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DIFFERENTIAL COST ANALYSIS

Differential Cost Analysis – is a managerial approach which attempts to determine
and make use of only relevant and objective costs in a business decision.

DECISION MAKING PROCESS

1. Defining the problem
2. Setting of criteria
3. Identifying the alternative courses of action
4. Determination of possible consequences of the alternatives
5. Evaluating the alternatives
6. Choosing the best alternative and making the decision.

SHORT-TERM NON-ROUTINE DECISIONS (AIMS CUCO)

1. Accept or reject a special order
2. Insource or outsource of a certain production process
3. Make or buy a part, subassembly or product line
4. Sell or process further a product
5. Continue or discontinue a business segment
6. Utilization of scarce resources
7. Change in profit factors.
8. Optimal product combination
APPROACHES IN DECISION MAKING

Total Approach – the total revenues and costs are determined for each alternative,
regardless of relevance, and the results are compared to serve as bases for making
decisions.

Differential Analysis – only considers relevant data in decision making in ascertaining

the best course of action in a decision making.

DEFINITION OF TERMS

Relevant Costs – future costs that are expected to be different under each alternative
course of action.
Differential Costs – the discrepancy in total costs between two alternatives.
Opportunity Costs – the benefit lost by taking one action as opposed to another.
Avoidable Costs – costs that will be saved or those that will not be incurred if a certain
decision is made.
Committed Costs – costs resulted from a binding contract or from other sources cannot
be easily reversed without any substantial losses to the company.
Postponable Costs – costs that may be deferred or shifted to a future date or period of
time without adversely affecting current operations.
Out-of-Pocket-Costs – costs that require current or near future cash outlays or incurring
of a liability for a decision at hand
Sunk Costs – refer to the non-recoverable costs incurred in the past
Joint Costs – costs incurred in simultaneously processing or manufacturing two or more
products which are difficult to identify individually as separate types of products until a
certain processing stage known as the point of separation or split-off point.
Allocated Costs – costs that are allocated across products or departments either through
traditional or activity-based costing, which are not usually eliminated even upon the
cessation of a product or department.

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MULTIPLE CHOICE (THEORIES)

1. Which of the following requires decision making?

a. Budgeting
b. Change in profit factors.
c. Investment in additional machineries in the plant facility
d. All of the above

2. What is the proper hierarchy of decision-making process?

i. Setting up the decision making benchmarks
ii. Problem definition
iii. Choosing the best alternative and making the decision.
iv. Identifying the alternative courses of action
v. Screening and evaluation of the alternative as against the benchmarks
vi. Determination of quantitative and qualitative impact of the alternatives

a. ii – i – iv – vi – iii – v
b. ii – i – iv – vi – v – iii
c. ii – iii – i – iv – vi –v
d. ii – i – vi – iv – v – iii

3. The following approaches can be used in solving decision making problems

Approach 1: Incremental Approach
Approach 2: Total Approach

a. Only approach 1
b. Only approach 2
c. Both approaches 1 and 2
d. None of the approaches

4. Which the following is false regarding differential analysis?

a. involves finding the most profitable alternative by analyzing the differential
revenues and costs.
b. the total revenues and costs are determined for each alternative, and the results
are compared to serve as bases for making decisions.
c. Only relevant costs and revenues are considered in the decision making
d. Not all future costs are included in the determination of relevant costs under each
alternative.

5. Which of the following is required attribute of a relevant cost?

Attribute 1: Future cost
Attribute 2: Different under each alternative

a. Only attribute 1
b. Only attribute 2
c. Both attributes 1 and 2
d. None of the choices

6. Which the following is always relevant in decision making?

a. costs that are incurred in the past
b. costs that will be avoided if a certain decision is made
c. future revenues/costs that are expected to be different under each alternative
course of action
d. the benefit lost by taking one action as opposed to another. The “other” action is
the best alternative available other than the one being contemplated

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7. Which the following is always irrelevant in the decision making process?
a. Recoverable costs incurred in the past
b. plant-wide costs to be allocated to a certain product-line or department
c. assumed or hypothetical costs representing the costs or value of a resource already
incurred and cannot be recovered in the future
d. costs to be incurred in simultaneously processing or manufacturing two or more
products which are difficult to identify individually as separate types of products until
a certain processing stage known as the point of separation or split-off point

8. Which the following may be relevant in the decision-making process?

a. Tuition fees paid in college
b. Cost of wedding reception for your college crush
c. The cost of review books you purchased in Recto
d. Cost of cellphone gifted by your parents

9. Sunk costs
a. are always arising from committed costs.
b. are relevant to long-term decisions but not to short-term decisions.
c. are relevant to decision making.
d. in and of themselves are not relevant to decision making.

10. The measurable value of an alternative use of resources is referred to as

a. Opportunity costs
b. Measurable costs
c. Differential costs
d. Sunk costs

11. Opportunity costs are usually

a. Relevant and journalized in the original books of entry
b. Not relevant but journalized in the original books of entry
c. Relevant but not recorded in the original books of entry
d. Ignored in decision making and accounting process

12. Costs that do not appear in accounting records and do not require peso outlays, but
do involve a foregone opportunity by the entity whose costs are being measured
a. Conversion costs
b. Imputed costs
c. Differential costs
d. Sunk costs

13. Which of following is considered in determining the relevant cost to make in a make or
buy decision making?
1. Direct materials used to produce the product
2. Direct labor cost of producing the product
3. Purchase price of the finished product
4. Labor cost of the inventory custodian
5. Depreciation of the equipment used in producing the goods
6. Electricity and maintenance costs of the equipment used in producing the goods
7. Profit from sale of the equipment

a. 1, 2, 5, 6, 7
b. 3, 4, 7
c. 1, 2, 4, 6, 7
d. 1, 2, 4, 5, 6, 7

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14. Which of the following is not to be considered in the decision making related to a special
sales order from a third party?
a. Variable manufacturing costs related to the product
b. Electricity costs for the equipment which has been operating in excess of normal
capacity to accommodate the special sales
c. Contribution margin from existing customers
d. Contribution margin from existing customers sacrificed to cover the required special
order amidst full production capacity.

15. Which of the following are considered in determining the minimum price that is
acceptable in an accept or reject a special-sales order decision making?
1. Variable manufacturing costs to produce the product
2. Conversion costs to produce the product
3. Additional costs related to customization
4. Contribution margin of lost sales to accommodate the special sales order
5. Cost of the special equipment required to extend the capacity to cater the special
sales order
6. Cost of outsourcing to accommodate the special sales order when a certain
production line is currently operating at full capacity
7. Electricity costs of the production facility already operating in excess of normal
hours
8. Special sales price
9. Original selling price

a. 1, 2, 3, 4, 5, 6, 7
b. 1, 2, 3, 5, 6, 9
c. 1, 3, 4, 5, 6, 7
d. 1, 3, 4, 5, 6, 9

16. Which of the following statements is/are true?

Statement 1: At full capacity, the minimum selling price for the special order is
equal to the original selling price of the product to be sold if there are sales from
original customers sacrificed.
Statement 2: The opportunity costs of using the idle capacity is considered in the
determination of minimum selling price for a special order

a. Statement 1 only
b. Statement 2 only
c. Both statements 1 and 2
d. None of the statements

17. Which of following is/are relevant in a sale or process further decision making?
1. Variable costs to produce the product
2. Variable costs of further processing
3. Fixed manufacturing costs to produce the product
4. Allocated fixed manufacturing cost of further processing
5. Sales value at split-off point
6. Sales value after further processing
7. Joint cost before split-off point

a. 1, 2, 5, 6
b. 1, 2, 5, 6, 7
c. 2, 4, 5, 6
d. 2, 5, 6

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18. Which of the following is the most relevant in determining whether a segment should
be continued or discontinued?
a. Contribution margin
b. Controllable margin
c. Manufacturing margin
d. Segment margin

19. Which formula represents segment margin using the following items:
1. Sales
2. Variable manufacturing costs of product sold
3. Variable selling and administrative expenses
4. Direct controllable fixed costs
5. Direct non-controllable fixed costs
6. Other indirect departmental costs
7. Company-wide allocated fixed costs

a. 1–2–3
b. 1–2–3–4
c. 1–2–3–4–5
d. 1–2–3–4–5–6–7

20. In analyzing whether to discontinue an unprofitable local branch, the salary of the
President at the corporate headquarters is:
a. relevant because the President is the top most decision making personnel of the
company.
b. relevant because this will probably change if the branch is discontinued
c. irrelevant since a certain percentage of the lost profit is charge against the
manager of the branch and not to the President.
d. irrelevant because it is a future cost that will not differ between the alternatives
under consideration

21. Which of the following is false regarding shutdown point?

a. It is the point at which sales activity results to revenue equals costs
b. Lies below the x-axis in a profit line graph
c. Can be presented as a percentage, total amount and unit basis
d. Shutdown costs is irrelevant

22. Which of following is considered in determining the shutdown costs?

1. Total fixed costs
2. Continuing fixed costs despite the shutdown
3. Start-up costs

a. 1 only
b. 1 and 2
c. 2 and 3
d. 1, 2 and 3

23. In an operation experiencing bottlenecks in a specific resource, it is advisable to focus

on the sale of product which has?
a. Highest revenue per unit of scarce input
b. Highest contribution margin per direct labor hours
c. Lowest cost per unit
d. Highest contribution margin per unit of scarce input

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PROBLEM 1
Mother: Baby, me and your dad already lost our job due to pandemic. I am sorry but we
can’t afford your CPA review anymore, huhu.

Daughter: Mom, it’s alright, I’ll do my best to help you.

With the sad news brought by your parents, you’ve decided to consider working to ease
their burden. You checked your savings and noted that you still have a measly amount of
P2,000. You felt hopeless that time and already in the midst of giving up your dream to
become CPA someday since most accounting review schools charge P13,000 as tuition
fee. Two days later, you were notified by your crush that a certain organization of CPA
reviewers launched a charitable institution to help all CPA hopefuls revive their dream to
become CPA amidst the pandemic. The participation fee based on their announcement
is around P3,500 but based on your qualification as a Cumlaude graduate, you will only
need to pay as low as P1,500 only for the 6-month review for the CPA Board Examination.
In deciding the whether to take the review, you listed the following monthly costs
(excluding participation fee) under the two independent alternatives:
Study Work
Internet fee ₱1,500 ₱2,500
Food 1,000 1,500
Electricity costs 250 1,200
Miscellaneous 500 1,000

Since most companies allow work from home arrangement, your expected expenses
related to electricity increases substantially. The minimum monthly wage that you can
earn is P14,000.

REQUIRED:
1. Supposing you can only choose one of the alternatives (study or work), determine the
following:
a. Total relevant costs to Study
b. Total relevant costs to Work

2. Supposing you are contemplating to do the review and working at the same time, what
is the net opportunity costS?

PROBLEM 2
Sour Bucks Inc. operates a coffee shop for its employees. The operation of the coffee
shop requires fixed costs of P80,000 per month and variable costs of 45% of the service
revenue. Sour Bucks service revenue are currently averaging P200,000 per month. The
company has the opportunity to replace the coffee shop with vending machines. Gross
customer spending at the vending machines is estimated to be 30% greater than the
current sales because the machines are available at all hours. By replacing the cafeteria
with vending machines, the company would receive 20% of the gross customer spending
and avoid all variable costs and 60% of the monthly fixed costs. The excess space can
be rented to an outside party for a monthly rent of P15,000.

REQUIRED:
1. Monthly income from the coffee shop (before shifting to vending machines)
2. Net annual opportunity cost if the coffee shop is to be discontinued.
3. Increase (decrease) in monthly profit as a result of replacing the coffee shop with
vending machines.

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PROBLEM 3
In my opinion, we already need to stop making our own trash bin and accept that outside
supplier’s offer,” said Levi Ackerman, managing director of Survey Corp. “At a price of
P5 per trash bin, we would be paying P1.50 less than it costs us to manufacture the bin
in our own plant facility. Since we produce 250,000 trash bins a year, that would be an
annual cost savings of P375,000.” Survey Corp’s present cost to produce a unit of trash
bin is provided below (based on 250,000 trash bins annually):

Direct material P2.35

Direct labor 1.50
Variable overhead 1.25
Fixed overhead
General 0.40
Depreciation 0.60
Supervision 0.40 1.40

Unit costs P6.50

A decision about whether to make or buy the bin is especially important at this time since
the machinery being used to make the trash bin is completely worn out and must be
replaced. The choices facing the company are:

OPTION 1: Purchase new machinery and continue to make the trash bin. The machinery
would cost P400,000; it would have a five-year useful life and no salvage value. The
company uses straight-line depreciation.

OPTION 2: Purchase the trash bin from an outside supplier at P5 per bin under a five-
year contract.

The new machinery would be more efficient than the machinery that Survey Corp. has
been using and, according to the manufacturer, would reduce variable conversion costs
by 20%. The old equipment has no resale value. Supervision cost (P100,000 per year)
and direct materials cost per bin would not be affected by the new equipment. The new
equipment’s capacity would be 400,000 bins per year. The company has no other use
for the space being used to produce the bins. The company’s total general company
overhead would be unaffected by this decision.

REQUIRED:
1. Assuming the planned capacity is to be maintained at 250,000 bins annually, which
course of action would you recommend to the managing director? What is the net
benefit of choosing the better course of action?

2. Would your recommendation in number 1 above be the same if the company’s needs
were 400,000 trash bins per year?

3. At planned capacity of 250,000 trash bins, at what percentage should the new
machinery be more efficient than the existing machinery to be indifferent in the
decision alternatives.

4. Refer to the information in number 1 but assuming the idle space can be rented for
100,000 annually and the cost of raw materials was reduced to P1.50 per unit, which
course of action would you recommend to the managing director? What is the net
benefit of choosing the better course of action?

5. Using the information given in number 4 above, compute for the maximum price per
unit that the company can accept from the outside supplier.

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PROBLEM 4
Yaeger Incorporated manufactures and sells a single product called Titan. Operating at
capacity, the company can produce and sell 50,000 Titans per year. Costs associated
with this level of production and sales are given in the next page. The Titans normally
sell for P100 each. Fixed manufacturing overhead is constant at P450,000 per year within
the range of 40,000 through 50,000 Titans per year.

Unit Total
Direct materials P30 P1,500,000
Direct labor 16 800,000
Variable manufacturing overhead 6 300,000
Fixed manufacturing overhead 18 900,000
Variable selling expense 8 400,000
Fixed selling expense 12 600,000
Total cost P90 P4,500,000

REQUIRED:
1. Assume that due to a recession, Yaeger expects to sell only 40,000 Titans through
regular channels next year. A large wholesaler has offered to purchase 10,000 Titans
if Yaeger is willing to accept a 20% discount off the regular price. There would be no
sales commissions on this order; thus, variable selling expenses would be slashed by
60%. However, Yaeger would have to purchase a special machine to meet the
specifications of the wholesaler on the 10,000 units. This machine would cost
P48,000. Yaeger Company has no assurance that the wholesaler will purchase
additional units any time in the future. Determine the impact on profits next year if this
special order is accepted.

2. Refer to the original data. Assume again that Yaeger expects to sell only 40,000
Titans through regular channels next year. One organization would like to make a
one-time purchase of 10,000 Titans. The organization would pay a fixed fee of P24.50
per Titan, and in addition it would reimburse Yaeger for all relevant production costs
associated with the units. Since the organization would pick up the Titan with its own
trucks, there variable selling expenses will decrease to 5%. If Yaeger accepts the
order, by how much will profits be increased or decreased for the year?

3. Assume the same situation as that described in (2) above, except that the company
expects to sell 45,000 Titan through regular channels next year. Thus, accepting the
organization’s order would require giving up regular sales of 5,000 Titan. If the
organization’s order is accepted, by how much will profits be increased or decreased
from what they would be if the 5,000 Titan were sold through regular channels?

4. Assume the same situation as that described in (3) above, except that Yaeger will
outsource the insufficient capacity of 5,000 units from a related party at P20 per unit
plus a fixed amount of P150,000 instead of sacrificing the sales from the regular
channels. What is the increase (decrease) in the profit?

5. Compute the minimum selling price Yaeger will accept under the requirements 1, 2, 3
and 4.

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PROBLEM 5
ARMIN Inc. produces Products W, X, Y and Z through a joint process. Products W, X and
Y can be processed further in Product A, B and C, respectively while Product Z is sold at
split-off point. Sales value and cost data are as follows:
W X Y Z
Sales value after further processing P40 P50 P100 P-
Sales value at split-off 24 20 75 16
Cost of further processing 20 24 30 -
Number of units 4,000 6,000 5,000 10,000

Joint costs amounted to P125,000. The Company uses net realizable method as the basis
of allocating joint cost.

REQUIRED:
1. Which product should be sold at split off point?
2. Which product should be processed further?
3. Supposing the company made the right decision, what is its net profit?

PROBLEM 6
Mikasa Corp. manages five branches of Filipino restaurants in the Metro Manila. Shown
below are the condensed income statements for each restaurants:
Manila Pasay Makati A Makati B BGC
Revenue P20,000 P24,200 P46,940 P37,560 P21,300
Expenses 16,000 26,000 52,000 48,000 26,000
Profit P4,000 (P1,800) (P5,060) (P10,440) (P4,700)

Included in the expenses is P24,000 of corporate overhead allocated to the restaurants

based on the revenue.

REQUIRED:
1. Which restaurant/s should the company consider closing?

2. Refer to requirement number 1, what is the increase in profit if the company made
the appropriate decision

3. Refer to requirement number 2, but closing the appropriate branches will result to an
increase in Makati A’s direct margin of 30% since some loyal customers that love
Mikasa’s dishes will shift to Makati A branch. This will result to an increase in profit
amounting to

4. Refer to the original information but instead of closing some of the branches, the
company decided to invest additional P15,000 for advertisements which is expect to
boost the sales of the unprofitable branches by 40%. Should the company continue
its plan to invest for advertisements for its unprofitable branches supposing it uses a
firm-wide contribution margin ratio of 70%?

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PROBLEM 7
Erwin Digital, Inc. is a leading manufacturer and retailer of digital devices and various
gadgets in the national capital region. It normally sells 25,000 units of devices monthly at
average price of P57.50. Annual cost data is as follows:
Variable cost per unit P40
Fixed cost 2,400,000

40% of the total variable costs represents selling costs while 70% of the total fixed costs
represents the fixed production costs. In March 2020, the government announced the
Enhanced Community Quarantine (MECQ) which requires the partial closure of various
business establishments of which Erwin Digital was included. The quarantine is expected
to last from April 1 to June 30. During this period, sales are only expected to be at 10,000
units per month. Further, due to strict guidelines by the pandemic task force,
rehabilitations and installation of health safety is expected to be P50,000 monthly, should
the company decided to operate during the quarantine. Should the company opted to
close its stores temporarily, it is expected that fixed production cost will decrease by 75%
while the remaining fixed costs will be reduced to 65%. Start-up costs will be at P75,000
upon resuming the operation after the quarantine
REQUIRED:
1. What would be the peso advantage or disadvantage of closing the plant during the
3-month period?
2. Compute for the shutdown point in units

PROBLEM 8

Annie Corporation produces three products: A, B, and C, all of which are made from the
same material. It has been using traditional absorption costing system in allocating
overhead to its products since the start of its operations. Information for the three products
for the last year is as follows:

Product A Product B Product C

Demand in units 15,000 12,000 18,000
Selling price per unit P75 P120 P130
Direct material usage (kg) per unit 2 3 4
Direct labor hours per unit 0.10 0.15 0.20
Machine hours per unit 0.50 0.70 0.90

The price of raw materials remained constant throughout the year at P12.00 per kg.
Similarly, the direct labor cost for the whole workforce was P120 per hour. Overhead are
applied at P60 per machine hours.

REQUIRED:
Determine the optimal product combination under each independent bottleneck scenario:
1. Total direct materials available for use is only 100,000 kilograms
2. Total direct labor hours for the coming period only 5,000 hrs.
3. Total machine hours for the coming period is only 25,000 hrs

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