Tactical Decision Making: Relevant Costing
Tactical Decision Making: Relevant Costing
Learning Objectives
1. Use differential analysis to analyze decisions.
2. Understand how to apply differential analysis to pricing decisions.
3. Understand several approaches for establishing prices based on costs for long-run
pricing decisions.
4. Understand how to apply differential analysis to production decisions.
5. Understand the theory of constraints.
Chapter Outline
I.
II.
III.
IV.
DIFFERENTIAL ANALYSIS
A. Differential costs versus total costs
B. Differential analysis and pricing decisions
• The full-cost fallacy in setting prices
C. Short-run versus long-run pricing decisions
D. Short-run pricing decisions: Special orders
E. Long-run pricing decisions
F. Long-run versus short-run pricing: Is there a difference?
G. Cost analysis for pricing
1. Life-cycle product costing and pricing
2. Target costing from target pricing
H. Legal issues relating costs and sales prices
1. Predatory pricing
2. Dumping
3. Price discrimination
4. Peak-load pricing
5. Price fixing
USE OF DIFFERENTIAL ANALYSIS FOR PRODUCTION DECISIONS
A. Make-it or buy-it decisions
B. Make-or-buy decisions involving differential fixed costs
C. Opportunity costs of making
D. Decision to add or drop a product line or close a business unit
• Nonfinancial considerations of closing a business unit
E. Product choice decisions
THE THEORY OF CONSTRAINTS
SUMMARY
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Tactical Decision Making: Relevant Costing
Key Concepts
Bible Verse:
“The lot is cast into the lap, but its every decision is from the Lord.”(Prov. 16:33).
LO 4-1 Use differential analysis to analyze decisions.
♦ Some common business decisions require an understanding of
(1) the effect of the decision on the organization’s revenues and costs, and
(2) the business and competitive environment.
• The decisions under consideration include:
How much business was required to be profitable?
How to price special orders?
Whether to do something in-house or outsource it to another firm?
Whether to drop one of the products?
What was the right product mix?
♦ Differential analysis refers to the process of estimating revenues and costs of alternative
actions available to decision makers and of comparing these estimates to the status quo.
• Every decision that a manager makes requires comparing one or more proposed
alternatives with the status quo.
• Differential analysis may be applicable for both short-run and long-run decisions.
• Short run is defined as the period of time over which capacity will be unchanged,
generally one year. Beyond that time frame, long-run considerations will apply.
• Both short-run and long-run decisions are concerned with the amount of cash flow.
Short-run decisions usually ignore the timing issues because the time value of money
is immaterial. For long-run decisions, the timing of cash flow is a significant factor.
Time value of money will be discussed in the Appendix to the book.
• The In Action box considers the impacts of cost analysis on the choice of office
space for a small business.
♦ Differential costs are costs that differ among alternatives. Differential costs change in
response to alternative courses of action.
• Both variable and fixed costs may be differential costs. All relevant facts for each
alternative should be examined to determine which costs will be affected, and
therefore differential.
• Variable costs are differential when a decision involves possible changes in volume.
• All of the affected costs are considered differential.
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Tactical Decision Making: Relevant Costing
• Sunk costs are costs incurred in the past that cannot be changed by present or future
decisions. Sunk costs are not differential and, therefore, not relevant for decision
making.
♦ For decision making purposes, the information for alternatives may be presented to
managers using either the total format, in which the detailed costs are included, or the
differential format, in which only the differences between alternatives are shown.
• There are two major advantages of using the total format:
(1) All the information is available so it is easy to derive the differential format if
desired;
(2) When a particular alternative is chosen, the information about the resources
required for implementation is readily available.
• The advantage of the differential format is that it highlights the differences between
alternatives.
LO 4-2 Understand how to apply differential analysis to pricing decisions.
♦ Prices are determined by supply and demand. Pricing decisions, which impact profits, allow
managers to determine whether to sell goods and/or provide services in the market, thereby
contributing to the supply curve.
♦ Full (product) cost is defined as the sum of the fixed and variable costs of manufacturing
and selling a unit.
• Full cost includes both
(1) the variable costs of producing and selling the product, and
(2) a share of the organization’s fixed costs.
• From the cost equation (TC = F + VX) in CVP analysis, full cost can be expressed
as
F + VX
X
=
F
X
+ V, where
V = Variable cost per unit,
X = Units of output, and
F = Fixed costs.
• In this setup, the fixed costs are unitized (i.e., divided by the units of output) and
added to the variable cost per unit to come up with the full cost. For short-run
decisions (such as whether to accept special orders), the fixed cost component
generally is not differential
and should not be considered. The use of full cost for some short-run decisions will
erroneously render the alternative option less attractive, creating what is known as
“the full-cost fallacy.”
• In the long run, all costs must be covered or the company will fail.
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Tactical Decision Making: Relevant Costing
Example 1: On a particular month, U-Develop receives a special order from an outof-town merchant who is willing to pay P4,000 for 10,000 photo prints developed, or
P0.40 per print. An analysis of U-Develop’s cost structure shows that it incurs
variable cost of P0.36 per print and P1,500 monthly fixed cost. U-Develop can
handle the special order without affecting its regular business.
The full cost of the special order is calculated by an employee as follows.
$1, 500 + $0.36  10, 000
10, 000
= P0.51 per print.
By unitizing the fixed cost, the full cost calculation gives the impression that the
special order is not a profitable one as the unit cost of P0.51 per print is higher than
the unit price offered of P0.40.
However, since the monthly fixed cost of P1,500 remains the same with or without
the special order, the differential cost relevant for this decision context is the variable
cost of P0.36 per print. Therefore, the special order should be accepted, netting an
additional profit of P400 (= (P0.40 - P0.36) × 10,000 prints) for the month. The “fullcost fallacy” is avoided.
♦ Short-run pricing decisions include
(1) pricing for a one-time-only special order without long-term implications, and
(2) adjusting product mix and volume in a competitive market.
• Long-run pricing decisions include pricing a main product in a large market in
which price setting has considerable leeway.
♦ Special order represents an order that will not affect other sales and is usually a short-run
occurrence. Exhibit 4.1 provides a framework for decision making in this context. Two
options are presented: status quo (reject special order) vs. alternative (accept special order).
The option that provides the highest economic value should be chosen.
• As seen in Exhibit 4.2, both the differential format and the total format work well to
resolve the special-order problem.
• For typical short-run decisions, fixed costs are not differential and therefore not
relevant.
• The differential approach leads to correct short-run pricing decisions.
• The differential approach indicates only a minimum acceptable price for both the
short run and the long run. Given the market conditions, the firm may choose to
charge a higher price.
• A special order is usually acceptable when idle capacity is adequate for the job and
when the regular sales are not affected. If idle capacity is not available, then the costs
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Tactical Decision Making: Relevant Costing
of additional personnel and machinery to tackle the job, both variable and fixed, must
be considered. If accepting the special order may adversely influence the regular sales,
then the lost sales due to the special order should also be considered.
• Financial analyses only look at factors that can be quantified. Nonfinancial issues
must be considered as well before a final decision is reached.
======================
Demonstration Problem 1
Nationwide Windows can produce 10,000 windows per year. Its normal year of operations
involves the following:
Sales (8,000 units @ P220)
Manufacturing cost
Variable per unit
Fixed
Selling and administrative cost
Variable (commission) per unit on
sales
Fixed
P1,760,000
150
260,000
12
60,000
During the year, Nationwide is approached by a contractor to buy 1,500 windows for P165
each. The variable sales commission is set to be a flat fee of P12,000 for the special order.
The fixed costs are not affected by the decision.
Required:
1. Should Nationwide Windows accept the special order? Explain.
2. If the contractor needs instead a total of 2,500 windows and still pays P165 each (all
other information remains the same), should Nationwide accept the special order?
Explain.
Solution:
1. The special order should be accepted, because it generates the additional profit of
P10,500.
Sales
Variable costs
Contribution margin
Fixed costs
Operating profit
Status Quo
(Do not accept)
P1,760,000
(1,296,000)
P464,000
(320,000)
P144,000
Alternative
(Accept)
P2,007,500
(1,521,000)
P486,500
(332,000)
P154,500
Difference
P247,500
(225,000)
P22,500
(12,000)
P10,500
2. The special order should be rejected because of the net loss of P3,500 relative to the
status quo. By accepting the special order, Nationwide can only sell 7,500 windows at
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Tactical Decision Making: Relevant Costing
the regular price of P220 each. The rest (up to its capacity limit of 10,000 windows
per year) will be delivered to the contractor for P165 each.
Sales
Variable costs
Contribution margin
Fixed costs
Operating profit
Status Quo
(Do not accept)
P1,760,000
(1,296,000)
P464,000
(320,000)
P144,000
Alternative
(Accept)
P2,062,500a
(1,590,000)b
P472,500
(332,000)c
P140,500
Difference
P302,500
(294,000)
P8,500
(12,000)
P(3,500)
a
P220 × 7,500 + P165 × 2,500 = P2,062,500
P162 × 7,500 + P150 × 2,500 = P1,590,000
c
P260,000 + P60,000 + P12,000 = P332,000
======================
b
LO 4-3 Understand several approaches for establishing prices based on
costs for long-run pricing decisions.
♦ Full cost includes all costs incurred by the activities that make up the value chain to
produce and sell a unit. The marketing department receives cost reports from the accounting
department, and then adds markups to determine benchmark or target prices for all products
the firm normally sells. This approach is known as the cost-plus pricing.
• Pricing decisions based on full cost may be appropriate when
(1) a long-term contractual relationship is established to supply a product and both the
variable and the fixed costs are specified in the contract,
(2) dealing with government procurements, customized products or regulated
industries in which full cost plus a markup determines product prices, or
(3) full-cost-based prices are adjusted upward or downward to reflect short-term
market conditions.
• For unique products in construction, defense, custom orders, and many new products,
full costs plus a markup become the basis for pricing as well as bidding on a job.
♦ Based on the differential analysis, short-run prices may be low enough just to cover the
variable costs of providing one additional unit of goods or services, much like the concept of
marginal cost in economics. On the other hand, long-run prices have to be much higher so
that both the variable and fixed costs can be recovered and still make a profit. This will
ensure a firm’s long-term survival.
• A common saying in business: “I can drop my price to just cover variable costs in
the short run, but in the long run, my prices have to cover full product costs.”
♦ In addition to the full cost or cost-plus approach, other cost-based pricing approaches
include
(1) life-cycle product costing and pricing, and
(2) target costing for target pricing.
• These approaches are especially useful in making long-run pricing decisions.
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Tactical Decision Making: Relevant Costing
♦ Product life cycle covers the time from initial research and development to the time at
which support to the customer ends.
• Life-cycle costing (or cradle-to-grave costing), the important basis for pricing, tracks
costs from start to finish for each product.
• A product life-cycle budget highlights for managers the importance of setting prices
that will cover costs in all value-chain categories to be profitable.
• Manufacturers of environmentally sensitive products have to meet the recent “takeback” requirement by paying for the recycling and disposal costs at the end of the
products’ useful life. The additional costs must be considered in making pricing
decisions. This in turn influences how products are designed to tradeoff the cost of
manufacture and disposal.
♦ Most of the firms in a competitive market are price takers. A target price is the price based
on customers’ perceived value for the product and the price that competitors charge. A target
cost equals the target price minus desire profit margin. That is,
Target cost = Target price – Desired profit margin.
• A firm constrained by the price it can charge, with a desire to make a healthy profit,
must limit the costs it incurs to manufacture the product in the long run in the spirit of
“price-based costing.”
♦ Legal issues regarding costing and pricing get a lot of attention as competition heats up and
as companies move more goods and provide services around the globe.
• Predatory pricing is the practice of setting a selling price below cost with the intent
to harm competition by driving competitors out of the market or by creating a barrier
to entry for new competitors.
• Predatory pricing is considered anti-competitive and illegal under antitrust laws.
• Marginal cost (in theory) or average variable cost (in practice) is used as the floor
below which predatory pricing practice is established in courts.
Example 2: Two companies, P(redator) and C(ompetitor), produce similar products
while employing similar technologies. The variable cost per unit is P5.10 for both.
Company C adopts an industry practice of adding 10% markup to the variable cost to
come up with a selling price of P5.61 per unit.
In order to dominate the market, Company P decides to charge a price of P5 per unit
for the same product, resulting a loss of P0.10. Over a short period time, the strategy
of predatory pricing attracts customers old and new, eventually driving Company C
out of the market. Company P then raises its price to P6.63, enjoying a markup of
30% and recouping its losses many times over.
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Tactical Decision Making: Relevant Costing
• Dumping occurs when a company exports its product to consumers in another
country at an export price below its domestic price.
• Dumping benefits consumers in the short run at the expense of the producers in the
importing country, who usually seek protection in the form of tariffs on the dumped
products to bring up the prices and to level the playing field.
• Policy makers disagree on the merits of prohibiting dumping: protection of domestic
industries for national security reasons vs. practice of free trade and free markets.
• Price discrimination is the practice of selling identical goods or services to
different customers at different prices.
• Price discrimination requires market segmentation based on price sensitivity.
• Price discrimination on the basis of race, religion, disability, or gender is illegal.
• Peak-load pricing is the practice of setting prices highest when the quantity
demanded for the product approaches the physical capacity to produce it (and lower at
other times).
• Price fixing represents the agreement among business competitors to set prices at a
particular level.
• The prices being “fixed” are at a level higher than the equilibrium prices in
competitive markets.
• Pricing fixing is not universally illegal. However, when it is considered illegal, mere
informal or unspoken agreements may result in jail time and/or huge fines.
LO 4-4 Understand how to apply differential analysis to production
decisions.
♦ Differential analysis helps managers address ongoing production and operating issues,
including
(1) make-or-buy decisions,
(2) whether to add or drop a product line or close a business unit,
(3) production choices, and
(4) product mix decisions.
• The keys are to identify relevant costs and revenues under different alternatives and
to choose the course of action that provides the best economic value for the firm.
♦ Make-or-buy decision involves any decision concerning whether to make the needed
goods internally or purchase them from outside sources.
• A sourcing decision is often strategic and long-run, as the firm chooses to either
integrate vertically upstream and/or downstream to exercise more control, or develop
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Tactical Decision Making: Relevant Costing
long-term relationships with suppliers and only specialize in certain areas of the total
manufacturing process.
• A make-or-buy decision is ultimately a question of which firm in the value chain can
produce the product or service at the lowest cost.
• In addition to quantitative considerations (i.e., differential costs and revenues), other
factors (such as market structure, suppliers’ dependability and quality control) may
also play a role.
• In make-or-buy decisions, the relevant costs include the variable manufacturing
costs (direct materials, direct labor, variable overhead) that can be saved, the fixed
overhead that may be eliminated, and the purchase price of the parts under
consideration. Exhibit 4.3 illustrates an example.
• Make-or-buy decisions are sensitive to volume. When the cost information can be
separated into variable and fixed components in the accounting system, a unique
volume may exist that makes the firm indifferent as to whether to outsource or not.
Above or below that volume, the decision will be reversed. That is, setting VX + F =
PX will lead to
X=
F
P−V
, where
X = The indifferent volume between make or buy,
V = Variable cost per unit,
F = Fixed costs, and
P = Purchase price per unit.
(VX + F) represents the costs of “Make,” while PX represents the costs of “Buy.” See
Exhibit 4.4 for an illustration.
• The Goal Seek formula in Microsoft Excel can also be used to find the volume
where the cost to make is the same as the cost to buy. Exhibit 4.5 shows how the
spreadsheet is set up.
• Opportunity costs are the forgone returns from not employing a resource in its best
alternative use and are not routinely reported with other accounting cost data. The fact
that they are difficult to estimate or subject to considerable uncertainty does not mean
that opportunity costs should be ignored. Exhibit 4.6 extends the case to consider the
opportunity cost of alternative facility use.
======================
Demonstration Problem 2
Cube Manufacturing usually produces its own parts for assembly. The following monthly
data are available for one of the parts, Part A31:
Manufacturing costs
Variable per unit
Fixed costs
P6
15,000
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Tactical Decision Making: Relevant Costing
Nonmanufacturing costs
Variable per unit
P1
Fixed costs
9,000
Cube needs 2,000 units of Part A31 every month. An outside supplier offers to deliver that
part for P11.5 each. By accepting the offer, Cube can save half of the fixed manufacturing
costs and all variable costs, but the fixed nonmanufacturing costs are not affected.
Required:
1. Should Cube Manufacturing accept the offer and outsource Part A31?
2. If the facility used to produce Part A31 can be leased out to generate a monthly rental
income of P3,000, what should Cube Manufacturing do?
Solution:
1. Cube Manufacturing should reject the offer and continue to make the part itself,
because the total costs will be higher.
Variable costs
Fixed costs
Purchase price
Total costs
Status Quo
(Make)
P14,000
24,000
P38,000
Alternative
(Buy)
Difference
P0 P14,000 lower
16,500
7,500 lower
23,000 23,000 higher
P39,500 P1,500 higher
2. In this scenario, Cube should accept the offer. The P3,000 monthly rental income
represents an opportunity cost for producing Part A31 internally, making outsourcing
more attractive.
Variable costs
Fixed costs
Purchase price
Opportunity cost
Total costs
Status Quo
(Make)
P14,000
24,000
3,000
P41,000
Alternative
(Buy)
Difference
P0 P14,000 lower
16,500
7,500 lower
23,000 23,000 higher
3,000 lower
P39,500 P1,500 lower
The P3,000 monthly rental income may be treated as cost savings as a result of
outsourcing. The conclusion remains the same.
Status Quo
(Make)
P14,000
24,000
Alternative
(Buy)
Difference
P0 P14,000 lower
16,500
7,500 lower
23,000 23,000 higher
(3,000)
3,000 lower
P36,500 P1,500 lower
Variable costs
Fixed costs
Purchase price
Opportunity cost
Total costs
P38,000
======================
♦ Unprofitable product lines and noncompetitive business units may be subjected to increased
scrutiny. Managers have to decide whether to keep or drop them.
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Tactical Decision Making: Relevant Costing
• Financial statements prepared in accordance with generally accepted accounting
principles do not routinely provide differential cost information. Differential cost
estimates depend on unique information that usually requires separate analysis.
• In deciding whether to eliminate a product line or a business unit, the differential
analysis should look at the CVP income statement with the emphases on the
contribution margin made by the division under consideration and on the disposition
of that division’s fixed costs.
• The divisional profits reported in income statement (see Exhibit 4.7) can be
misleading because all costs, not just differential ones, are present. Differential cost
estimates depend on unique information that usually requires separate analysis (see
Exhibit 4.8).
• Other considerations include the potential opportunity costs of keeping the product
lines (such as the alternative use of the shelf space), the impacts on related products or
units which will stay, and nonfinancial factors such as the potential impacts on
employees and communities.
======================
Demonstration Problem 3
Cube Manufacturing produces three different products: Platinum, Gold, and Silver. The
financial statement from last quarter is shown below.
Sales
Variable costs
Contribution margin
Fixed costs
Operating profit (loss)
Platinum
P500,000
(350,000)
P150,000
(80,000)
P70,000
Gold
P400,000
(300,000)
P100,000
(60,000)
P40,000
Silver
P200,000
(160,000)
P40,000
(50,000)
P(10,000)
Total
P1,100,000
(810,000)
P290,000
(190,000)
P100,000
The general manager is thinking of eliminating the Silver product line to improve the
financial results. The cost accountant cautions that the fixed costs allocated to Silver have to
be absorbed by the remaining two products if the decision is finalized.
Required:
What should the general manager of Cube Manufacturing do? Please explain.
Solution:
The general manager should keep the Silver product line. If Silver is dropped, the total
fixed costs of P190,000 remain the same while the contribution margin from Silver will
be lost, resulting a net loss of P40,000 for the company as a whole.
Sales
Variable costs
Contribution margin
Fixed costs
Operating profit (loss)
Status quo
(Keep Silver)
P1,100,000
(810,000)
P290,000
(190,000)
P100,000
2-11
Alternative
(Drop Silver)
P900,000
(650,000)
P250,000
(190,000)
P60,000
Difference
P200,000 decrease
160,000 decrease
P40,000 decrease
P40,000 decrease
Tactical Decision Making: Relevant Costing
♦ In the short run, capacity is fixed and limited. In general, firms face constraints, such as
activities, resources, or policies that limit or bound the attainment of an objective.
its
• Given the constraints, a firm has to choose what products to offer that will maximize
contribution margin. This is a product choice decision, or a decision to optimize the
product mix offered.
• The important measure of profitability is based on the contribution margin per
unit of scarce resource, a particular input with limited availability. By concentrating
on the product(s) that yield the higher contribution margin per unit of scarce resource,
a firm can maximize its profit.
• Microsoft Excel’s Solver function can be used to find the optimal product mix when
there are constraining resources.
LO 4-5 Understand the theory of constraints.
♦ Theory of constraints (TOC) focuses on revenue and cost management when faced with
bottlenecks, defined as operations where the work required limits production.
• Dependencies among multiple parts and processes to produce goods give rise to
bottlenecks as the constraining resources.
• Maximizing the output of the constrained resources is the best route to increased
marginal revenues.
• The three components in the theory of constraints are
(1) throughput contribution: sales pesos minus direct materials costs and other
variable costs such as energy and piecework labor,
(2) investments: inventories, equipment, buildings, and other assets used to generate
throughput contribution, and
(3) other operating costs: all operating costs other than direct materials and other
variable costs incurred to earn throughput contribution, including most salaries
and wages, rent, utilities, and depreciation.
• The theory of constraints assumes a short-run time horizon and considers only
materials, purchased parts, piecework labor, and energy to run machines to be
variable; everything else is assumed fixed and will be expensed in the period in which
they are incurred.
• The objective of the theory of constraints is to maximize throughput contribution
while minimizing investments and other operating costs, therefore maximizing the
contribution margin per unit of the constraining resource.
Example 3: The following illustrates the manufacturing process in a factory. Every
unit of the finished product has to go through three departments as identified by the
machines used, A, B, and C. There are three “A” machines (capacity: 1,200 units
each per hour), one “B” machine (capacity: 3,000 units per hour), and two “C”
machines (capacity: 1,600 units each per hour).
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Tactical Decision Making: Relevant Costing
1,200 units each
1,600 units each
A
3,000 units
Raw
Materials
A
C
Finished
Goods
B
C
A
When “A” machines are utilized at full capacity, their output results in inventory
buildup in front of “B” machine because its capacity can not keep pace. “B” machine
is identified as the bottleneck of the whole operation.
The full-capacity output from “B” machine can be handled with ease by the
downstream “C” machines. Theory of constraints dictates maximizing the output
from “B” machine while subordinating the other two departments to the pace of “B”
machine in order to optimize the operations.
Matching
A.
B.
C.
D.
E.
F.
Bottleneck
Differential analysis
Full cost
Dumping
Make-or-buy decision
Peak-load pricing
G.
H.
I.
J.
K.
L.
Price discrimination
Product life cycle
Special order
Sunk cost
Target price
Throughput contribution
_____ 1. Occurs when a company exports its product to consumers in another country at an
export price below its domestic price.
_____ 2. Sales pesos minus direct materials costs and other variable costs such as energy
and piecework labor.
_____ 3. Involves any decision concerning whether to make the needed goods internally or
purchase them from outside sources.
_____ 4. Refers to the process of estimating revenues and costs of alternative actions
available to decision makers and of comparing these estimates to the status quo.
_____ 5. Represents an order that will not affect other sales and is usually a short-run
occurrence.
_____ 6. The sum of the fixed and variable costs of manufacturing and selling a unit.
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Tactical Decision Making: Relevant Costing
_____ 7. Covers the time from initial research and development to the time at which
support to the customer ends.
_____ 8. The practice of selling identical goods or services to different customers at
different prices.
_____ 9. The practice of setting prices highest when the quantity demanded for the product
approaches the physical capacity to produce it (and lower at other times).
_____ 10. Operations where the work required limits production.
_____ 11. The price based on customers’ perceived value for the product and the price that
competitors charge.
_____ 12. Costs incurred in the past that cannot be changed by present or future decisions.
Answer: D, L, E, B, I, C, H, G, F, A, K, J
Multiple Choice
1. Which of the following statements is correct?
a. Life-cycle costing tracking costs from start to finish.
b. Product life cycle ends when the product is delivered to customers.
c. Product price must be set to cover the costs of manufacturing activities only.
d. “Take-back” requirement for product recycle and disposal is customers’ responsibility.
2. A division has the following data: Sales P320,000, Variable costs P200,000, and Fixed
costs P140,000. If the division were eliminated, the fixed costs would be allocated to
other divisions. What will be the net impact on the company’s overall profit?
a. P20,000 increase.
b. P60,000 decrease.
c. P120,000 decrease.
d. Can not be determined from the data provided
3. Two alternative projects are under consideration:
Revenues
Variable costs
Fixed costs
Project A
P360,000
210,000
90,000
Project B
280,000
180,000
90,000
Which of the following are relevant in choosing between the projects?
a. Revenues.
b. Variable costs.
c. Fixed costs.
d. Both a and b.
4. Which of the following statements is correct?
a. Predatory pricing is illegal.
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Tactical Decision Making: Relevant Costing
b. Dumping hurts consumers in the long run.
c. Price discrimination requires market segmentation.
d. All of the above.
5. For differential analysis,
a. Differential costs are relevant costs.
b. No fixed costs are differential.
c. Most variable costs are differential.
d. Both a and c.
6. Full cost is
a. The sum of variable and fixed cost per unit.
b. Always relevant for short-run decisions.
c. Useful for long-run pricing decisions.
d. Both a and c.
7. In a competitive market where firms are price takers,
a. Each firm can set its own prices.
b. Target pricing is appropriate.
c. Target cost must be achieved in the short run.
d. Cost-based pricing should be adopted.
The following information is for questions 8 – 9.
Company B is considering whether to outsource Part#375 needed to produce finished
products. If manufactured internally, it will cost direct materials P2 per unit, direct labor
P1.20 per unit, variable overhead P1.50 per unit, and fixed overhead P18,000. An outside
supplier is available to provide between 5,000 and 50,000 units of Part#375 at P6.20 per unit.
8. At what volume will Company B become indifferent to the make-or-buy choice?
a. 8,000 units.
b. 12,000 units.
c. 20,000 units.
d. 31,000 units.
9. If Company B needs 8,000 units of Part#375, and outsourcing saves only 25% of the
fixed overhead, then Company B’s make-or-buy decision and cost advantage are
a. Make, P7,500.
b. Make, P6,000.
c. Buy, P2,000.
d. Buy, P4,000.
10. Theory of constraints (TOC)
a. Applies to long-run cost management.
b. Is concerned with improving bottleneck operations.
c. Tries to minimize throughput contribution.
d. Considers most salaries and wages, rent, utilities and depreciation to be variable costs.
11. A company currently manufactures a subassembly for its main product. The unit costs for
the subassembly are:
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Tactical Decision Making: Relevant Costing
Prime costs P25, Variable overhead P10, and Fixed overhead P8.
The fixed overhead is an allocated amount shared by other operations. What is the
relevant cost of the subassembly?
a. P25.
b. P35.
c. P43.
d. P33.
12. Differential analysis is suitable for the following situations except
a. Make-or-buy decisions.
b. Whether to close a business unit.
c. Cost behavior analysis.
d. Product mix decisions.
Answers
1. a
2. c
3. d
4. d
5. d
6. d
7. b
8. b
9. a
10. b
11. b
12. c
Reflection:
1. Describe briefly what you gained from this topic. Explain how this will affect your future
as a CPA/business owner or practitioner.
2. Read again the Bible verse presented at the start of the learning material. Write here your
short reflection. (this is not mandatory. But Sir Vic strongly suggest you do it because the
Bible is truth which gives you LIFE not only now but even for the world to come. You may
also highlight the verse in your own Bible).
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