Mindanao State University
College of Business Administration and Accountancy
DEPARTMENT OF ACCOUNTANCY
Marawi City
SHORT-TERM NON-ROUTINE DECISIONS
Accounting 142
THE DECISION-MAKING PROCESS
Decision making is one of the important roles played by a
manager in an organization. It is integral to the other three
functions of planning, directing and motivating and
controlling. As with every facet of one’s life, decisions are
made in all phases of organizational activities.
Decision-making means choosing from at least two
alternative courses of actions. No decision making problem
exists when there is only one course of action available. A
formal method used by managers for making a choice is
the decision model.
The basic steps in a decision model are as follows:
A. Defining the problem – a decision making problem
exists when a need arises for the manager to
consider alternative courses of action. In defining
the problem, caution should be taken so as not to
define the problem too narrowly for this might limit
evaluation of alternative solutions. Neither should
the problem be defined too broadly.
B. Establishing a decision rule or criteria – criteria for
good judgment must be set to serve as bases for
choosing the best alternative course of action. In
most cases, these criteria are set considering the
company’s goals such as profit maximization, cost
minimization and optimum utilization of the
company’ capabilities and scarce resources.
C. Identifying alternative courses of action – different
alternative courses of action are identified to
answer or solve the problem previously defined.
D.
E.
Determining the possible consequences of the
alternatives – relevant information regarding each
alternative is gathered and predictions regarding
the consequences of each alternative are made.
These are used in evaluating the alternative
courses of actions.
Evaluating each alternative – only relevant factors
should be considered in evaluating the
alternatives. These factors could be broken down
into two major categories:
 Qualitative factors – those that cannot easily
and accurately be expressed in terms of
money or any other numerical unit of
measure.
 Quantitative factors – those that can more
easily be expressed in terms of money or other
unit of measure.
No general rule exists as to which factors are more
important in making the final decision. These
factors are evaluated depending on the alternative
choice decisions on hand and the criteria set for
the case.
F.
Choosing the best alternative and making the
decision – as a general rule, the best alternative is
the one that will give the organization the highest
income or lowest loss.
G. Implementing the decision – the chosen alternative
is carried out to solve the problem at hand.
H. Evaluate the performance of the decision
implemented to provide feedback – this feedback
can help the decision maker in making better
decisions in the future.
TYPES OF BUSINESS DECISIONS
Business decisions may be classified as strategic, tactical
and operational.
A. Strategic decisions – have long-term effects. Its
focus is growth and stability and its objective is to
meet the needs of investors. These types of
decisions are made by top managers.
B. Tactical decisions – made regularly and with
medium-term effects to organizational results. Its
focus is profitability and liquidity and is concerned
with customer’s satisfaction. These types of
decisions are made by middle managers.
C. Operational decisions – made on a daily basis
where the judgmental call of a supervisor is at its
greatest use. These types of decisions are made by
operational managers.
Moreover, business decisions can be classified as routinary
(repetitive) or non-routinary (non-repetitive).
A. Routine decisions – those that are made from time
to time, involve the same situations and pose the
same problem. These are covered by standard
operating policies (SOPs) of an entity which are
normally codified in a manual. Examples are
policies on expense approval, warehousing of
inventories and hiring of personnel.
B. Non-routine decisions – those that are nonrepetitive in nature and thus, not covered by SOPs.
They may be long-term in nature as in the case of
capital investment decisions or short-term in nature.
APPROACHES TO SOLVING DECISION PROBLEMS
Some alternative choice decisions are based primarily on
judgment, especially those that involve mostly qualitative
factors. Others involve the use of some accounting
information and other quantitative factors.
In making a quantitative analysis of the factors, two
approaches can be applied:
A. Total approach – all costs whether relevant or not
will be enumerated. All variable costs and all fixed
costs will be included in the computation for all
alternatives to show a comprehensive comparison
of all items among the choices given.
B. Differential approach – only those costs that are
expected to change in the future are included in
the analysis since these items are important or
relevant in making the decision. Irrelevant items are
no longer included in the analysis. This approach is
also known as relevant costing.
For decision making purposes, the following cost
classification is relevant:
A. Relevant costs – future costs that will differ under
alternative courses of actions. These costs are to be
given due consideration when making a decision.
For a cost to be considered relevant, such cost
must possess the following two basic characteristics:
 Future-oriented – the cost must be expected
to be incurred in the future. Future costs are
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
Page|1 of 6
B.
referred to as planned costs, budgeted costs,
projected costs or estimated costs.
 Differential – the cost must differ from one
option to another; it is present in one
alternative but is absent in whole or in part in
another alternative. Differential costs are
either:
a. Incremental costs – increase in cost from
one alternative to the other.
b. Decremental costs – decrease in cost
from one alternative to the other.
Relevant costs include the following types of costs:
 Avoidable cost – a cost that can be
eliminated in whole or in part when one
alternative is chosen over another in a
decision making case.
 Opportunity cost – cost of benefits foregone
as the result of the acceptance of an
alternative. It is measured as the benefits that
would result from the next best alternative use
of the same resources that were rejected in
favor of the one accepted.
 Imputed cost – hypothetical cost representing
the usage value of a particular resource.
Irrelevant cost – costs that will not affect the
decision making process, thus, is ignored and not
given consideration in the decision making analysis.
Irrelevant costs include the following types of costs:
 Postponable costs – costs that may be
deferred or shifted to a future date or period
of time without adversely affecting current
operations.
 Unavoidable cost – costs that remain
regardless of what decision or alternative is
chosen.
 Sunk or past or historical cost – cost which are
already incurred and therefore irrelevant in
decision making process.
 Joint cost – costs incurred in simultaneously
processing or manufacturing two or more
products which are difficult to identify
individually as separate types of products until
a certain processing stage known as the split
off point.
The classification of a cost as relevant or irrelevant is
context-sensitive. A cost that is relevant in a particular
decision may be irrelevant in another.
SHORT-TERM NON-ROUTINE DECISION MAKING
Short-term non-routine decisions fall within the ambit of
tactical and operational decisions. They have an effect of
the profitability of an entity but have no visible impact on
the long-term stability of an entity. Thus, profitability is the
key factor in these types of decisions.
The following are some of the common short-term nonroutine decision situations encountered by managers:
 MAKE OR BUY A COMPONENT PART OR MATERIAL
Make or buy decisions involve the firm choosing between
producing an item or performing the service itself or
purchasing the item or availing of the service from an
outside supplier.
Decision rule: Whichever option gives a lower relevant cost
would be a better alternative, assuming no other
quantitative and qualitative factors are considered.
Data analysis format:
Direct materials plus handling charges
Direct labor
Variable overhead costs
Avoidable fixed overhead costs
Other avoidable incremental costs
Relevant costs to make
P xxx
X xxx
X xxx
X xxx
X xxx
P xxx
Purchase costs plus handling charges
Other incremental costs to buy
Less: Incremental revenue or earnings from use of
released resources
Relevant costs to buy
P xxx
X xxx
X xxx
P xxx
Relevant costs to make
Less: Relevant costs to buy
Net advantage (disadvantage) to buy
P xxx
X xxx
P xxx
 ACCEPT OR REJECT A SPECIAL ORDER
Accept or reject a special order involves accepting or not
a special sales order that is outside of the regular sales of a
business. This is also referred to as special sales pricing.
Decision rule: Accept the special sales order if the
incremental revenue is greater than incremental costs.
Otherwise, reject the special sales order.
Decision factors: Additional decisions factors to be
considered as follows:
A. The existence of excess capacity and if there is,
whether it has an alternative use.
B. The effect of special sales on regular sales.
C. The nature of the sales order, whether it is a onetime, no repeat business or not.
Data analysis format (with idle capacity with no alternative
use):
Incremental revenue
Less: Incremental costs
Incremental profit (loss)
P xxx
X xxx
P xxx
Data analysis format (with idle capacity with alternative
use):
Incremental revenue
Less: Incremental costs
Incremental profit (loss)
Less: Opportunity costs (benefit) from the
alternative use of the capacity
Net advantage (disadvantage) of accepting the
special sales order
P xxx
X xxx
P xxx
X xxx
P xxx
Opportunity costs, in this case, refers to the net benefit that
could have been derived from another alternative had the
special order been rejected such as rent income and
contribution margin from production and sale of another
product.
Data analysis format (without idle capacity):
Incremental revenue
Less: Incremental costs
Incremental profit (loss)
Less: Opportunity costs (benefit) from the
alternative use of the capacity
Net advantage (disadvantage) of accepting the
special sales order
P xxx
X xxx
P xxx
X xxx
P xxx
Opportunity cost, in this case, refers to the lost contribution
margin from regular sales or the best use of that capacity.
 SELL AS IS OR PROCESS FURTHER
Sells as is or process further occurs when an entity
manufacture products which have a ready market once a
certain stage of completion is reached and the entity may
decide to process the product further to give it a higher
sales value though additional processing costs may be
incurred.
Decision rule: Process further if the incremental revenue
from further processing is greater than the incremental
processing costs.
Decision analysis format:
Selling price after processing further
Less: Selling price at split off point
Incremental revenue
Less: Incremental costs
Net advantage (disadvantage) of accepting the
special sales order
P xxx
X xxx
P xxx
X xxx
P xxx
The total joint cost is irrelevant in the decision to sell as is or
process further.
 DROP OR CONTINUE A BUSINESS SEGMENT
Drop or continue a business segment involves the firm
choosing to continue operating a business segment, which
could be a division, product line or geographical
operations, or discontinue it for some strategic, operational
or financial reasons.
Decision rule: Continue operating the segment if first, the
segment margin is positive and second, it is greater than
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
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the best alternative use of the released capacity if the
segment is discontinued.
Decision analysis format:
Sales
Less: Variable manufacturing cost
Manufacturing contribution margin
Less: Variable non-manufacturing costs
Contribution margin
Less: Controllable fixed costs
Short-run performance or controllable margin
Less: Direct, non-controllable fixed costs
Segment margin
Less: Common costs allocated to segment
Operating income
Less: Provision for income tax
Net income
P xxx
X xxx
P xxx
X xxx
P xxx
X xxx
P xxx
X xxx
P xxx
X xxx
P xxx
X xxx
P xxx
Alternatively, segment margin is computed as:
Contribution margin
Less: Avoidable fixed costs and expenses
Segment margin
Continue or temporarily shutdown operations involves
deciding to continue operating or to temporarily shutdown
operations during slack seasons where the business
normally incurs losses. This also applies for closures during
specific hours of the day like restaurant operations. In this
decision situation, the following terms are relevant:
A. Shutdown point – the level of operations where the
loss from continuing operations is equal to the loss
from discontinuing operations.
B. Shutdown savings – difference between the total
fixed costs under normal operations and total
shutdown costs.
C. Shutdown costs – costs incurred even after
operations are temporarily stopped. It includes:
 Unavoidable fixed costs such as security,
insurance, rental, depreciation, property taxes
and salaries of remaining executives and
personnel.
 Restart-up costs such as rehiring and retraining
personnel, refurbishing the plant and refueling
and aligning machines and equipment.
D. Abandonment – the permanent closure of business
or stoppage of work.
Decision rule: Continue operating even if at a loss if the
demand for the product is greater than the shutdown
point.
Data analysis format:
Shutdown savings
Contribution margin per unit
 MAXIMUM AND MINIMUM BID PRICE
Maximum and minimum bid price involves determining the
minimum amount a firm can bid to get a contract or
project and determining the maximum amount a firm can
accept for the acquisition of a particular product or
service.
Decision rule: Submit the highest bid to win but in no way
should it be below the minimum bid price and accept the
highest bid but in no way should it exceed the maximum
bid price.
Avoidable costs
Opportunity costs from the best alternative use of
capacity
Maximum bid price
Selling price per unit
Less: Variable cost per unit
Contribution margin per unit
Divided by: Scarce resource needed per unit of
output
Contribution margin per unit of scarce resource
P xxx
X xxx
P xxx
xxx
P xxx
Sell now or sell later occurs when the sales price of a
product is expected to increase after a period of time and
the firm has to decide whether to keep it and sell it later.
Decision rule: Sell the product now if the incremental
revenue is lesser than the incremental cost of keeping the
product.
Decision analysis format:
Selling price later
Less: Selling price now
Incremental revenue
Less: Incremental costs
Net advantage (disadvantage) of selling later
P xxx
X( xxx
P xxx
X xxx
P xxx
Incremental costs include storage costs, maintenance costs
and opportunity costs of the money locked in the product.
 REPLACE OR RETAIN AN OLD ASSET
Replace or retain an old asset involves deciding on
replacing or not an asset that is still functionally useful and
has not yet reached its point of technological or physical
obsolescence. Old assets tend to have higher maintenance
costs over new ones though new assets would entail an
immediate outflow of cash.
Decision rule: Replace the old asset if the cash inflows are
greater than the cash outflows over the life of the new
asset.
Decision analysis format (asset for asset):
Total operating expenses under old asset
Less: Total operating expenses under new asset
Total savings in operating expenses
Current salvage value of old equipment
Difference in salvage value of assets at the end of
their useful lives
Less: Incremental costs of purchasing new asset
Net advantage (disadvantage) of replacing old
asset
P xxx
X xxx
P xxx
X xxx
X xxx
X xxx
P xxx
This decision analysis is under the assumption that the useful
life of the new asset, compared to the old asset is equal
and the time value of money and effects of taxes are
ignored.
Decision analysis format (asset for operations):
Income from the new asset
Less: Income from the operations
Net advantage (disadvantage) of replacing the
operations
X xxx
X xxx
P xxx
 SCRAP OR REWORK A DEFECTIVE UNIT
Decision analysis format:
Incremental costs
Opportunity costs from the best alternative use of
capacity
Minimum bid price
Decision analysis format:
 SELL NOW OR SELL LATER
P xxx
X xxx
P xxx
 CONTINUE OR TEMPORARILY SHUTDOWN
Shutdown point =
Decision rule: Use all resources in producing or providing
the product or service that has the highest contribution
margin per unit of scarce resource unless it has market
limitation. In such case, after satisfying all the market need
for the product that has the highest contribution margin per
unit of scarce resource, produce and sell the product that
has the next highest contribution margin per unit of scarce
resource and so on.
P xxx
X xxx
P xxx
P xxx
X xxx
P xxx
 OPTIMIZATION OF SCARCE RESOURCES
Optimization of scarce resources involves determining the
best allocation of a productive resource such as machine
hours, direct labor hours and supply of materials that is
limited to maximize profit of a firm or minimize its costs.
Scrap or rework a defective unit involves deciding whether
to sell products that do not meet standard production
specifications as scrap or rework such products and sell
them later at a higher value.
Decision rule: Rework the defective product if the net profit
from reworking is greater than the net profit from selling it as
scrap.
Decision analysis format:
Incremental revenue from reworking
Less: Incremental costs from reworking
Incremental profit from reworking
Less: Incremental profit from selling as scrap
Net advantage (disadvantage) of reworking
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
P xxx
X xxx
P xxx
X( xxx
P xxx
Page|3 of 6
The total past cost of producing the product is irrelevant in
the decision to rework the product or sell it as scrap.
 DETERMINING THE INDIFFERENCE POINT
The indifference point is the point of equality between two
alternatives, that is regardless of the choice taken, the
results would be the same. Specifically, it is the point where:
Profit a = Profit b
The concept of indifference point can be applied in various
decision problems including choosing between:
A. A high salary but low commission scheme and a
lower salary but a higher commission scheme for
sales persons.
B. A highly automated production process with low
variable cost per unit and a lower technology with
higher variable costs per unit and lower fixed costs.
C. A broad advertising campaign with higher selling
prices and a minimal advertising but with lower
selling prices.
Decision rule: Choose the alternative providing the higher
contribution margin per unit or that incurs the lower
variable costs if the expected demand for the company’s
product is higher than the indifference point.
Decision analysis format:
IP in units
=
IP in pesos =
Difference in total fixed costs
Difference in contribution margin per unit
Difference in total fixed costs
Difference in contribution margin ratio
The breakeven point, economic order quantity (EOQ) and
shutdown point concepts are applications of indifference
point.
ILLUSTRATIVE PROBLEMS
PROBLEM 1: Toblerone Corporation manufactures Part X-24
for use in its production cycle. The cost per unit for 10,000
units of Part X-24 is as follows:
Direct materials
P 6.00
Materials handling costs (20%)
1.20
Direct labor
20.00
Variable overhead
5.00
Fixed overhead
11.00
Total
P 43.20
Ferrero Company has offered to sell Toblerone Corporation
10,000 units of Part X-24 for P40 per unit. If Toblerone
accepts Ferrero’s offer, P4 of fixed overhead per unit could
be eliminated. The materials handling costs pertain to cost
of receiving and inspecting incoming materials and other
components which are not included in the overhead.
If the part is outsourced from an outside supplier, one-half
of the released facilities could be used to produce a new
product, Snickers, which is expected to generate
contribution margin of P90,000 per year. Additionally, a
savings of P15,000 is expected if the parts are purchased
outside. The other half of the released facilities could be
rented out for P60,000 per annum.
The outside supplier requires that an equipment be leased
to meet the order of the company. The equipment rental
cost of P80,000 shall be charged to the company.
Requirements:
1. What alternative is better, make or buy the part and
by how much is its advantage?
2. What is the indifference price of the two alternatives?
3. What should be the purchase price so that Toblerone
will have a savings of P10 per part?
4. What is the sunk cost or irrelevant cost in the decision
of making or buying the part?
PROBLEM 2: Knox Company uses 12,000 units of a part in its
production process. The costs to make a part are: direct
material, P12; direct labor, P25; variable overhead, P13;
and applied fixed overhead, P30. Knox has received a
quote of P55 from a potential supplier for this part. If Knox
buys the part, 60% of the applied fixed overhead would
continue.
Requirements:
1. What is the total relevant cost to manufacture
relating to this “make or buy” decision?
2. If Know choose to manufacture the part, Knox would
be better off (worse off) by how much?
PROBLEM 3: “In my opinion, we ought to stop making our
own drums and accept that outside supplier’s offer,” said
Wim Niewindt, managing director of Antilles Refining
Company.
“At a price of P18 per drum, we would be paying P5 less
than it costs us to manufacture the drums in our own plant.
Since we use 60,000 drums a year, that would be an annual
cost savings of P300,000.”
Antilles Refining's present cost to manufacture one drum is
given below based on 60,000 drums per year:
Direct materials
Direct labor
Variable overhead
Fixed overhead (P2.80 general company
overhead, P1.60 depreciation and
P0.75 supervision)
Total
P 10.35
6.00
1.50
5.15
P 23.00
A decision about whether to make or buy the drums is
especially important at this time since the equipment being
used to make the drums is completely worn out and must
be replaced. The choices facing the company are:
Option A: Purchase new equipment and continue to
make the drums. The equipment would cost
P810,000. It would have a 6 year useful life and no
salvage value. The company uses straight line
depreciation.
Option B: Purchase the drums from an outside supplier
at P18 per drum under a 6 year contract.
The new equipment would be more efficient than the
equipment that Antilles Refining has been using and
according to the manufacturer, would reduce direct
labor and variable overhead costs by 30%. The old
equipment has no resale value. Supervision cost of
P45,000 per year and direct material cost per drum would
not be affected by the new equipment. The new
equipment’s capacity would be 90,000 drums per year.
The company has no other use for the space being used
to produce the drums and the company’s total general
company overhead would be unaffected by this
decision.
Requirements:
1. To assist the managing director in making a decision,
prepare an analysis showing what the total cost and
the cost per drum would be under each of the two
alternatives given above. Assume that 60,000 drums
are needed each year. Which course of action
would you recommend to the managing director?
2. Would your recommendation above be the same if
the company’s needs were 75,000 drums per year or
90,000 drums per year?
3. What other factors would you recommend that the
company consider before making a decision?
PROBLEM 4: The Melrose Company produces a single
product, Product C. Melrose has the capacity to produce
70,000 units of Product C each year. If Melrose produces at
capacity, the per unit costs to produce and sell one unit of
Product C are as follows:
Direct materials
P 20.00
Direct labor
17.00
Variable manufacturing overhead
13.00
Fixed manufacturing overhead
14.00
Variable selling expense
12.00
Fixed selling expense
8.00
The regular selling price of one unit of Product C is P100. A
special order has been received by Melrose from Moore
Company to purchase 7,000 units of Product C during the
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
Page|4 of 6
upcoming year. If this special order is accepted, the
variable selling expense will be reduced by 75%. Total fixed
manufacturing overhead and fixed selling expenses would
be unaffected except that Melrose will need to purchase a
specialized machine to engrave the Moore name on each
unit of product C in the special order. The machine will cost
P10,500 and will have no use after the special order is filled.
Requirements:
1.
2.
3.
Assume that Melrose expects to sell 60,000 units of
Product C to regular customers next year. At what
selling price for the 7,000 units would Melrose be
economically indifferent between accepting and
rejecting the special order from Moore?
Assume Melrose expects to sell 60,000 units of Product
C to regular customers next year. If Moore company
offers to buy the special units at P90 per unit, the
effect of accepting the special order on Melrose's
net operating income for next year will be an
increase (decrease) of:
Suppose Melrose can sell 68,000 units of Product C to
regular customers next year. If Moore Company
offers to buy the special order units at P95 per unit,
the effect of accepting the special order for 7,000
units on Melrose's net operating income for next year
will be an increase (decrease) of:
PROBLEM 5: Polaski Company manufactures and sells a
single product called a “ret”. Operating at capacity, the
company can produce and sell 20,000 rets per year. Costs
associated with this level of production and sales are given
below:
Unit
Total
Direct materials
P12.00
P240,000
Direct labor
6.00
120,000
Variable manufacturing overhead
4.00
80,000
Fixed manufacturing overhead
7.00
140,000
Variable selling expense
3.00
60,000
Fixed selling expense
4.00
80,000
Total cost
P36.00
P720,000
The rets normally sell for P42.00 each. Fixed manufacturing
overhead is constant at P140,000 per year within the range
of 15,000 through 20,000 rets per year.
Requirements:
1.
2.
3.
Assume that due to a recession, Polaski Company
expects to sell only 15,000 rets through regular
channels next year. A large retail chain has offered
to purchase 5,000 rets if Polaski Company is willing to
accept a 15% discount off the regular price. There
would be no sales commissions on this order; thus,
variable selling expenses would be slashed by 80%.
However, Polaski Company would have to purchase
a special machine to engrave the retail chain’s
name on the 5,000 units. This machine would cost
P5,000. This would be a one-time order that would
have no effect on regular sales. Determine the
impact on profits next year if this special order is
accepted.
Assume again that Polaski Company expects to sell
only 15,000 rets through regular channels next year.
The Philippine Army would like to make a one-timeonly purchase of 5,000 rets. The Army would pay a
fixed fee of P7.00 per ret, and in addition it would
reimburse Polaski Company for all costs of production
(variable and fixed) associated with the units. There
would be no variable selling expenses of any type
associated with this order. If Polaski Company
accepts the order, by how much will profits be
increased or decreased for the year?
Assume the same situation as that described in (2)
above, except that the company expects to sell
20,000 rets through regular channels next year. Thus,
accepting the Canadian 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 be
increased or decreased from what they would be if
the 5,000 rets were sold through regular channels?
PROBLEM 6: Scooter Company produces three products
from a joint process costing P100,000. The following
information is available:
A
B
C
Units
produced
10,000
20,000
30,000
Selling
price at
split off
P 3.50
4.00
2.00
Cost to
process
further
P 7,000
3,000
9,000
Selling price
after further
processing
P 4.00
4.50
2.50
Requirements:
1.
2.
If a “sell as is or process further” analysis was made
correctly, what amount of incremental income will
Scooter Company earn by processing further the
right products?
If all three products are currently processed further
before being sold, how higher (lower) would income
be if the three products are rather sold at split off?
PROBLEM 7: Madison Company operates a joint process.
Three products, B, C and D emerge from that process, each
of which can be sold immediately or processed further.
Monthly output is 50,000 gallons; 50% is B, 30% is C, and 20%
is D. You have the following additional information:
Per gallon split off price
Per gallon price after
further processing
Per gallon variable cost
of further processing
Avoidable direct fixed
costs per month of
further processing
Unavoidable direct fixed
costs per month of
further processing
Product B
P 8.00
Product C
P 9.00
Product D
P 6.00
13.00
15.00
12.00
4.00
2.00
4.00
35,000
45,000
18,000
18,000
40,000
7,000
Requirements:
1.
2.
Determine which product(s), if any, should be sold at
split-off.
What amount of incremental income will Scooter
Company earn by processing further the right
products?
PROBLEM 8: Wilson Company expects the following results
for the year 2011:
Sales
Variable costs
Contribution margin
Avoidable fixed costs
Unavoidable fixed
costs
Profit (loss)
Product A
P1,000,000
(400,000)
P 600,000
(200,000)
Product B
P 3,000,000
(1,000,000)
P 2,000,000
(300,000)
Total
P 4,000,000
(1,400,000)
P 2,600,000
(500,000)
(500,000)
P (100,000)
(1,000,000)
P 700,000
(1,500,000)
P 600,000
The unavoidable costs are allocated based on unit sales of
1,000 for Product A and 2,000 for Product B.
Requirements:
1.
2.
3.
Compute for Wilson Company's income if Product A
is dropped.
If product A were dropped and the unit sales of
product B increased by 30%, what would the
company's income be?
Product A can be dropped and replaced with a new
product, Product C which would have avoidable
fixed costs of P500,000. Product C would sell for
P6,000, have variable costs of P2,000, and expected
volume of 400 units. Compute for Wilson Company's
income if A were replaced by C.
PROBLEM 9: The income statement of Marinduque
Corporation’s Department 4 for October 2012 is given
below:
Marinduque Corporation
Income Statement of Department 4
For the Month Ended October 31, 2012
Sales
Less: Variable costs and expenses
Contribution margin
Less: Fixed costs and expenses
Net loss
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
P 2,400,000
1,800,000
P 600,000
800,000
P 200,000
Page|5 of 6
Sixty percent of the total fixed costs and expenses are
allocated from the head office. The company’s president is
contemplating to drop Department 4 on account of its
unfavorable
performance.
The
discontinuance
of
Department 4 would not affect sales of other departments.
Requirements:
1.
2.
Compute for the segment margin of Department in
October 2012. Based on this amount, would you
recommend Department 4 to be dropped or
continue operating?
Would your recommendation be the same if the
space used by Department 4 could be rented to
outside parties for P300,000 a month?
PROBLEM 10: Levy Corporation had been experiencing a
slowdown in business activities in August, September and
October and is considering temporarily shutting down its
operations during those months. The accounting
department has provided the following normal operating
data for considerations:
Unit sales price
P 150.00
Unit variable production costs
60.00
Unit variable marketing costs
10.00
Monthly fixed overhead
600,000
Monthly fixed expenses
200,000
Regular sales in units per month
10,000
Estimated total unit sales for August,
September and October
6,000
If the company shuts down its operations, the following
costs are expected to be incurred:
Security and safety
P 200,000 per month
Restart up costs
320,000 per set up
Regular fixed overhead
40% will be avoided
Regular fixed expenses
30% will remain
Requirements:
1.
2.
3.
Determine the total amount of shutdown costs for the
three month period.
What is the shutdown point of Levy Corporation in
three months?
Which alternative, continuing or discontinuing
operations is advisable and by how much is its
advantage?
PROBLEM 11: The Samuels Company normally produces
150,000 units of Product LM per year. Due to an economic
downturn, the company has some idle capacity. Product
LM sells for P15 per unit. The firm's production, marketing,
and administration costs per unit at its normal capacity of
150,000 units are:
Direct material
P 1.00
Direct labor
2.00
Variable overhead
1.50
Variable marketing cost
1.05
3.00
Fixed overhead
1.40
Fixed marketing and administrative cost
For the current year, the firm expects to sell the same
number of units as it sold in the prior year. However, in a
trade newspaper, the firm noticed an invitation to bid on
selling LM to a local government. There are no marketing
costs associated with the order if Davis is awarded the
contract. The company wishes to prepare a bid for 40,000
units at its full manufacturing cost plus P0.25 per unit.
Requirements:
1.
2.
What is the lowest price the firm can bid and how
much should it bid?
If Davis is successful at getting the contract, what
would be the increase in its operating income?
PROBLEM 12: Regis Company makes the plugs it uses in one
of its products at a cost of P36 per unit. This cost includes P8
of fixed overhead. Regis needs 30,000 of these plugs
annually and Orlan Company has offered to sell them to
Regis at P33 per unit. If Regis decides to purchase the plugs,
P60,000 of the annual fixed overhead will be eliminated,
and the company may be able to rent the facility
previously used for manufacturing the plugs.
Determine the maximum amount the company should be
willing to pay an outside supplier per unit for the part if the
supplier commits to supplying all 50,000 units required each
year.
PROBLEM 13: Bear Valley produces three products: A, B,
and C. One machine is used to produce the products.
There are 2,400 minutes available on the machine during
the week. The contribution margins, sales demands and
time on the machine are as follows:
Product type
A
B
C
Demand
in units
100
80
150
Contribution
margin
P250.00/unit
180.00/unit
300.00/unit
Time
on Machine
10 minutes
5 minutes
10 minutes
Requirements:
1. How many units of each product type should be
produced and sold to maximize the weekly
contribution?
2. What is the maximum contribution margin that can
be earned by Bear Valley during the week?
3. Assuming Bear Valley can buy as many machines it
needs, which of the products is the most profitable?
PROBLEM 14: Tashima Corporation sells artifacts and other
historical items. It is now studying whether to sell now or later
one of its items, a Chinese porcelain dated back in 1541,
with the following data:
Cost of discovery
P 700,000
Cost of monthly storage in a special
place
30,000
Selling price now
2,600,000
Expected sales price 8 months from now
2,900,000
Requirements:
1.
2.
What are the irrelevant costs in this decision
alternative?
What is the net advantage (disadvantage) of selling
the merchandise eight months later?
PROBLEM 15: Pink Industries, Inc. has an opportunity to
acquire a new equipment to replace one of its existing
equipment. The following data are gathered relative to the
new and old assets:
Old
New
Book value
P 700,000
Purchase price
P 1,200,000
Life in years
5 years
5 years
P
50,000
Salvage value – current
None
None
Salvage value – after 5 years
P 1,300,000 P 1,000,000
Variable operating expenses
Determine the appropriate action that Pink Industries
should take, retain or replace its old equipment.
PROBLEM 16: Light Company has 2,000 obsolete light fixtures
that are carried in inventory at a manufacturing cost of
P30,000. If the fixtures are reworked for P10,000, they could
be sold for P18,000. Alternatively, light fixtures could be sold
for P3,000 to a jobber located in a distant city.
Requirements:
1. In a decision model analyzing these alternatives, the
opportunity cost of selling the light fixtures to a scrap
would be:
2. In a decision model analyzing these alternatives, the
sunk cost would be:
PROBLEM 17: Eat n’ Eat Shop operates sandwiches on the
go in shopping malls. The average selling price of a
sandwich is P100 and the average cost of each sandwich is
P70. A new mall is opening where Eat n’ Eat wants to locate
a shop but the location manager is not sure about the rent
method to accept. The mall operator offers two options for
shop rental as follows:
A. Paying a base rent of P40,000 plus 9% of revenue
received.
B. Paying a base rent of P20,000 plus 20% of revenue
received up to a maximum of P80,000.
Determine the level of sales in pesos and in units where Eat
n’ Eat will be indifferent between the two options.
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
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