Relevant Costing Problems
I.
Contribution approach, relevant costs. Air Frisco owns a single jet
aircraft and operates between San Francisco and the Fiji Islands. Flights leave San
Francisco on Mondays and Thursdays and depart from Fiji on Wednesdays and
Saturdays. Air Frisco cannot offer any more flights between San Francisco and Fiji.
Only tourist-class seats are available on its planes. An analyst has collected the following
information:
Seating capacity per plane
Average number of passengers per flight
Flights per week
Flights per year
Average one-way fare
Variable fuel costs
Food and beverage service costs
(no charge to passenger)
Commission to travel agents paid by Air Frisco
(all tickets are booked by travel agents)
Fixed annual lease costs allocated to each flight
Fixed ground services (maintenance, check in,
baggage handling) costs allocated to each flight
Fixed flight crew salaries allocated to each flight
360 passengers
200 passengers
4 flights
208 flights
$500
$14,000 per flight
$20 per passenger
8% of fare
$53,000 per flight
$7,000 per flight
$4,000 per flight
For simplicity, assume that fuel costs are unaffected by the actual number of passengers
on a flight.
Required
1. Calculate the operating income that Air Frisco earns on each one-way flight
between San Francisco and Fiji.
2. The Market Research Department of Air Frisco indicates that lowering the
average one-way fare to $480 will increase the average number of passengers per
flight to 212. Should Air Frisco lower its fare? Show your calculations.
3. Travel International, a tour operator, approaches Air Frisco on the possibility of
chartering (renting out) its jet aircraft twice each month, first to take Travel
International’s tourists from San Francisco to Fiji and then to bring the tourists
back from Fiji to San Francisco. If Air Frisco accepts Travel International’s offer,
Air Frisco will be able to offer only 184 (208 – 24) of its own flights each year.
The terms of the charter are as follows: (a) For each one-way flight, Travel
International will pay Air Frisco $75,000 to charter the plane and to use its flight
crew and ground service staff; (b) Travel International will pay for fuel costs; and
(c) Travel International will pay for all food costs. On purely financial
considerations, should Air Frisco accept Travel International’s offer? Show your
calculations. What other factors should Air Frisco consider in deciding whether
or not to charter its plane to Travel International?
II.
Discontinuing a product line, selling more units. The Northern
Division of Grossman Corporation makes and sells tables and beds. The following
estimated revenue and cost information from the division’s activity-based costing system
is available for 1999.
4,000
Tables
5,000
Beds
Revenues ($125 x 4,000; $200 x 5,000)
$500,000
$1,000,000 $1,500,000
Variable direct materials and direct manufacturing
labor costs ($75 x 4,000; $105 x 5,000)
300,000
525,000
825,000
Depreciation on equipment used exclusively by
each product line
42,000
58,000
100,000
Marketing and distribution costs
$40,000 (fixed) + $750 per shipment x 40 shipments
70,000
Total
205,000
$60,000 (fixed) + $750 per shipment x 100 shipments
135,000
Fixed general administration costs of the division
allocated to product lines on the basis of revenues
110,000
220,000
330,000
Allocated corporate office costs allocated to
product lines on the basis of revenues
50,000
100,000
150,000
Total costs
572,000
1,038,000
Operating income (loss)
$ (72,000)
$ (38,000) $(110,000)
1,610,000
Additional information includes:
a. On January 1, 1999, the equipment has a book value of $100,000 and zero
disposal price. Any equipment not used will remain idle.
b. Fixed marketing and distribution costs of a product line can be avoided if the line
is discontinued.
c. Fixed general administration costs of the division and corporate office costs will
not change if sales of individual product lines are increased or decreased, or if
product lines are added or dropped.
Required
1. Should the Northern Division discontinue the tables product line assuming the
released facilities remain idle? Show your calculations.
2. What will be the effect on Northern Division’s operating income if it were to sell
4,000 more tables? Assume that to do so, the division would have to acquire
additional equipment costing $42,000 with a 1-year useful life. Assume further
that the fixed marketing and distribution costs will not change but that the number
of shipments will double. Show your calculations.
III.
Multiple choice, comprehensive problem on relevant costs. The following are
the Class Company’s unit costs of manufacturing and marketing a high-style pen at an
output level of 20,000 units per month:
Manufacturing costs
Direct materials
Direct manufacturing labor
Variable manufacturing indirect costs
Fixed manufacturing indirect costs
Marketing costs
Variable
Fixed
$1.00
1.20
0.80
0.50
1.50
0.90
Required
The following situations refer only to the preceding data: there is no connection between
the situations. Unless stated otherwise, assume a regular selling price of $6 per unit.
Choose the best answer to each question. Show your calculations.
1. In an inventory of 10,000 units of the high-style pen presented in the balance sheet,
the unit cost used should be (a) $3.00, (b) $3.50, (c) $5.00, (d) $2.20, (e) $5.90.
2. The pen is usually produced and sold at the rate of 240,000 units per year (an average
of 20,000 per month). The selling price is $6 per unit, which yields total annual
revenues of $1,440,000. Total costs are $1,416,000, and operating income is
$24,000, or $0.10 per unit. Market research estimates that unit sales could be
increased by 10% if prices were cut to $5.80. Assuming the implied cost-behavior
patterns continue, this action, if taken, would
a) Decrease operating income by $7,200.
b) Decrease operating income by $0.20 per unit ($48,000) but increase operating
income by 10% of revenues ($144,000) for a net increase of $96,000.
c) Decrease unit fixed costs by 10%, or $0.14, per unit, and thus decrease operating
income by $0.06 ($0.20 - $0.14) per unit.
d) Increase unit sales to 264,000 units, which at the $5.80 price would give total
revenues of $1,531,200, and lead to costs of $5.90 per unit for 264,000 units,
which would equal $1,557,600, and result in an operating loss of $26,400.
e) None of these.
3. A contract with the government for 5,000 units of the pens calls for the
reimbursement of all manufacturing costs plus a fixed fee of $1,000. No variable
marketing costs are incurred on the government contract. You are asked to compare
the following two alternatives:
Sales Each Month to
Regular customers
Government
Alternative A
15,000 units
0 units
Alternative B
15,000 units
5,000 units
Operating income under alternative B is greater than that under alternative A by (a)
$1,000, (b) $2,500, (c) $3,500, (d) $300, (e) none of these.
4. Assume the same data with respect to the government contract as in requirement 3
except that the two alternatives to be compared are:
Sales Each Month to
Regular customers
Government
Alternative A
20,000 units
0 units
Alternative B
15,000 units
5,000 units
Operating income under alternative B relative to that under alternative A is (a) $4,000
less, (b) $3,000 greater, (c) $6,500 less, (d) $500 greater, (c) none of these.
5. The company wants to enter a foreign market in which price competition is keen.
The company seeks a one-time-only special order for 10,000 units on a minimumunit-price basis. It expects that shipping costs for this order will amount to only
$0.75 per unit, but the fixed costs of obtaining the contract will be $4,000. The
company incurs no variable marketing costs other than shipping costs. Domestic
business will be unaffected. The selling price to break even is (a) $3.50, (b) $4.15,
(c) $4.25, (d) $3.00, (e) $5.00.
6. The company has an inventory of 1,000 units of pens that must be sold immediately
at reduced prices. Otherwise, the inventory will be worthless. The unit cost that is
relevant for establishing the minimum selling price is (a) $4.50, (b) $4.00 (c) $3.00,
(d) $5.90, (e) $1.50.
7. A proposal is received from an outside supplier who will make and ship these highstyle pens directly to the Class Company’s customers as sales orders are forwarded
from Class’s sales staff. Class’s fixed marketing costs will be unaffected, but its
variable marketing costs will be slashed by 20 percent. Class’s plant will be idle, but
its fixed manufacturing overhead will continue at 50% of present levels. How much
per unit would the company be able to pay the supplier without decreasing operating
income? (a) $4.75, (b) $3.95, (c) $2.95, (d) $5.35, (e) none of these.