MAC 2
Relevant Costing and Decision-Making Activity
PROBLEM 1
The following costs relate to a variety of decision settings:
Cost
1. Allocated corporate overhead
2. Cost of an old car
3. Direct materials
4. Salary of marketing manager
5. Home theater installation
6. Unavoidable fixed overhead
Research expenditures incurred
7.
last year, related to new product
8. Php4 million advertising program
Manufactured cost of existing
9.
inventory
Required:
Consider each of the nine costs listed and determine whether it is relevant or irrelevant
to the decision cited. If the cost is irrelevant, briefly explain why.
Answer:
Cost
1. Allocated corporate overhead
2. Cost of an old car
3. Direct materials
4. Salary of marketing manager
Decision
Closing a money-losing department
Vehicle replacement
Make or buy a product
Project discontinuance; manager to be
transferred elsewhere in the firm
Purchase of a new home
Plant closure
Product introduction to marketplace
Whether to promote product A or B with the
Php4 million program
Whether to discard the goods or sell them
to a third-world country
Decision
Closing a money-losing department
Irrelevant because corporate overhead
cost is unavoidable and will still be needed
to be paid by the company as these are
expenses connected to the business
operation.
Vehicle replacement
Irrelevant – because cost of the old car had
already been incurred in the past.
Make or buy a product - Relevant
Project discontinuance; manager to be
transferred elsewhere in the firm
 Irrelevant because even if a project is
discontinued or the manager is to be
transferred, he/she is still employed within
the company and is obliged to pay for the
managers salary.
Purchase of a new home
5. Home theater installation
Relevant
Plant closure

Irrelevant - even if the company close one

6. Unavoidable fixed overhead
Research expenditures incurred
7.
last year, related to new product
8. Php4 million advertising program
Manufactured cost of existing
9.
inventory
of its plants they are still to allocate funds for
their fixed overhead. Also, relevant costs
are cost that could be avoided by the
company.
Product introduction to marketplace
Irrelevant because these are sunk cost that
the company had already spend in the
past.
Whether to promote product A or B with the
Php4 million program
Irrelevant – no matter which product the
company decides to promote they will still
incur cost for advertisement.
Whether to discard the goods or sell them
to a third-world country
Irrelevant because these are cost that had
already been incurred in the past and can
no longer be deducted nor avoided.

PROBLEM 2

Vanessa Corporation manufactures faucets. Several weeks ago, the firm received a
special-order inquiry from Yale, Inc. Yale desires to market a faucet similar to Vanessa's
model no. 55 and has offered to purchase 3,000 units. The following data are available:

Cost data for Vanessa's model no. 55 faucet: direct materials, P45; direct labor, P30 (2
hours at P15 per hour); and manufacturing overhead, P70 (2 hours at P35 per hour).
The normal selling price of model no. 55 is P180; however, Yale has offered Cornell only
P115 because of the large quantity it is willing to purchase.

Yale requires a design modification that will allow a P4 reduction in direct-material cost.
Vanessa's production supervisor notes that the company will incur P8,700 in additional
set-up costs and will have to purchase a P3,300 special device to manufacture these
units. The device will be discarded once the special order is completed.
Total manufacturing overhead costs are applied to production at the rate of P35 per
labor hour. This figure is based, in part, on budgeted yearly fixed overhead of P624,000
and planned production activity of 24,000 labor hours.
Vanessa will allocate P5,000 of existing fixed administrative costs to the order as "…part
of the cost of doing business."

Required:
One of Vanessa's staff accountants wants to reject the special order because
"financially, it's a loser." Do you agree with this conclusion if Vanessa currently has excess
capacity? Show calculations to support your answer.

Solution:

Reject Accept
Differential - P 345,000
Revenue
Differential Cost - (P 435,000)
Loss - (P 90,000)
• Differential Revenue = (P 115* 3,000) = P 345,000
• Differential Cost
Materials P 123,000
Labor 90,000
Overhead 210,000
Additional Cost 12,000
Total P 435,000

Answer: As evidenced by the computations above, I agree with Vanessa’s staff

accountant/s.

If Vanessa currently has no excess capacity, should the order be rejected from a financial
perspective? Briefly explain.

Answer: Yes, the order special order should be rejected. Without excess capacity, the
loss of P 90,000 will rise due to the profit that will be forgone from the lost regular sales (i.e.
normal sales that will be given up to accommodate the special order).

Assume that Vanessa currently has no excess capacity. Would outsourcing be an option
that Vanessa could consider if management truly wanted to do business with
Yale? Briefly discuss, citing several key considerations for Vanessa in your answer.

Answer: With excess capacity, Vanessa will be incurring a loss. With no excess capacity,
such loss will further increase brought by the forgone profit from the lost regular sales that
was sacrificed. Thus, if management truly wants to accept the order for whatever
intangible reason (good reputation, good relationship etc.), then outsourcing might as
well be considered as an option to mitigate loss or if possible, may be a way for such
accommodation of special order to generate profit rather than loss. Nevertheless, if
outsourcing will rather increase the loss, then it would be discouraged.

PROBLEM 3

Anchor Wheel’s Pizza store no. 16 has fallen on hard times and is about to be
closed. The following figures are available for the period just ended:

Sales P205,000
Cost of sales 67,900
Building occupancy costs:
Rent 36,500
Utilities 15,000
Supplies used 5,600
Wages 77,700
Miscellaneous 2,400
Allocated corporate
16,800
overhead

All employees except the store manager would be discharged. The manager, who
earns P27,000 annually, would be transferred to store no. 19 in a neighboring suburb. Also,
no. 16's furnishings and equipment are fully depreciated and would be removed and
transported to Anchor Wheel's warehouse at a cost of P2,800.

Required:

What is store no. 16's reported loss for the period just ended?
Should the store be closed? Why?

Answers:

No.16’s Loss for the Period Ended is 16,900 Php

Sales P 205,000
Cost of Sales (67,900)
Gross Profit P 137,100
Other Expenses (154,000)
Net Loss (P 16,900)
As supported by the computations below, the store should be CLOSED. The extracted
segment margin loss alone indicates that the segment does not generate any
contribution to recover the unavoidable cost and rather produces additional loss for
the entity. Moreover, the discontinuance of such store may result to savings which
would be favorable for the entity.

Sales Continue Discontinue

Segment Margin Loss (P 100) -
Avoidable Cost: Wages - P 50,700
Additional Cost: Equipment - (2,800)
Removal
Unavoidable Cost: Allocated (16,800) (16,800)
Overhead
(Loss)/Savings (P 16, 900) P 31,100

Would Anchor Wheel's likely lose all P205,000 of sales revenue if store no. 16 were
closed?

Answer: No, suppose that store no. 16 merely operates as a distribution outlet and sells
the products similar to other stores, then the discontinuance of such distribution outlet
may not necessarily mean that such sales revenue will also be lost. Customers (regular
or not) may simply shift and transact the same through other distribution outlets that
offers the same.