PRACTICE PROBLEMS-RELEVANT COSTING AND INCREMENTAL ANALYSIS

1. Juan Products manufactures 30,000 units of part S-6 each year for use on its production line. At this level of activity, the cost
per unit for part S-6 is:
Direct materials P36.00
Direct labor 100.00
Variable manufacturing OH 24.00
Fixed manufacturing OH 90.00

An outside supplier has offered to sell 30,000 units of part S-6 each year to Juan Products for P 210 per part. If Juan Products
accepts this offer, the facilities now being used to manufacture part S-6 could be rented to another company at an annual rental
of P 800,000. However, Juan Products has determined that two-thirds of the fixed manufacturing overhead being applied to part
S-6 would continue even if part S-6 were purchased from the outside supplier.
Required:
What is the financial advantage (disadvantage) of accepting the outside supplier’s offer?

Per unit Per unit 30,000 30,000

Relevant costs to Relevant costs to Units make Units buys
make buy
Cost of purchasing P210.00 P6,300,000
Cost of making
Direct materials P36.00 P1,080,000
Direct labor 100.00 P3,000,000
Variable manufacturing OH 24.00 720,000
Fixed manufacturing OH (90 x 1/3) 30.00 900,000
Total P190 P210.00 P5,700,000 P6,300,000

Total relevant costs to make= P5,700,000 + P800,000

= P6,500,000
Total relevant costs to buy = P6,300,000
Financial advantage: P6,500,000 - P6,300,000
= P200,000

Answer: The financial advantage of accepting the outside supplier’s offer is P200,000

2. Dos Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to
diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter
lotions and creams to prevent dry and chapped skin. After considerable research, a winter products line has been developed.
However, Dos’s president has decided to introduce only one of the new products for this coming winter. If the product is a
success, further expansion in future years will be initiated. The product selected (called Chap-Off) is a lip balm that will be
sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for P 80 per box. Because of excess
capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a P 900,000
charge for fixed manufacturing overhead will be absorbed by the product under the company’s absorption costing system.
Using the estimated sales and production of 100,000 boxes of Chap-Off, the Accounting Department has developed the
following manufacturing cost per box:
Direct material P36.00
Direct labor 20.00
Manufacturing OH 14.00

The costs above relate to making both the lip balm and the tube that contains it. As an alternative to making the tubes for Chap-
Off, Silven has approached a supplier to discuss the possibility of buying the tubes. The purchase price of the supplier’s empty
tubes would be P 1.35 per box of 24 tubes. If Dos Industries stops making the tubes and buys them from the outside supplier, its
direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and its direct materials
costs would be reduced by 25%.
Required:
1. If Dos buys its tubes from the outside supplier, how much of its own Chap-Off manufacturing costs per box will it be able
to avoid? (Hint: You need to separate the manufacturing overhead of P 14 per box that is shown above into its variable and fixed
components to derive the correct answer.)

Total MOH cost per box P14

Less: Fixed portion (P900K / 100K boxes) 9
Variable MOH P5

Cost avoided by purchasing the tubes

Direct material (P36 x 25%) P9.00
Direct labor (P20 x 10%) 2.00
Variable MOH (P5 x 10%) 0.50
Avoidable manufacturing cost per box P11.50

Answer: The avoidable manufacturing costs per box is P11.50

2. What is the financial advantage (disadvantage) per box of Chap-Off if Dos buys its tubes from the outside supplier?

Avoidable manufacturing costs per box P11.50

Less: Price paid to supplier 1.35
Financial advantage per box P10.15

Answer: If Dos buys its tubes from the outside supplier, the financial advantage per box is P10.15.

3. What is the financial advantage (disadvantage) in total (not per box) if Dos buys 100,000 boxes of tubes from the outside
supplier?

Number of boxes 100,000

Multiply by: Financial advantage per box 10.15
Financial advantage in total P1,015,000

Answer: The financial advantage in total is P1,015,000.

4. Should Dos Industries make or buy the tubes?

Answer:
Dos Industries should buy the tubes because the avoidable manufacturing cost per unit exceeds the price paid
to the supplier.