Horngren ch06

CHAPTER 6
RELEVANT INFORMATION AND DECISION MAKING: PRODUCTION DECISIONS
Learning Objectives
1. Use opportunity cost to analyze the income effects of a given alternative.

2. Decide whether to make or to buy certain parts or products.
3. Decide whether a joint product should be processed beyond the split-off point.
4. Identify irrelevant information in disposal of obsolete inventory and equipment
replacement decisions.
5. Explain how unit costs can be misleading.
6. Discuss how performance measures can affect decision making.
7. Construct absorption and contribution format income statements and identify
which is better for decision making.
True/False:
1. Opportunity costs need to be considered when deciding on the use of limited

resources.
2. Opportunity cost depends on alternatives available at a point in time.
3. Opportunity costs and outlay costs are widely used synonyms.
4. The opportunity cost of facilities idled as a result of a make-or-buy decision is

zero.
5. Outsourcing is a make-or-buy decision for services.
6. Qualitative factors may affect a make-or-buy decision.
7. Separable costs are part of a joint process and cannot be exclusively identified
with individual products.
8. The split-off point is the juncture in manufacturing where the joint products
become individually identifiable.
9. The relevant information for a sell or process further decision includes the costs
incurred before the split-off point.
F (L.O. 3, easy)
10. It is profitable to extend processing or to incur additional distribution

costs on a joint product if the additional revenue exceeds joint cost.
F (L.O. 3, easy)
11. The disposal value of old equipment is relevant.
12. Sunk cost is another term for historical cost or past cost.
13. When making a decision to replace some old equipment with new, the
depreciation taken on both the old or new equipment is irrelevant information.
188
14. In practice, sunk costs often influence important decisions, especially when a
decision maker doesn't want to admit that a previous decision was a bad decision.
15. Future costs are relevant if they are the same under all feasible alternatives.
16. Only unit costs computed using the same denominator level of production should
be compared.
17. Conflicts in the decision making process can arise when superiors evaluate a
manager's performance using a model consistent with the decision model.
18. The absorption approach to the income statement is used by companies for
external financial reporting.
19. The absorption approach emphasizes the distribution between fixed and variable
costs.
20. The contribution margin is computed using variable manufacturing costs and
variable selling and administrative costs.
Multiple Choice:
21. A homeowner has paid off the mortgage on his house and continues to live in the
house. The interest income foregone by not selling the house and investing the
proceeds is an example of a(n)
a. sunk cost.
b. detrimental cost.
c. opportunity cost.
d. outlay cost.
L.O. 1 Moderate
189
22. Opportunity cost
a. is the contribution of the best alternative that is excluded from consideration.
b. applies to resources owned by the company.
c. is the cost of resources owned by the company.
d. all of the above.
L.O. 1 Easy
23. Opportunity cost is specifically mentioned in

a. a differential cost analysis.
b. an opportunity cost analysis.
c. both of the above.
d. neither. Opportunity cost is not relevant for decision making.
L.O. 1 Easy
24. War Eagle Mill paid $120,000 for a machine used to mill wheat flour. The annual
contribution margin from wheat flour sales is $50,000. The machine could be
sold for $80,000. The opportunity cost of producing wheat flour is L.O. 1
a. $100,000.
b. $80,000.
c. $50,000.
d. $30,000.
L.O. 1 Easy
25. The salary foregone by a person who quits a job to start a business is an example
of a(n)
a. sunk cost.
b. opportunity cost.
c. depreciable cost.
d. outlay cost.
L.O. 1 Easy
26. Karen is considering leaving her current position to open a tea shop. Karen’s
current salary is $45,000. Annual tea shop revenue and costs are estimated at
$250,000 and $210,000 respectively.
What is the outlay cost associated with the decision to open the tea shop?
a. $45,000
b. $210,000
c. $255,000
d. $40,000
L.O. 1 Moderate
190
What is the opportunity cost of opening the tea shop?

a. $45,000
b. $210,000
c. $255,000
d. $40,000
L.O. 1 Moderate
28. Karen is considering leaving her current position to open a tea shop. Karen’s current
salary is $45,000. Annual tea shop revenue and costs are estimated at $250,000
and $210,000 respectively.
What is the opportunity cost of remaining employed?

a. $45,000
b. $210,000
c. $255,000
d. $40,000
L.O. 1 Moderate
If Karen decides to open the tea shop, the change in Karen’s annual income
would be
a. $5000
b. ($5000)
c. $250,000
d. $40,000
L.O. 1 Moderate
191
30. Bull Company manufactures a part for its production cycle. The costs per unit
for 5,000 units of this part are as follows:
Direct materials $3
Direct labor 5
Variable factory overhead 4
Fixed factory overhead 2
Total costs $14
The fixed factory overhead costs are unavoidable.
Heat Corporation has offered to sell 5,000 units of the same part to Bull
Company for $13 a unit. Assuming no other use for the facilities, Bull Company
should:
a. buy from Heat as this would save $1 per unit.
b. make the part as this would save $1 per unit.
c. buy from Heat as this would save $5 per unit.
d. make the part as this would save $5 per unit
L.O. 2 Moderate
Direct materials $3
Direct labor 5
Total costs $14
Assuming no other use of their facilities, the highest price that Bull Company
should be willing to pay for the part is
a. $12.
b. $14.
c. $8.
d. $11.
L.O. 2 Moderate
192
Direct materials $3
Direct labor 5
Total costs $14
Assume that Bull Company has been offered 5,000 units of the part from another
producer for $15 each. The facilities currently used to make the part could be
rented out to another manufacturer for $20,000 a year. Bull Company should
a. make the part as that would save $1 per unit.
b. buy the part as that would save $3 per unit.
c. buy the part as that would save $1 per unit.
d. make the part as that would save $3 per unit.
Direct materials $3
Direct labor 5
Total costs $14
Assume that Bull Company has been offered 5,000 units of the part from another
producer for $14 each. The facilities currently used could be used to make 5,000
units of a product that would contribute $5 a unit to fixed expenses. No
additional fixed costs would be incurred. Bull Company should
a. make the new product and buy the part to earn an extra $3 per unit
contribution to profit.
b. make the new product and buy the part to earn an extra $1 per unit
c. continue to make the part to earn an extra $1 per unit contribution to profit.
d. continue to make the part to earn an extra $3 per unit contribution to profit.
193
34. Herbert Company manufactures a part for its production cycle. The costs per
unit for 10,000 units of this part are as follows:
Direct materials $20

Direct labor 15
Total costs $61
P. Forresterips Company has offered to sell 10,000 units of the same part to
Herbert Company for $55 a unit. Assuming no other use for the facilities,
Herbert Company should
a. make the part as this would save $4 per unit.
b. buy from P. Forresterips as this would save $6 per unit.
c. make the part as this would save $6 per unit
d. buy from P. Forresterips as this would save $4 per unit.
L.O. 2 Moderate

Direct labor 15
Total costs $61
Assuming no other use of their facilities, the highest price that Herbert Company
should be willing to pay for the part is
a. $41.
b. $35.
c. $45.
d. $51.
L.O. 2 Moderate
194

Direct labor 15
Total costs $61
Assume that Herbert Company can buy 10,000 units of the part from another
producer for $60 each. The facilities currently used to make the part could be
rented out to another manufacturer for $100,000 a year. Herbert Company
should
a. buy the part as that would save $2.50 per unit.
b. buy the part as that would save $1 per unit.
c. make the part as that would save $2.50 per unit.
d. make the part as that would save $1 per unit.
L.O. 2 Moderate

Direct labor 15
Total costs $61
Assume that Herbert Company can buy 10,000 units of the part from another
producer for $56 each. The current facilities could be used to make 10,000 units
of a product that has a contribution margin of $20 per unit. No additional fixed
costs would be incurred. Herbert Company should
a. make the new product and buy the part to earn an extra $5 per unit
b. continue to make the part to earn an extra $5 per unit contribution to profit.
c. continue to make the part to earn an extra $15 per unit contribution to profit.
d. make the new product and buy the part to earn an extra $15 per unit
L.O. 2 Moderate
195
38. Cooper Company currently produces a key part at a total cost of $210,000.
Variable costs are $170,000. Of the fixed cost, $10,000 relate specifically to this
part. The remaining fixed costs are unavoidable.
Another manufacturer has offered to supply the part for $190. The facilities
currently used to manufacture the part could be used to manufacture a new
product with an expected contribution margin of $30,000. Alternately, the
facilities could be rented out at $60,000.
Given all of these alternatives, what is Cooper’s lowest net cost for the part?
a. $170,000
b. $180,000
c. $190,000
d. $130,000
L.O. 2 Moderate
39. Cooper Company currently produces 10,000 units of a key part at a total cost of
$210,000. Variable costs are $170,000. Of the fixed cost, $10,000 relate
specifically to this part. The remaining fixed costs are unavoidable.
Another manufacturer has offered to supply the part for $190 per unit. The
facilities currently used to manufacture the part could be used to manufacture a
new product with an expected contribution margin of $30,000. Alternately, the
What is the opportunity cost to Cooper for making the part?

a. ($20,000)
b. $60,000
c. $50,000
d. ($10,000)
L.O. 2 Moderate
40. Trey Company currently produces 10,000 units of a key part at a total cost of
Given all of these alternatives, what is Trey’s lowest net cost per unit for the part?
a. $300
b. $480
c. $420
d. $440
L.O. 2 Moderate
41. Trey Company currently produces 10,000 units of a key part at a total cost of
196
Given all of these alternatives, what is Trey’s lowest net cost per unit for the
What is the opportunity cost to Trey to make the part

a. $60,000
b. $30,000
c. $480,000
d. $300,000
42. Devlin Company produces a part that is used in the manufacture of one of its
products. The costs associated with the production of 5,000 units of this part are
as follows:
Direct materials $108,000
Direct labor 156,000
Variable factory overhead 72,000
Fixed factory overhead 168,000
Total costs $504,000
Of the fixed factory overhead costs, $72,000 are avoidable.
Sundvold Company has offered to sell 5,000 units of the same part to Devlin for
$86.40 per unit. Assuming there is no other use for the facilities, Devlin should
a. make the part as this would save $14.40 per unit.
b. buy the part as this would save $14.40 per unit.
c. buy the part as this would save the company $72,000.
d. make the part as this would save $4.80 per unit.
L.O. 2 Moderate
197
43. Devlin Company produces a part that is used in the manufacture of one of its products.
The costs associated with the production of 5,000 units of this part are as follows:

Assuming no other use of their facilities, the highest price that Devlin should be
willing to pay for 5,000 units of the part is
a. $504,000.
b. $336,000.
c. $408,000.
d. $288,000.
L.O. 2 Challenging
as follows:

Assume that Devlin can buy 5,000 units of the part from another producer for
$105.60 each. The facilities currently used to make the part could be rented out
to another manufacturer for $96,000 a year. Devlin should
a. make the part as that would save $19.20 per unit.
b. make the part as that would save the company $24,000.
c. buy the part as that would save $14.40 per unit.
d. buy the part as that would save the company $96,000.
L.O. 2 Moderate
198
as follows:

Assume that Devlin can buy 5,000 units of the part from another producer for
$100.80 each. The current facilities could be used to make 5,000 units of a
product that has a contribution margin of $24 per unit. Fixed factory overhead
costs to produce this new product would be exactly the same as for the currently
produced part. Devlin should
a. continue to make the part and earn an extra $48,000 in profit.
b. buy the part and produce the new product and earn an extra $4.80 per unit
c. continue to make the part and earn an extra $4.80 per unit contribution to
profit.
d. buy the part and produce the new product and earn an extra $24 per
unit contribution to profit.
L.O. 2 Moderate
46. A key factor in a make or buy decision is

a. whether or not there are idle facilities.
b. the amount of the sunk costs.
c. gain or loss on the disposal of equipment.
d. the total joint costs.
L.O. 2 Easy
47. Which of the following is a qualitative factor of a make-or-buy decision?

a. variable manufacturing costs.
b. avoidable costs.
c. long term relationship with suppliers.
d. opportunity costs.
L.O. 2 Easy
48. Future costs are relevant in decision making when

a. they exceed future revenues.
b. they are not based on estimates.
c. they differ between alternatives.
d. they are the same between alternatives.
L.O. 2 Easy
199
49. Which of the following would be a consideration in a make or buy decision?
a. excess capacity
b. variable factory overhead
c. rental income from unused facilities
d. all of the above
L.O. 2 Easy
50. If a company has excess capacity, the most it would pay for buying a product that
it currently makes would be the
a. total cost of producing the product.
b. market value of the product.
c. market value less usual markup on the product.
d. total variable cost of producing the product.
L.O. 2 Moderate
51. Hogan Corporation has a joint process which produces three products, M, L and
B. Each product may be sold at split off or processed further and then sold. Joint
processing costs for a year amount to $25,000. Other relevant data are as
follows:
Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion
M $32,000 $5,000 $40,000

L 12,500 6,500 19,000
B 6,400 5,000 10,000
Once product M is produced, processing it further will cause profits to

a. increase by $8,000.
b. decrease by $5,000.
c. decrease by $8,000.
d. increase by $3,000.
L.O. 3 Moderate
200
52. Hogan Corporation has a joint process that produces three products, M, L and B.
Each product may be sold at split off or processed further and then sold. Joint
processing costs for a year amount to $25,000. Other relevant data are as
follows:
Separable
Processing
M $32,000 $5,000 $40,000

L 12,500 6,500 19,000
B 6,400 5,000 10,000
Product L
a. should be processed further to increase profits by $6,500.
b. should be sold at split-off since processing further would only reduce profits
by $6,500.
c. should be processed further to increase profits by $19,000.
d. can be processed further or sold at split-off. There is no difference in
profit.
L.O. 3 Moderate
53. Hogan Corporation has a joint process that produces two products, A and B. Each
product may be sold at split off or processed further and then sold. Joint
processing costs for a year amount to $25,000.
Product A can be sold at split off form $32,000. Alternately, product A can be
processed further and sold for $40,000. Additional processing costs are $5,000.
In deciding whether to sell product A at the split off point or to process further.
Which of the costs is NOT relevant?
a. joint processing cost, $25,000
b. sales value at split off, $32,000
c. sales value at completion, $40,000
d. all of the costs are relevant
L.O. 3 Moderate
201
54. Bermuda Corporation has a joint process which produces three products, X, Y
and Z. Each product may be sold at split-off or processed further and then sold.
Joint processing costs for a year amount to $100,000. Other relevant data are as
follows:
Separable
Processing
X $128,000 $16,000 $160,000

Y 50,000 26,000 76,000
Z 25,600 20,000 40,000
Once product X is produced, processing it further will cause profits to

b. decrease by $16,000.
c. decrease by $32,000.
d. increase by $16,000.
L.O. 3 Moderate
follows:
Separable
Processing
X $128,000 $16,000 $160,000

Y 50,000 26,000 76,000
Z 25,600 20,000 40,000
Product Y
a. should be processed further to increase profits by $26,000.
b. should be sold at split-off since processing further would only reduce profits
by $26,000.
c. should be processed further to increase profits by $76,000.
d. can be processed further or sold at split-off. There is no difference in
profit.
L.O. 3 Moderate
202
follows:
Separable
Processing
X $128,000 $16,000 $160,000

Y 50,000 26,000 76,000
Z 25,600 20,000 40,000
To maximize profits, which products should Bermuda process further?

a. Product Z only
b. Product Y only
c. Product X only
d. Products X, Y and Z
L.O. 3 Moderate
follows:
Separable
Processing
X $128,000 $16,000 $160,000

Y 50,000 26,000 76,000
Z 25,600 20,000 40,000
In processing Product Z further,

a. profits will decrease by $5,600.
b. incremental profits will exceed incremental costs.
c. profits will increase by $20,000.
d. the additional revenue produced will exceed the additional costs.
L.O. 3 Moderate
203
58. Mango Manufacturing Company produces three products using a joint process
which provides for $25,000 in joint costs. The products, A, B and C can be sold
at split-off or processed further and then sold. The production level for each
product is 10,000 units. The following unit information is also available:
Separable
Processing
A $12 $9 $21
B 10 4 17
C 15 6 19
If product A is processed beyond the split-off point, profit will

b. increase by $120,000.
c. increase by 90,000.
d. stay the same
L.O. 3 Moderate
that provides for $25,000 in joint costs. The products, A, B and C can be sold at
split-off or processed further and then sold. The production level for each
Separable
Processing
A $12 $9 $21
B 10 4 17
C 15 6 19
Product B
a. should be processed further as this will increase profits by $70,000.
b. should be sold at split-off to maximize profits.
c. should be processed further to increase profits by $3 per unit.
d. can be processed further or sold at split-off, it makes no difference.
L.O. 3 Moderate
204
product is 10,000 units. The following unit information is also available
Separable
Processing
A $12 $9 $21
B 10 4 17
C 15 6 19
To maximize profits, which products should Mango process further?

a. Product A only
b. Product B only
c. Product C only
d. Products A, B and C
L.O. 3 Moderate
Separable
Processing
A $12 $9 $21
B 10 4 17
C 15 6 19
Product C should be processed beyond the split-off point because

a. incremental revenues will exceed incremental costs.
b. incremental costs exceed incremental revenue.
c. sales value at completion exceeds sales value at split-off.
d. Product C should not be processed beyond the split-off point.
L.O. 3 Moderate
205
Separable
Processing
A $12 $9 $21
B 10 4 17
C 15 6 19
If Mango makes the decisions that maximize profit, Mango’s net income will be
a. $47,000
b. $32,000
c. $30,000
d. $15,000
L.O. 3 Challenging
63. Joint products should be processed beyond the split-off point if

a. incremental expenses exceed incremental revenues.
b. sale of the product is guaranteed.
c. additional net revenue exceeds the sales value at split off.
d. there is a market for the joint products.
L.O. 3 Easy
64. Which of the following is an example of a joint product?

a. Flour
b. Chemicals
c. Lumber
d. All of the above
L.O.3 Moderate
65. _______________ manufacturing costs incurred after the split-off are known as.
a. Joint costs
b. Product costs
c. Split-off costs
d. Separable costs
L.O. 3 Easy
206
66. _______________ is the juncture in manufacturing where the joint products
become individually identifiable.
a. Joint processing juncture
b. Split-off point
c. Common point
d. Significant juncture
L.O. 3 Easy
67. ______________ are costs of manufacturing two or more products that are NOT
separately identifiable as individual products until their split-off point.
a. Separable costs
b. Joint costs
c. Incremental costs
d. Sunk costs
L.O. 3 Easy
68. Which of the following is NOT likely to be relevant in a decision concerning the
disposal of obsolete inventory?
a. Inventory cost
b. Expected future revenues
c. Scrap value of inventory
d. Expected future costs
L.O. 4 Moderate
69. Which of the following is relevant in a decision to replace equipment?

a. Cost of old equipment
b. Book value of old equipment
c. depreciation accrued on old equipment
d. Maintenance costs of old equipment
L.O. 4 Moderate
70. Depreciation is
a. The periodic cost of equipment spread over the future periods in which
the equipment is expected to be used
b. the decline in equipment value due to obsolescence.
c. the difference between the original cost and current market value.
d. all of the above.
L.O. 4 Easy
71. Book value is defined as

a. disposal value.
b. disposal value less accumulated depreciation.
c. cost less accumulation depreciation.
d. disposal value less original cost.
L.O. 4 Easy
207
72. Eudora Company is considering replacing a machine that is presently used in the
production of its product. The following data are available:
Replacement
Old Machine Machine
Original cost $45,000 $35,000

Useful life in years 10 5
Current age in years 5 0
Book value $25,000 -
Disposal value now $8,000 -
Disposal value in 5 years 0 0
Annual cash operating costs $7,000 $4,000
Which of the data provided in the table is irrelevant?

a. the annual operating cost of the old machine
b. the original cost of the replacement machine
c. the disposal value of the old machine
d. the book value of the old machine
L.O. 4 Moderate
Replacement
Old Machine Machine

Which of the data provided in the table is a sunk cost?

a. the annual cash operating costs of the old machine
b. the annual cash operating costs of the replacement machine
c. the disposal value of the old machine
d. the original cost of the old machine
L.O. 4 Challenging
208
Replacement
Old Machine Machine

The total relevant costs to consider if the old machine is kept are
a. $60,000.
b. $35,000.
c. $47,000.
d. $72,000.
L.O. 4 Challenging
Replacement
Old Machine Machine

The difference in cost between keeping the old machine and replacing the old
machine, ignoring income taxes, is
a. $37,000 in favor of keeping the old machine.
b. $12,000 in favor of keeping the old machine.
c. $37,000 in favor of replacing the old machine.
d. $12,000 in favor of replacing the old machine.
L.O. 4 Challenging
209
76. Karesh Company is considering replacing a machine that is presently used in the
Replacement
Old Machine Machine
Original cost $200,000 $160,000

Which of the data provided in the table is irrelevant?

a. the original cost of the replacement machine
b. the disposal value of the old machine
c. the book value of the old machine
d. the annual operating cost of the old machine
L.O. 4 Moderate
Replacement
Old Machine Machine
Original cost $200,000 $160,000

Which of the data provided in the table is a sunk cost?

a. the disposal value of the old machine
b. the original cost of the old machine
c. the annual cash operating costs of the old machine
d. the annual cash operating costs of the replacement machine
L.O. 4 Moderate
210
Replacement
Old Machine Machine
Original cost $200,000 $160,000

Ignoring income taxes, the difference in cost between the old and new machine is
a. $98,000 in favor of the old machine
b. $98,000 in favor of the new machine.
c. $40,000 in favor of the new machine
d. $12,000 in favor of the new machine
L.O. 4 Moderate
79. The gain or loss on the disposal of equipment is determined by

a. adding the book value of the old equipment to the cost of the new equipment.
b. adding the disposal value and the book value of the old equipment.
c. subtracting the book value from the disposal value of the old equipment.
d. subtracting the book value of the old equipment from the cost of the new
equipment.
L.O. 4 Moderate
80. Which of the following statements regarding a decision to keep or replace

existing equipment is FALSE?
a. The disposal value of the old equipment is irrelevant.
b. The book value of the old equipment is irrelevant.
c. The cost of the new equipment is relevant.
d. Depreciation on the new equipment is relevant.
L.O. 4 Moderate
81. Thomas Company produces and sells a product that has variable costs of $9 per
unit and fixed costs of $200,000 per year.
If production decreases from 50,000 to 40,000 units, what is the change in the
cost per unit?
a. Cost per unit will increase by $1.
b. Cost per unit will decrease by $1.
c. Cost per unit will increase to $13.
d. Cost per unit will decrease to $14.
L.O.5 Easy
211
82. Bond Company produces and sells a product that has variable costs of $7 per unit
and fixed costs of $200,000 per year.
What is the cost per unit if 20,000 units per year are produced and sold?
a. $7
b. $17
c. $10
e. $12
L.O.5 Easy
What is the cost per unit if 40,000 units per year are produced and sold?
a. $7
b. $17
c. $10
d. $12
L.O.5 Moderate
If production increases from 20,000 units to 25,000 units, what is the change in
unit cost?
a. unit cost will increase by $35,000.
b. unit cost will decrease by $8 per unit.
c. unit cost will decrease by $2 per unit.
d. unit cost will not change.
L.O.5 Challenging
85. Past costs that are unavoidable and unchangeable are known as
a. fixed overhead costs.
b. operating costs.
c. product production costs.
d. sunk costs.
L.O. 4 Easy
86. How does the choice of the absorption or contribution approach affect the
manufacturing cost per unit?
a. Manufacturing cost per unit is higher if the absorption approach is used.
b. Manufacturing cost per unit is higher if the contribution approach is used.
c. Manufacturing cost per unit is the same regardless of the approach.
d. Manufacturing cost per unit is independent of the approach.
L.O. Moderate
212
87. How does the choice of the absorption or contribution approach affect a firm’s
contribution margin?
a. Contribution margin is higher if the contribution approach is used.
b. Contribution margin is lower if the contribution approach is used.
C. Contribution margin is independent of the approach.
d. Contribution margin is the same regardless of the approach.
L.O.6 Moderate
88. The absorption approach to the computation of manufacturing cost differs from
the contribution approach in that the absorption approach
a. includes variable selling and administrative costs
b. includes fixed overhead
c. includes all fixed costs
d. includes all selling and administrative costs
L.O.6 Moderate
89. Which of the statements regarding the contribution approach and the absorption
approach is correct
a. The contribution income statement provides a gross margin.
b. The absorption income statement provides a contribution margin.
c. Both statements are true.
d. neither statement is true.
L.O.6 Easy
90. Ciao Company provided the following information regarding its one and only
product, skateboards.
Direct materials used $350,000

Fixed overhead 80,000
Variable overhead 20,000
Variable selling and administrative 50,000
Units produced and sold 40,000
What is the manufacturing cost per unit if the absorption approach is used?
a. $13.00
b. $13.50
c. $14.75
d. $15.50
L.O.7 Moderate
213

What is the manufacturing cost per unit if the contribution approach is used?
a. $13.00
b. $13.50
c. $14.75
d. $15.50
L.O.7 Moderate

What is the difference in manufacturing cost per unit if the absorption approach
is used in place of the contribution approach?
a. Cost per unit increases by $2
b. Cost per unit decreases by $2
c. Cost per unit increases by $0.75
d. Cost per unit decreases by $0.75
L.O.7 Moderate
214
93. Aloha Company provided the following information regarding its one and only
product, rollerblades.

Direct Labor 80,000
Fixed Overhead 100,000
Fixed selling and administrative costs 150,000
Variable Overhead 20,000
Variable selling and administrative costs 60,000
Selling unit price 75
What is the manufacturing cost per unit if the absorption approach

is used?
a. $28
b. $30
c. $36
d. $40
L.O.7 Moderate

Direct Labor 80,000
What is the total manufacturing cost if the absorption approach is used?

a. $280,000
b. $300,000
c. $360,000
d. $400,000
L.O.7 Moderate
215

Direct Labor 80,000
What is the gross margin if the absorption approach is used?

a. $350,000
b. $390,000
c. $470,000
d. $450,000
L.O.7 Moderate

Direct Labor 80,000
What is the manufacturing cost per unit if the contribution approach is used?
a. $28
b. $30
c. $36
d. $40
L.O.7 Moderate
216

Direct Labor 80,000
What is the total manufacturing cost if the contribution approach is used?

a. $280,000
b. $300,000
c. $360,000
d. $400,000
L.O.7 Moderate

Direct Labor 80,000
What is the contribution margin if the contribution approach is used?

a. $350,000
b. $390,000
c. $470,000
d. $450,000
L.O.7 Moderate
217

Direct Labor 80,000
What is the difference in total product cost between the absorption approach and
the contribution approach?
a. $100,000
b. $150,000
c. $210,000
d. $250,000
L.O.7 Moderate

Direct Labor 80,000
What is the difference in manufacturing cost per unit between the absorption
approach and contribution approach?
a. cost per unit is $10 higher if absorption cost is used.
b. cost per unit is $10 higher if contribution cost is used.
c. cost per unit is $36 higher if absorption is used.
d. cost per unit is $36 higher if contribution is used.
L.O.7 Challenging
218
Short Answer:
101. The maximum available contribution to profit foregone by using limited

resources for a particular purpose.
Opportunity cost (L.O. 1, easy)
102. A cost that requires a future cash disbursement.

Outlay cost (L.O. 1, easy)
103. The strategic use of outside resources to perform activities traditionally

handled by internal staff and resources.
Out sourcing (L.O. 2, easy)
104. The difference in total cost between two alternatives.

Differential cost (L.O. 2, easy)
105. An analysis where one alternative includes all costs of a second alternative, plus
some additional costs.
Incremental cost (L.O. 1, easy)
106. Two or more manufactured products that have relatively significant sales values
and are not separately identifiable as individual products until their split-off
point.
Joint products (L.O. 3, easy)
107. The juncture in manufacturing where the joint products become individually
identifiable.
Split-off point (L.O. 3, easy)
108. Product costs incurred after the split-off point.

Separable costs (L.O. 3, easy)
109. The costs of manufacturing joint products prior to the split-off point.
Joint costs (L.O. 3, easy)
110. The sum of all depreciation charged to past periods.

Depreciation (L.O.3, easy)
111. The original cost of equipment less accumulated depreciation.

Book value (L.O. 4, easy)
112. A cost that has already been incurred and is irrelevant to the decision making
process.
Sunk cost (L.O. 4, easy)
113. The difference between book value and disposal value.

Gain or loss on disposal (L.O. 7, easy)
114. A costing approach that considers all factory overhead as product cost.
Absorption approach (L.O. 7, easy)
219
115. A method of internal reporting that emphasizes the distinction between variable
and fixed costs.
Contribution approach (L.O. 7, easy)
Problems:
116. Downtown Hotel has been offered a contract by a convention planner to

reserve a block of 30 rooms for 365 nights at a reduced rate of $60 per night.
Downtown’s usual room rate is $120 per night. When a local sports team is
in the playoffs, the rooms can sell for $150. per night.
a. Compute the opportunity cost of accepting the contract on a usual night when
15 of the rooms would normally be occupied.
b. Compute the opportunity cost of accepting the contract in a playoff night

when all of the rooms would normally be occupied.
c. Using the usual room rate of $120, what percentage of rooms would have to
be rented to make Downtown indifferent about accepting the offer.
Answer:
a. (30 x $60) – (15 x $120) = 0
b. 30 x ($150 - $60) = $700
c. ($60 x 30) /$120 = 15

30/15 = 50 percent
L.O.1 Moderate
220
117. Hubbard Company purchases 5,000 units of a part that it needs for production of
its product. Notification has just been received from the supplier that a price
increase will take effect shortly which will bring the price of each part to $15.
Hubbard is considering using some idle facilities to produce the part. The
production costs to produce the needed 5,000 parts are as follows:

Direct labor 20,000
The idle facilities could also be rented out at an annual rent of $9,000. All the
factory overhead costs are avoidable.
Required:
Determine if Hubbard should continue to buy the part or produce it in house.
Answer:
Hubbard should continue to buy the part and should rent out the idle facilities.
This would result in an $9,000 benefit as follows:
Buy part:
$15 x 5,000 units = $75,000 - $9,000 rental income = $66,000
Make part:
$17,500 + $20,000 + $14,000 + $23,500 = $75,000
L.O.2 Moderate
221
118. Forrester Company manufactures a part for its production cycle. The costs per

Direct labor 12

Unavoidable fixed factory overhead 18
Total cost $65
The Company has been approached by a supplier who claims it can sell Forrester
20,000 units of the same part for $940,000.
Required:
a. Assuming there is no alternative use for the facilities how much money
would Forrester save by buying the part?
b. Assuming the facilities can be rented out for $30,000 per year, should
Forrester buy the part, and if so, how much money would be saved?
c. Are there any other factors Forrester should consider?
Answer:
a. $15 + $12 + $20 = $47 x 20,000 units = $940,000 variable costs to produce
vs. $940,000 to buy. Forrester would be indifferent between making or
buying the part.
b. $940,000 - $30,000 = $910,000 net cost to buy vs. $940,000 to make. Buy
the part for a total savings of $30,000.
c. Forrester might also consider qualitative factors such as maintaining product

quality which would favor making the part.
L.O.2 Moderate
222
119. Anderson Company produces a part that is used in the manufacture of one of its
products. The costs associated with the production of 10,000 units of this part
are as follows:

Direct labor 34,000
$164,000
Required:
a. Assuming there is no alternative use for the facilities, should Anderson take
advantage of an offer from a supplier who is willing to sell Anderson 10,000
units of the same part for $12.80 per unit?
b. Would your answer to Part A change if the facilities could be rented for
$10,000 a year?
Answer:
a. $20,000 + $34,000 + $60,000 + $7,000 = $121,000 to make vs. $12.80 x

10,000 units = $128,000 to buy. Continue to make the part.
b. $128,000 - $10,000 = $118,000 net cost to buy vs. $121,000 to make.

Recommend to buy the part which will save the company $3,000.
L.O. 2 Moderate
223
120. Warner Company has a joint process which produces three products, AA, BB and
CC. Each product may be sold at split-off or processed further and then sold.
follows:
Separable
Processing
AA $15,500 $2,200 $17,700

BB 18,000 8,000 23,000
CC 24,000 11,500 37,500
Required:
a. What will be the effect on profits of processing each product further?
b. Assume the company maximizes profits, what is the company’s operating

income?
Answer:
The company should continue to process Product CC.
a. Product AA:
Additional revenue $17,700 - $15,500 = $2,200

Additional cost = $2,200
Net profit -0-
Product BB:

Net loss
($3,000)
Product CC:

Net profit $ 2,000
c. $15,500 + $18,000 + ($37,500 - $11,500) - $30,000 = $29,500
L.O.2 Moderate
224
121. Jackson Corporation uses a joint process to produce products A, B and C. Each
product may be sold at split-off or processed further and then sold. Joint
processing costs for the year amounted to $100,000. Other information is
presented below:
Separable
Processing
A $84,000 $28,000 $106,000

B 50,000 8,000 72,000
C 56,000 14,000 70,000
Required:
a. Which products, if any, should be processed further?
b. If all three products were processed further, what would be the effect on
profits?
Answer:
a. Product B should be processed further as this would result in an increase in

profits. Abbey would be indifferent as to the further production of C as this
would not add any profits to the company.
b. Product A:
$106,000 - $28,000 = $78,000 - $84,000 = $(6,000)
Product B:
$72,000 - $8,000 = $64,000 - $50,000 = $14,000
Product C:
$70,000 - $14,000 = $56,000 - $56,000 = -0-
Net increase to profits $8,000
L.O.3 Moderate
225
122. Rodman Company is considering the replacement of a machine that is presently
used to produce its single product. The following data are available:
Replacement
Old Equipment Equipment

Required:
Ignoring income taxes, prepare a cost comparison of all relevant items for the
next seven years together. Indicate the best alternative for Rodman Company.
Answer:
Keep Replace Difference
Cash operating costs $84,000 $63,000 $21,000

Disposal value of old machine - (28,000) 28,000
New machine, acquisition cost - 60,000 (60,000)
Total relevant costs $84,000 $95,000 $(11,000)
The cumulative effect over the seven years is $11,000 in favor of keeping the old
machine.
L.O.4 Challenging
226
123. The Hicks Corporation is contemplating the replacement of some old equipment.
The pertinent information is as follows:
Replacement
Old Equipment Equipment

Required:
Prepare a cost comparison of all relevant items for the next six years together.
Ignore income taxes. Comment on the best alternative for Hicks Corporation.
Answer:
Keep Replace Difference
Cash operating costs $108,000 $66,000 $42,000

Disposal value of old
equipment - (35,000) 35,000
New equipment,
acquisition cost - 60,000 (60,000)
Total relevant costs $108,000 $91,000 $17,000
The cumulative effect over the six years of $17,000 is in favor of replacing the
old equipment.
L.O.4 Challenging
227
124. Melvin Company gathered the following information regarding its one and
only product:

Direct labor 12,000
Variable selling and administrative expenses 15,000
Fixed selling and administrative expenses 8,000

Selling price per unit $10
Required:
a. Compute the unit manufacturing cost of the product under the absorption
approach.
b. Compute the unit manufacturing cost of the product under the contribution
approach.
c. Compute the effect on net income of accepting a special order for 500 units
at $8 per unit assuming excess capacity.
Answer:
a. ($7,000 + $12,000 + $14,000 + $9,000) / 10,000 = $4.20 per unit
b. ($7,000 + $12,000 + $14,000) / 10000 = $3.30 per unit
c. ($8.00 - $3.30) x 500 units = $2,350 increase in net income
L.O. 2 Moderate
228
125 Pierce Company has been producing and selling 100,000 units per year. They
have excess capacity. The following budget was prepared for the next year
Selling price per unit $12.50
Variable cost per unit:

Direct materials $5.00
Direct labor 3.00
Overhead 1.00
Selling and administrative 2.50
Fixed costs in total:

Overhead $80,000
Selling and administrative 35,000
Required:
a. Prepare an income statement using the contribution approach.
b. Prepare an income statement using the absorption approach.
Answer:
a. Sales $1,250,000
Less: Variable expenses:
Direct materials 500,000
Total variable manufacturing 900,000
Variable selling and admin. 35,000
Total Variable expenses 925,000
Contribution margin $325,000
Fixed costs:
Manufacturing 80,000
Selling and admin. 35,000 115,000
Operating income $210,000
b. Sales $1,250,000
Less: Manufacturing cost of goods sold
Direct materials 500,000
Fixed overhead 80,000 980,000
Gross margin or Gross profit 270,000
Variable selling and admin. 25,000
Fixed selling and admin. 35,000 60,000
$210,000
L.O. 7 Moderate
229
Critical Thinking:
127. "Variable costs are irrelevant whenever they do not differ among the alternatives
at hand." Do you agree? Explain.
Answer:
Yes. The statement is correct in terms of total variable costs.
L.O. 5 Easy
128. There are two major reasons why unit costs should be analyzed with care in
decision making. What are they?
Answer:
Two reasons why unit costs should be analyzed with care in decision making are:
1. Most unit costs are stable only over a certain range of output, and care must
be taken to see that allowances are made when alternatives are considered
outside that range.
2. Some unit costs are an allocation of fixed costs; thus when a higher volume
of output is being considered, unit cost will decrease proportionately, and
vice versa.
SUPPORTING CALCULATIONS
True/False:
3. Opportunity cost and outlay cost are not synonyms.
7. Separable costs are incurred after a joint process and can be exclusively identified with
individual products.
9. The relevant information for a sell or process further decision includes the costs that
differ after the split-off point.
10. It is profitable to extend processing or to incur additional distribution costs on a joint

product if the additional revenue exceeds additional expenses.
13. When making a decision to replace some old equipment with new, the depreciation taken
on both the old or new equipment is relevant information.
15. Future costs are irrelevant if they are the same under all feasible alternatives.
17. Conflicts in the decision making process can arise when superiors evaluate a
manager's performance using a model inconsistent with the decision model.
19. The contribution approach emphasizes the distinction between fixed and variable costs.
230
Multiple Choice:
28. $250,000 - 210,000 = $40,000
29. $40,000 - 45,000 = ($5,000)
30. $13 - ($3 + $5 + $4) = $1 Save
31. $3 + $5 + $4 = $12
32. Buy: (5,000 x $15) - $20,000 = $55,000 Buy

Make: (5,000 x $122) = $60,000
($60,000 - $55,000)/5,000 units = $1 per unit
33. ($14 - $5) - $12 = $(3)
34. $55 - ($20 + $15 + $16) = $4 Save
35. $20 + $15 + $16 = $51
36. Buy: (10,000 x $60) - $80,000 = $520,000

Make: (10,000 x $51) = $510,000
($500,000 - $510,000)/10,000 = $
37. ($56 - $20) - $51 = $(15)
38. $190,000 - 60,000 = $130,000
39. ($170,000 - 10,000) + 60,000 = $240,000
40. ($480,000 - $60,000)/10,000 units = $420 per unit
42. $108,000 + $156,000 + $72,000 + $72,000 = $408,000

$86.40 - ($408,000/5,000) = $4.80
43. $408,000
44. ($105.60 x 5,000) - $96,000 - $408,000 = $24,000
45. Buy: $100.80 - $24.00 = $76.80

Make: $504,000/5,000 = $100.80
51. ($40,000 - $32,000) - $5,000 = $3,000
52. ($19,000 - $12,500) - $6,500 = $0
54. ($160,000 - $128,000) - $16,000 = $16,000
55. ($76,000 - $50,000) - $26,000 = $0
231
56. X: ($160,000 - $128,000) - $16,000 = $16,000
Y: ($76,000 - $50,000) - $26,000 = $0
Z: ($40,000 - $25,600) - 20,000 = $(5,600)
57. ($40,000 - $25,600) - $20,000 = $(5,600)
58. ($21 - $12) - $9 = $0
59. (($17 - $10) - $4) =$3
60. A: ($21 - $12) - $9 = $0

B: (($17 - $10) - $4) x 10,000 = $30,000
C: (($19 - $15) - $6) x 10,000 = $(20,000)
62. ($12 x 10,000) + ((17-4) x 10,000) + (15 x 10,000) - 25,000 = $15,000
74. $7,000 x 5 = $35,000
76. $35,000 + (5 x $4,000) - $8,000 + (5 x $7,000) = $12,000
78. ($20,000 x 5) - (14000 x 5) - 160,000 + 32,000
81. ($200,000/50,000) – ($200,000/40,000) = $1
82. $7 + (200,000 / 20,000) = $17
83. $7 + (200,000 / 40,000) = $12
84. ($200,000 / 20,000) - (200,000 / 25,000) = $2
90. ($350,000 + $170,000 + $80,000 + $20,000) / 40,000 units = $15.50 per unit
91. ($350,000 + $170,000 + $20,000) / 40,000 units = $13.50 per unit
92. $15.50 - $13.50 = $2.00 increase
93. ($80,000 / 10,000) + (200,000 / 10,000) + (100,000 / 10,000) + (20,000 / 10,000) = $40
94. $80,000 + $200,000 + $100,000 + $20,000 = $400,000
95. ($75 - $40) x 10,000 = $35,000
96. ($80,000 + $200,000 + $20,000) / 10,000 = $30
97. $80,000 + 200,000 + 20,000 = $300,000
98. ($75 - $30) x 10,000 = $45,000
99. $100,000 = Fixed overhead
100. $100,000 / 10,000 = $10 higher
232

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CHAPTER 6

RELEVANT INFORMATION AND DECISION MAKING: PRODUCTION DECISIONS

1. Use opportunity cost to analyze the income effects of a given alternative.

1. Opportunity costs need to be considered when deciding on the use of limited

2. Opportunity cost depends on alternatives available at a point in time.

3. Opportunity costs and outlay costs are widely used synonyms.

4. The opportunity cost of facilities idled as a result of a make-or-buy decision is

5. Outsourcing is a make-or-buy decision for services.

6. Qualitative factors may affect a make-or-buy decision.

10. It is profitable to extend processing or to incur additional distribution

11. The disposal value of old equipment is relevant.

23. Opportunity cost is specifically mentioned in

What is the opportunity cost of opening the tea shop?

What is the opportunity cost of remaining employed?

The fixed factory overhead costs are unavoidable.

The fixed factory overhead costs are unavoidable.

The fixed factory overhead costs are unavoidable.

The fixed factory overhead costs are unavoidable.

Direct materials $20

The fixed factory overhead costs are unavoidable.

Direct materials $20

The fixed factory overhead costs are unavoidable.

Direct materials $20

The fixed factory overhead costs are unavoidable.

Direct materials $20

The fixed factory overhead costs are unavoidable.

What is the opportunity cost to Cooper for making the part?

What is the opportunity cost to Trey to make the part

Of the fixed factory overhead costs, $72,000 are avoidable.

Direct materials $108,000

Of the fixed factory overhead costs, $72,000 are avoidable.

Direct materials $108,000

Of the fixed factory overhead costs, $72,000 are avoidable.

Direct materials $108,000

Of the fixed factory overhead costs, $72,000 are avoidable.

46. A key factor in a make or buy decision is

47. Which of the following is a qualitative factor of a make-or-buy decision?

48. Future costs are relevant in decision making when

M $32,000 $5,000 $40,000

Once product M is produced, processing it further will cause profits to

M $32,000 $5,000 $40,000

X $128,000 $16,000 $160,000

Once product X is produced, processing it further will cause profits to

X $128,000 $16,000 $160,000

X $128,000 $16,000 $160,000

To maximize profits, which products should Bermuda process further?

X $128,000 $16,000 $160,000

In processing Product Z further,

If product A is processed beyond the split-off point, profit will

To maximize profits, which products should Mango process further?

Product C should be processed beyond the split-off point because

63. Joint products should be processed beyond the split-off point if

64. Which of the following is an example of a joint product?

69. Which of the following is relevant in a decision to replace equipment?

71. Book value is defined as

Original cost $45,000 $35,000

Which of the data provided in the table is irrelevant?

Original cost $45,000 $35,000

Which of the data provided in the table is a sunk cost?

Original cost $45,000 $35,000

Original cost $45,000 $35,000

Original cost $200,000 $160,000