RELEVANT COSTING PROF. JON D.

INOCENTES,CPA

MAKE OR BUY ( INSOURCE OR OUTSOURCE)

Decision guidelines: The alternative that gives lower relevant costs savings and should be preferred.
The tabulation of relevant costs in making and buying a part is as follows:
Cost to make Cost to Buy
Purchase price Px
DM,DL,VOH,Material handling costs Px
Avoidable fixed overhead x
Savings if the part is bought (x)
Rental income from released facilities (x)
Contribution margin from a new product being
produced using the released facilities (x)
Rental expense if the part is bought __________________________________
PX PX
SAMPLE PROBLEM
R Motors uses production of large diesel engines. The cost to manufacture one unit of T305 is presented below:
DM P 2,000
Materials handling (20% of DM) 400
DL 16,000
Manufacturing overhead ( 150% of DL) 24,000
P 42,000
Materials handling, which is not included in manufacturing overhead , represents the direct variable costs of receiving
department that are applied to direct materials and purchased components on the basis of their cost. R’s annual
manufacturing overhead is one-third variable and two-thirds fixed. S castings, one of R’s reliable vendors, has offered to
supply T305 at unit price of P 30,000.

1. Assume R motors is able to rent all the idle capacity for P 50,000 per month. If R decides to purchase the 10 units from
Castings, R’s monthly cost for T305 would
a. Increase P 46,000 b. P Increase P 3,600 c. Increase P 9,600 d. Decrease P4,400

2. Assume the rental opportunity does not exist and R Motors could use the idle capacity to manufacture another product
that would contribute P 104,000 per month . If R chooses to manufacture the ten T305 in order to quality control, R’s
oppurtunity cost is
a. P 68,000 b. P P 88,000 c. P P 8,000 d. P(96,000)

ACCEPT OR REJECT SPECIAL ORDER

DECISION GUIDELINE: If there is an incremental profit, accept!
In deciding wether to accept or reject a special order, the paramount consideration is incremental profit,determined as
follows:
Incremental sales Px
Incremental costs (x)
Incremental profit or (loss) X
Opportunity costs (benefit) from the alternative use of capacity (x)
Net advantage (disadvantage) of accepting special order X

SAMPLE PROBLEM
1. Sound, Inc., reported the following results from the sale of 24,000 units of IT-54:
Sales P528,000
Variable manufacturing costs 288,000
Fixed manufacturing costs 120,000
Variable selling costs 52,800
Fixed administrative costs 35,200
Rhythm Company has offered to purchase 3,000 IT-54s at P16 each. Sound has available capacity, and the president is in
favor of accepting the order. She feels it would be profitable because no variable selling costs will be incurred. The plant
manager is opposed because the "full cost" of production is P17. Which of the following correctly notes the change in
income if the special order is accepted?
A. P3,000 decrease. B. P3,000 increase. C. P12,000 decrease. D. P12,000 increase.

2. Thomas Company is currently operating at a loss of P15,000. The sales manager has received a special order for
5,000 units of product, which normally sells for P35 per unit. Costs associated with the product are: direct material,
P6; direct labor, P10; variable overhead, P3; applied fixed overhead, P4; and variable selling expenses, P2. The special
order would allow the use of a slightly lower grade of direct material, thereby lowering the price per unit by P1.50
and selling expenses would be decreased by P1. If Thomas wants this special order to increase the total net income
for the firm to P10,000, what sales price must be quoted for each of the 5,000 units?
a.P23.50 b.P24.50 c.P27.50 d.P34.00

DROP OR CONTINUE AN ORGANIZATIONAL SEGMENT

DECISION GUIDELINES: If the direct segment margin is positive and there is no other more beneficial
alternative,then,continue
 The segment margin maybe determined either under conditions with alternative use of the capacity or there is no
alternative use of the capacity. One determined, decisions shall be made as follows;

With no alternative use of capacity

- If the segment margin is positive, continue the division.
With alternative use of capacity
- Compare the segment margin from the net benefit of the alternative. If the segment margin is greater then
continue,Otherwise discontinue the division and undertake the alternative that gives the higher profit.

Segment margin equals:

Benchmark computation:
CM-Avoidable Fixed expenses = Controllable segment margin
Alternative computation:
CM PX
Controllable direct cost (x)
Controllable margin x
Non controllable Fixed expenses (x)
Segment (direct) margin X

1. Doyle Company has 3 divisions: R, S, and T. Division R's income statement shows the following for the year ended
December 31:
Sales P1,000,000
Cost of goods sold (800,000)
Gross profit P 200,000
Selling expenses P100,000
Administrative expenses 250,000 (350,000)
Net loss P (150,000)

Cost of goods sold is 75 percent variable and 25 percent fixed. Of the fixed costs, 60 percent are avoidable if the division is
closed. All of the selling expenses relate to the division and would be eliminated if Division R were eliminated. Of the
administrative expenses, 90 percent are applied from corporate costs. If Division R were eliminated, Doyle’s income would
a.increase by P150,000. b.decrease by P 75,000. c.decrease by P155,000. d.decrease by P215,000.

2. Holt Industries has two sales territories-East and West. Financial information for the two territories is presented below:
East West
Sales P980,000 P750,000
Direct costs:
Variable (343,000) (225,000)
Fixed (450,000) (325,000)
Allocated common costs (275,000) (175,000)
Net income (loss) P(88,000) P 25,000
Because the company is in a start-up stage, corporate management feels that the East sales territory is creating too much
of a cash drain on the company and it should be eliminated. If the East territory is discontinued, one sales manager
(whose salary is P40,000 per year) will be relocated to the West territory. By how much would Holt's income change if the
East territory is eliminated?
a. increase by P88,000 b.increase by P48,000 c.decrease by P267,000 d.decrease by P227,000

3. Nakinnat Corporation’s Outlet No. 5 reported the following results of operations for the
period just ended:
Sales P2,500,000
Less: Variable expenses 1,000,000
Contribution margin P1,500,000
Less: Fixed expenses
Salaries & wages P 750,000
Insurance on inventories 50,000
Depreciation on equipment 325,000
Advertising 500,000 1,625,000
Net income (loss) (P125,000)
The management is contemplating on dropping outlet No. 5 due to the unfavorable operational
results. If this would happen, one employee will have to be retained with an annual salary of
P150,000. The equipment has no resale value. Outlet No. 5 should
a. Not be dropped due to foregone overall income of P350,000.
b. Be dropped due to foregone overall income of P325,000.
c. Not be dropped due to foregone overall income of P25,000.
d. Be dropped due to overall operational loss of P25,000.

SELL-AS-IS OR PROCESS FURTHER

DECISION GUIDELINES: If there is a profit from from further processing, then process further.
Basic computational guideline is:
Incremental sales P xx
Incremental cost (xx)
Savings from further processing X
Incremental profit or loss X

SAMPLE PROBLEM
India Corporation has P200,000 of joint processing costs and is studying whether to process J and K beyond the split-off
point. Information about J and K follows.
Product J Product K
1. Tons produced 25,000 15,000
Separable variable processing costs beyond split-off P64,00 P100,000
Selling price per ton at split-off 15 52
Selling price per ton after additional processing 21 58
If India desires to maximize total company income, what should the firm do with regard to Products J and K?
Product J Product K
A.Sell at split-off Sell at split-off
B.Sell at split-off Process beyond split-off
C.Process beyond split-off Sell at split-off
D.Process beyond split-off Process beyond split-off

3. Julius International produces weekly 15,000 units of Product JI and 30,000 units of JII for
which P800,000 common variable costs are incurred. These two products can be sold as is or
processed further. Further processing of either product does not delay the production of
subsequent batches of the joint products. Below are some information:
JI JII
Unit selling price without further processing P24 P18
Unit selling price with further processing P30 P22
Total separate weekly variable costs of further P100,000 P90,000
processing
To maximize Julius’ manufacturing contribution margin, the total separate variable costs of
further processing that should be incurred each week are
a. P95,000 b. P90,000 c. P100,000 d. P190,000

OPTIMIZATION OF SCARCE RESOURCE

DECISIONN GUIDELINES: Prioritize the product that gives that gives the highest CM per limited resource.
To optimize scarce resources,sales and production should be allocated to a product that gives the highest profit per scarce
resource. If the scarce resource is direct labor hour, then produce the product that gives the highest CM per DL hour ,
computed as follows:
CM per hour= UCM/No. Of hours per unit
CM per hour= UCM x no. Units per hour

SAMPLE PROBLEM
Glamorous Grooming Corporation makes and sells brushes and combs. It can sell all of either product it can make. The
following data are pertinent to each respective product:
Brushes Combs
Units of output per machine hour 8 20
Selling price per unit P12.00 P4.00
Product cost per unit
Direct material P1.00 P1.20
Direct labor 2.00 0.10
Variable overhead 0.50 0.05
Total fixed overhead is P380,000.
The company has 40,000 machine hours available for production. What sales mix will maximize profits?
a.320,000 brushes and 0 combs
b.0 brushes and 800,000 combs
c.160,000 brushes and 600,000 combs
d.252,630 brushes and 252,630 combs

2. Smith Manufacturing has 27,000 labor hours available for producing X and Y. Consider the following information:
Product X Product Y
Required labor time per unit (hours) 2 3
Maximum demand (units) 6,000 8,000
Contribution margin per unit P5.00 P6.00
Contribution margin per labor hourP 2.50 P2.00
If Smith follows proper managerial accounting practices, which of the following production schedules should the company
set
Product X Product Y
A. 0 units 8,000 units
B. 1,500 units 8,000 units
C. 6,000 units 0 units
D. 6,000 units 5,000 units
CONTINUE OPERATIONS OR TEMPORARILY SHUTDOWN OPERATIONS:
DECISION GUIDELINES: If sales are greater than the shutdown point, it would be better to continue operating.
Shutdown point :
Fixed cost- Shut down cost
Unit contribution margin
SAMPLE PROBLEM
Ben Corporation had been experiencing a a slowdown in business activities in August and September and is considering
Temporarily shutting down its operations during those months. The accounting Department has provided the following
normal operating data for considerations.

Usit sales price P 150

Unit variable production costs 60
Unit variable marketing costs 10
Monthly fixed overhead 500,000
Monthly fixed expenses 200,000
Regular sales in units 10,000 per month
Estimated sales in units in Aug and September 5,000 per month

If the company shut down its operations, the following costs are expected to be incurred.
Security and safety P 200,000
Re-start up costs P 100,000
Regular fixed overhead 40% of the total remain
Regular fixed expenses will be reduced by 30%
1. The total shutdown cost amount to:
a. P 840,000 b. P 940,000 c. P 1,180,000 d. P 1,040,000
2. The shutdown point in two months is
a. 7,000 units b. 3,500 units c. P2,750 units d. 10,500
3. Which alternative, continuing or discontinuing the operations , is advisable and by how much is its advantage?
a. P 580,000,shutdown b. P 580,000 continue c. P 60,000, shutdwon d. P 60,000 continue