Exam 10: Relevant Costing for Managerial Decisions

The Mad Hatter Company owns a machine that manufactures two types of chimney caps. Production time is .20 hours for cap A and .40 hours for cap B. The machine's capacity is 2,000 hours per year. Both products are sold to a single customer who has agreed to buy all of the company's output up to a maximum of 1,000 units of cap A and 6,000 units of cap B. Selling prices and variable costs per unit are shown below. Based on this information, what is the Mad Hatter's most profitable sales mix? Cap A Cap B Selling price per unit \ 80 \ 60 Variable costsper unit 53 42

The potential benefits lost by taking a specific action when two or more alternative choices are available is known as a(n):

Ahngram Corp. has 1,000 defective units of a product that cost $3 per unit in direct costs and $6.50 per unit in indirect cost when produced last year. The units can be sold as scrap for $4 per unit or reworked at an additional cost of $2.50 and sold at full price of $12. The incremental net income (loss) from the choice of reworking the units would be:

A(n) ________ is the potential benefit lost by taking a specific action when two or more alternative choices are available.

Relevant costs are also known as ________.

Granfield Company is considering eliminating its backpack division, which reported an operating loss for the recent year of $42,000. The division sales for the year were $960,000 and the variable costs were $475,000. The fixed costs of the division were $527,000. If the backpack division is dropped, 40% of the fixed costs allocated to that division could be eliminated. The impact on Granfield's operating income for eliminating this business segment would be:

Significant sunk costs are relevant to decisions about the future.

If the cost to buy a part is less than the direct material, direct labor, and incremental overhead cost of making the part, the company should buy the part.

Minor Electric has received a special one-time order for 1,500 light fixtures (units) at $5 per unit. Minor currently produces and sells 7,500 units at $6.00 each. This level represents 75% of its capacity. Production costs for these units are $4.50 per unit, which includes $3.00 variable cost and $1.50 fixed cost. To produce the special order, a new machine needs to be purchased at a cost of $1,000 with a zero salvage value. Management expects no other changes in costs as a result of the additional production. Should the company accept the special order?

The decision to accept an additional volume of business should be based on a comparison of the revenue from the additional business with the sunk costs of producing that revenue.

To maximize profit when a constrained resource exists, management should produce the sales mix that has the highest contribution margin per unit of scarce resource.

In a make or buy decision, management should focus on costs that are the same under the two alternatives.

Opportunity costs are the additional or incremental revenues generated by selecting a certain course of action.

Additional business in the form of a special order of goods or services should be accepted when the incremental revenue equals the incremental costs.

A sunk cost arises from a past decision and cannot be avoided or changed.

Elliot Company can sell all of its products A and Z that it can produce, but it has limited production capacity. It can produce 8 units of A per hour or 10 units of Z per hour, and it has 20,000 production hours available. Contribution margin per unit is $12 for A and $10 for Z. What is the most profitable sales mix for Elliot Company?

An opportunity cost:

Bluebird Mfg. has received a special one-time order for 15,000 bird feeders at $3 per unit. Bluebird currently produces and sells 75,000 units at $7.00 each. This level represents 80% of its capacity. These bird feeders would be marketed under the wholesaler's name and would not affect Bluebird's sales through its normal channels. Production costs for these units are $3.50 per unit, which includes $2.25 variable cost and $1.25 fixed cost. If Bluebird accepts this additional business, the effect on net income will be:

Another name for relevant cost is unavoidable cost.

A company is planning to introduce a new portable computer to its existing product line. Management must decide whether to make the computer case or buy it from an outside supplier. The lowest outside price is $90. If the case is produced internally, the company will have to purchase new equipment that will yield annual depreciation of $130,000. The company will also need to rent a new production facility at $200,000 a year. At 20,000 cases per year, a preliminary analysis of production costs shows the following: Per Case Direct materials $ 40.00 Direct labor 32.00 Variable overhead 10.00 Equipment depreciation 6.50 Building rental 10.00 Allocated fixed overhead 7.50 Total cost $106.00 Required: (1) Determine whether the company should make the cases or buy them from the outside supplier. (2) What other factors, besides cost, should the company consider?