RELEVANT COSTING (LIVE SESSION)

1. (MAKE OR BUY) AAA FOODS, a large restaurant chain, needed to

determine if it would be cheaper to produce 5,000 units of its main
food ingredient for use in its restaurants or to purchase them from an
outside supplier for P12 each. Cost information on internal
production includes the following:
Total Cost Unit Cost
Direct materials P25,000 P5.00
Direct labor 15,000 3.00
Variable overhead 7,500 1.50
Variable marketing 10,000 2.00
Fixed plant overhead 30,000 6.00
Fixed overhead will continue whether the ingredient is produced
internally or externally. No additional costs of purchasing will be
incurred beyond the purchase price.
a. Net advantage to make or buy? By how much?
b. Assume that 20% of the fixed overhead can be avoided if the
ingredient is purchased externally. Which alternative is more cost
effective and by how much?
c. Assume that if AAA purchased the items, the machine can be used to
other matter and can earned an income of P3,000. Which alternative
is more cost effective and by how much?

2. (MAKE OR BUY) AAA Mftg had always made its components in-
house. However, AAA Component works had recently offered to
supply one component, K2, at a price of P25 each. AAA uses 10,000
units of Component K2 each year. The cost per unit are as follows:
DM – P12.00; DL – P8.25; Variable OH – P4.50; Fixed OH – P2.00.
a. If the fixed overhead is an allocated expense and none of it will
be eliminated if production of Component K2 stopped. How
much is the net advantage to make or buy?
b. Assume that 75% of AAA Mftg fixed overhead for Component
K2 would be eliminated if that component were no longer
produced. How much is the net advantage to make or buy?
c. By how much percentage should be the decrease in overhead so
that the cost will be indifferent by making and purchasing?

3. (MAKE OR BUY) AAA Company is currently manufacturing PartQ,

producing 35,000 units annually. The part is used in the production of
several products made by AAA. The cost per unit is as follows: DM –
P6; DL – P2; Variable OH – P1.50; Fixed OH – P3.50.
 a. Of the total fixed cost, P77,000 is direct fixed overhead
(meaning, it is no longer incurred if the line is dropped). The
remaining fixed overhead is common fixed overhead. An
outside supplier has offered to sell the part to AAA for P11.
There is no alternative use for the facilities currently used to
produce the part.
i. Net advantage to make or buy? How much?
ii. What is the most that AAA would willing to pay to an
outside supplier?
b. Assume that the fixed cost is common. An outside supplier has
offered to sell the part to AAA for P11. There is no alternative
use for the facilities currently used to produce the part.
i. Net advantage to make or buy? How much?
ii. What is the most that AAA would willing to pay to an
outside supplier?

4. (Special Order) AAA Company has been approached by a new

customer with an offer to purchase 10,000 units at a price of P4 each.
The new customer is geographically separated from the company’s
other customers, and existing sales would not be affected. AAA
normally produces 75,000 units per year but only plans to produce
and sell 60,000 in the coming year. The normal sales price is P12 per
unit. Cost are as follows: DM – P1.50; DL – P2.00; Variable OH –
P1.00; Fixed OH – P3.25. Fixed overhead will not be affected by
whether or not the special order is accepted. By how much increase
or decrease in income if special order is accepted?

5. (Special Order) AAA manufactures professional paperweights and

has been approached by a new customer with an offer to purchase
15,000 units at P7.00 each. AAA normally produces 82,000 units but
plans to produce and sells only 65,000 in the coming year. The
normal sales price is P12 per unit. Unit cost are as follows: DM –
P3.00; DL – P2.25; Variable OH – P1.15; Fixed OH – P1.80.
a. Accept or reject special order? How much is the increase or
decrease in income?
b. Assume that in addition above, AAA needs to purchase a special
logo labeling machine that will cost P14,000. The machine will
be able to label the 15,000 units and then it will be scrapped. No
other fixed overhead activities will be incurred. Accept or reject
special order? How much is the increase or decrease in income?
c. Assume that instead of 65,000 units plans to produce and sold
next year it will now be 70,000 units. If AAA accepts the new
 customer orders, the company will reject the old customers if it
is beyond the capacity. Accept or reject special order? How
much is the increase or decrease in income?

6. (Special Order) Polaski Company manufactures and sells a single

product called a Ret. Operating at capacity, the company can produce
and sell 30,000 Rets per year. Costs associated with this level of
production and sales are given below:
Per Unit 15,000 units per year
Direct Materials P15 P450,000
Direct Labor 8 240,000
Variable OH 3 90,000
Fixed OH 9 270,000
Variable Selling 4 120,000
Fixed Selling 6 180,000
The Rets would normally sells for P50 each. Fixed
manufacturing OH is constant at P270,000 per year within the range
of 25,000 through 30,000 Rets per year.

a. Assume that Polaski Company expects to sell only 25,000

Rets through regular channel. A large retail chain offered to
purchase 5,000 Rets if the price is discounted by 16%. No
sales commission on this order thus variable selling would be
slashed by 75%. However, a special machine would be
purchased for this order amounting to P10,000 and no
assurance of future purchases from this customer. Accept or
reject Special Order?
b. Assume again Polaski expects to sell 25,000 units through
regular channels. The US Army would like to purchase 5,000
Rets for P1.80 per Ret and it would reimburse for all the
costs of production (fixed and variable). Because the Army
has its own truck, there will be no more variable selling
expense associated with this order. Accept or Reject Special
order?
c. Assume the same situation with (b), except the company
expects to sell 30,000 Rets through regular channels. Thus,
accepting the US Army’s order would require giving up
regular sales of 5,000 rets. If the Army’s order is accepted, by
how much will profits increase or decrease from what they
would be if the 5,000 rets were sold through regular channels?

7. (Continue or Discontinue Business Segment) AAA Company

produces three products: A, B and C. A segmented income statement
with amounts are as follows:
 A B C Total
Sales P1,280 P185 P300 P1,765
Less: Variable cost (1,115) (45) (75) (380)
Contribution Margin P165 P140 P75 P380
Less: Direct Fixed Expenses
Depreciation (50) (15) (10) (75)
Salaries (95) (85) (80) (260)
Segment Margin P20 P40 P(15) P45
Direct fixed expenses consist of depreciation and plant
supervisory salaries. All depreciation on the equipment is dedicated
to the product lines. None of the equipment can be sold.

a. Assume that each products has a different supervisor whose

position will remain if the associated product were dropped.
Continue or Discontinue C? How much is the effect to the income
if discontinue?
b. Assume that each products has a different supervisor whose
position will be eliminated if the associated product were dropped.
Continue or Discontinue C? How much is the effect to the income
if discontinue?
c. Using the data in B and further assume that 20% of the A
customers choose to buy from AAA because of C product and
would go elsewhere if C is not offered. Continue or Discontinue
C? How much is the effect to the income if discontinue?

8. (Continue or Discontinue) AAA Company has two departments,

Hardware and Linens. The company’s most recent monthly
contribution format income statement follows:
Total Hardware Linens
Sales P4,000,000 P3,000,000 P1,000,000
Variable Expense 1,300,000 900,000 400,000
Contribution Margin 2,700,000 2,100,000 600,000
Fixed Expenses 2,200,000 1,400,000 800,000
Net Income/loss 500,000 700,000 (200,000)
A study indicates that P340,000 of the fixed expenses being charged
to Linens are sunk costs or allocated costs that will continue even if
the Linens Department is dropped. In addition, the elimination of the
Linens Department will result in a 10% decrease in sales of the
Hardware Department. Continue or Discontinue Linens? How much
is the effect to the income if discontinue?

9. (Continue or Temporary Shutdown) ABC Company is now operating

below 50% of its practical capacity and it expects that the volume of
sales will drop below 5,000 units per month. An operating statement
prepared below for 5,000 units:
Sales (5,000x P3) P15,000
Variable Cost (P2) (10,000)
Contribution Margin P 5,000
Fixed Cost (5,000)
Operating Income/Loss P0
Assume that the shutdown cost is P2,000 per month:
(a) Continue or shutdown, when units sold was only 4,000?
(b) Continue or shutdown, when units sold was only 2,000?
(c) What is the indifference point between loss from continued
operation and loss from shutdown?

10. (Sell or process further) AAA Company receives 8,000 large trees
each period that it subsequently processes into rough logs by
stripping off the tree bark and leaves. AAA then must decide whether
to sell its rough logs at split off point or to process them further into
refined lumber. AAA’s normally sells log for a per unit price of P500.
Alternately, each log can be processed further into 800 feet of lumber
at an additional cost of P0.15 per board foot. Also, lumber can be
sold for P0.75 per board foot. Sell or process further? How much is
the net advantage of such decision?

11. (Sell or process further) AAA inc manufactures two products from a
joint production process. The joint process costs P110,000 and yields
6,000 lbs of LTE compound and 20,000 lbs of HS Compound. LTE
can be sold at split off for P55 per pound. HS can be sold at SOP for
P8 per pound. A buyer of HS asked AAA to process HS further into
CS compound. If HS were processed further, it would cost P34,000 to
turn 20,000 pounds of HS into 4,000 lbs of CS. The CS would sell for
P45 per pound. Sell or process further CS? How much is the net
advantage or disadvantage to process further?

12. (Optimization of Scarce Resource) AAA Company manufactures

two types of university sweatshirts, the Swoop and the Rufus, with
UCM of P5 and P15 respectively. Regardless of type, each sweatshirt
must be fed through a stitching machine to affix the appropriate
university logo. The firm leases seven machines that each provides
1,000 hrs of machine time per year. Each Swoop sweatshirt requires 6
minutes of machine time, and each Rufus sweatshirt requires 20
minutes of machine time. (Note: For all answers that are less than 1.0
round the answer to 2 decimal places. For all unit answers, round the
answers to the nearest whole number).
a. What is the optimal mix of sweatshirts? What is the total
contribution margin earned for the optimal mix?
b. Assume that the maximum of 40,000 units of each sweatshirt
 can be sold. What is the optimal mix of sweatshirts? What is the
total contribution margin earned for the optimal mix?

13. (Optimization of Scarce Resource) AAA Company produces two

products, Reno and Tahoe. Each product goes through its own
assembly and finishing departments. However, both of them must go
through the painting department. The painting department has
capacity of 2,460 hours per year. Product Reno has a UCM of P120
and requires 5 hours of painting department time. Product Tahoe, has
a UCM of P75 and requires three hours of painting department time.
a. What is the optimal mix of the products? What is the total
contribution margin earned for the optimal mix?
b. Assume that only 500 units of each product can be sold. What is
the optimal mix of the products? What is the total contribution
margin earned for the optimal mix?