Dia Mae A.

Generoso BSA-II
M-W-F 1:00-4:00 pm

Finals Unit 5 Exercises

Short-run Decision making: Relevant Costing

Refer to Chapter 11 of your book.

1. Special Order Decision

Robin Company produces a light-weight travel raincoat with the following unit cost:

Direct materials P4.00

Direct labor P1.00
Variable overhead P1.75
Fixed overhead P2.00
Unit cost P8.75

While production capacity is 200,000 units per year, Robin expects to produce only 170,000
raincoats for the coming year. The fixed selling costs total P85,000 per year, and variable selling
costs are P0.50 per unit sold. The raincoats normally sell for P12 each.
At the beginning of the year, a customer form a geographic region outside the area normally
served by the company offered to buy 20,000 raincoats for P8 each. The customer would pay all
transportation costs, and there would be no variable selling costs.

Required:
Should the company accept the order? Provide both qualitative and quantitative justification for
your decision. Assume that no other orders are expected beyond the regular business and the
special order.

Solution:

Status Quo Alternative Difference

Sales P2,040,000 P2,200,000 P160,000
Less: Variable Cost 1,232,500 1,367,500 135,000
Contribution Margin P807,500 P832,500 P25,000
Less: Fixed Cost 425,000 425,000 -
Operating Profit P382,500 P407,500 P25,000

The company should accept the order because operating profit will increase by P25,000.

2. Optimal Mix

Two type of gears are produced: Y and Z. Gear Y has a unit contribution margin of P200, and Gear Z
has a unit contribution margin of P400. Gear Y uses two hours of grinding time, and Gear Z uses five
hours of grinding time. There are 200 hours of grinding time available per week. This is the only
constraint.

Required:
a. Is the grinding constraint an internal constraint or external constraint? It is an internal constraint.
b. Determine the optimal mix. What is the total contribution margin?

Solution:

Optimal Mix Gear Y Gear Z

Contribution Margin per Unit P200 P400
Divided by: Grinding time per unit (in hours) 2 5
Contribution Margin per grinding hour P100 P80

Unit Gear Y = 200 total hours/ 2 hours per Gear Y = 100

The total Optimal Mix is gear Y=100 units and Gear Z= 0 units

Total Contribution Margin of Optimal Mix= (100 units Gea Y) P200

= P20,000

c. Suppose that there is additional demand constraint: Market conditions will allow the sale of only
80 units of each gear. Now, what is the optimal mix? The total contribution margin per week?

Solution:

Grinding time required for maximum amount of Gear Y

= 80 units x hours
= 160 hours needed to manufacture 80 Gear Y units
Remaining Grinding Time for Gear Z = 200 hours – 160 hours
= 40 hours
Units of Gear Z to be produced in remaining 40 hours = 40 hours/ 5 hours per unit
= 8 units

Total Contribution Margin of Optimal Mix = (80 units Gear Y x P200) + (8 units Gear Z x P400)
= P16,000 + P3,200
= P19,200
3. Make or Buy

Hailey Company uses 5,000 units of Part C each year as a component in the assembly of one of
its products. The company is presently producing Part C internally at a total cost of P100,000,
computed as follows:
Direct materials P 15,000
Direct labor 30,000
Variable MOH 10,000
Fixed MOH 45,000
Total Costs P100,000
An outside supplier has offered to provide Part C at a price of P18 per unit. Hailey Company
stops producing the part internally, one-third of the fixed manufacturing overhead would be
eliminated.

Required:

Prepare an analysis showing the annual peso advantage or disadvantage of accepting the outside
supplier’s offer.

Solution:

Make Buy Differential Cost to Make

Direct Materials P15,000 - P15,000
Direct Labor 30,000 - 30,000
Variable MOH 10,000 - 10,000
Fixed MOH 45,000 P30,000 15,000
Purchase Cost - 90,000 (90,000)
Total relevant cost P100,000 P120,000 (20,000)

It is cheaper by P20,000 to produce the part internally.

4. Sell or Process Further

Spongebob Company manufactures three products from a common input in a joint processing
operation. Joint processing costs up to the split-off point total P100,000 per year. The company
allocates these costs to the joint products on the basis of their total sales value at the split-off
point. These sales values are as follows: product A, P50,000; product B, P90,000; and product C,
P60,000.

Each product may be sold at the split-off point or processed further. Additional processing
requires no special facilities. The additional processing costs and the sales value after further
processing for each product (on an annual basis) are shown below:
 Product Additional Processing Costs Sales Value
A P35,000 P80,000
B 40,000 150,000
C 12,000 75,000

Required:

Which product or products should be sold at the split-off point, and which product or products
should be processed further? Show computations.

Solution:

A B C

Incremental revenue from

further processing P30,000 PP60,000 P15,000

Incremental cost of
further processing 35,000 40,000 12,000

Profit (loss) from further

processing (P5,000) P20,000 P3,000

As shown above, Product B and C should be processed further whereas Product A should
be sold at the split-off point.

5. Target Costing

Olivia Auto Supply, Inc., produces and distributes auto supplies. The company is anxious to enter
the rapidly growing market for long-life batteries that is based on lithium technology.
Management believes that to be fully competitive, the price of the new battery that the company
is developing cannot exceed P65. At this price, management is confident that the company can
sell 50,000 batteries per year. The batteries would require an investment of P2,500,000, and the
desired ROI is 20%.

Required:

Compute the target cost of one battery.

Solution:
 Desired Profit = 0.20 x Target Price
= 0,20 x P65
= P13

Target Cost = Target Price – Desired Profit

= P65 – P13
= P52

6. Utilization of a Constrained Resource

Jayvee Company produces three products: X, Y and Z. The selling price, variable costs, and
contribution margin for one unit of each product follow:

Product X Y Z
Selling price P60 P90 P80
Less variable costs:
Direct materials 27 14 40
Direct labor 12 32 16
Variable manufacturing overhead 3 8 4
Total variable cost 42 54 60
Contribution margin P18 P36 P20
Contribution margin ratio 30% 40% 25%

Due to a strike in the plant of one of its competitors, demand for the company’s products far
exceeds its capacity to product. Management is trying to determine which product(s) to
concentrate on the next week in filling its backlog of orders. The direct labor rate is P8 per hour,
and only 3,000 hours of labor time are available each week.

Required:

a. Compute the amount of contribution margin that will be obtained per hour of time spent on
each product.
Solution:
X Y Z
Contribution margin per unit P18 P36 P20
Direct labor cost per unit P12 P16 P16
Direct labor rate per hour 8 8 8
Direct labor-hours required per unit 1.5 4.0 2.0
Contribution margin per direct labor-hour P12 P9 P10

b. Which orders would you recommend that the company work on next week – the orders for
product X, product Y, or product Z? Show computations
Solution:
The company should concentrate its labor time on producing product X:
X Y Z
Contribution margin per direct labor-hour P12 P9 P10
Direct labor-hours available x 3,000 x 3,000 x 3,000
Total contribution margin P36,000 P27,000 P30,000

Although product X has the lowest contribution margin per unit and the second lowest contribution
margin ratio, it has the highest contribution margin per direct labor-hour.