P(20,000) P5,000 P55,000

1. What is the impact of dropping OOO on the overall profits of the company?

2. If OOO is in some way a complement for DDD, and closing down OOO will decrease DDD’s sales by 10%,
should the company drop OOO?

3. If OOO is in some way a substitute for DDD, and closing down OOO will increase DDD’s sales by 10%,
should the company drop OOO?

Problem B. COD Company plans to discontinue its KKK department that has a contribution margin of P240,000
and P480,000 in fixed cost. Of the fixed cost, P210,000 can be avoided if KKK is discontinued.

1. What is the effect of the discontinuation of KKK on COD’s overall net operating income?

Problem C. COD Company is deciding whether or not to eliminate the KKK Segment of its business. KKK Segment
generates total sales of P104,000, its direct expenses are P22,000, and its indirect expenses are P26,000. Its cost of
goods sold is P64,000. Only P6,000 of the direct expenses and P8,000 of the indirect expenses are avoidable.

1. Which of the following statements is false?

a. The segment has a net loss of P8,000
b. The segment is a good candidate for elimination
c. The segment’s revenue is greater than its avoidable costs
d. The segment’s avoidable costs are greater than unavoidable costs
Handout #7 LGM
Relevant Cost
 
Shut Down or Continue Operations

*avoidable costs
*startup costs

Problem A. SDC Corporation has been experiencing a slowdown in business activities in August and September
and is considering shutting down its operations during those months. The accounting department has provided
the following normal operating data for considerations:

Regular sales in units 10,000 units per month

Estimates sales in units during August and September 5,000 units per month

Units sales price P150

Unit variable production costs 60
Unit variable selling costs 10

Monthly fixed overhead P500,000

Monthly fixed administrative expense P200,000

If the company shuts down its operations, the following costs are expected to be incurred:

Additional Security and Safety P200,000 per month

Restart-up cost P100,000 per set up
Retained regular fixed overhead 40% of the total will be retained
Retained regular administrative expense Will be reduced by 30%

1. How much is the total shutdown cost?

2. Should the company shut down or continue its operations?

3. What is the shutdown point?

Problem B. SDC Company is a supplier of food products. It normally sells 30,000 units per month. One unit normally
sells for P22, with variable costs per unit of P14, fixed overhead of P150,000 per month, and fixed administrative of
P30,000 per month.

Because of CoViD-19 Enhanced Community Quarantine, SDC’s sales are expected to drop to 9,000 units per
month. The lockdown period is expected to last for 2 months. Being a supplier of an essential good, SDC has a
choice whether it would continue or shutdown during this 2-month period. Should the company choose to
temporarily shut down, its estimated fixed overhead cost can be reduced to P105,000 per month, and its fixed
administrative cost can be reduced by 10%. Start-up cost at the end of the quarantine period is estimated to
total P8,000.

1. In a strictly financial sense, should the company shut down or continue its operations?

2. In a strictly financial sense, at what level of sales (in units) for the two month period should the company
feel indifferent between shutting down and continuing its operations?
Handout #7 LGM
Relevant Cost
 
Sell at Split-off or Process Further

*incremental costs
*opportunity costs

Problem A. SOP Corporation’s cost to manufacture an unfinished unit is P40 (P30 variable and P10 fixed). The
selling price for an unfinished unit is P50. The company has unused production capacity and has determined that
units could be finished and sold for P65 with an increase in variable costs of 40%.

1. How much is the additional net income per unit to be gained by finishing the unit?

Problem B. SOP Corporation produces two products from a joint process. Information are provided:
Product AAA Product BBB
Anticipated production 2,000 units 4,000 units
Selling price per unit at split-off P30 P16
Additional processing cost per unit 15 30
after split off
Ultimate selling price 40 50
Joint cost P85,000

Currently, the company sells both products AAA and BBB at split-off.

1. If the company makes the decision which maximizes profit, its profits will increase by ______.

Problem C. SOP Corporation schedules its weekly production of 15,000 units of Product X and 30,000 units of
Product Y for which P800,000 common variable costs are incurred. These two products can be sold as is or
processed further. Further processing of either product does not delay the production of subsequent batches of
the joint products. Below are the information gathered:
Product X Product Y
Unit selling price without further processing P25 P19
Unit selling price with further processing 31 23
Total separate weekly variable costs of further 100,000 110,000
processing

1. To maximize the company’s contribution margin, the total separate variable costs of further processing
that should be incurred each week should amount to?