Relevant Cost Potpourri
Relevant Costing Decision Rule
JOINT PRODUCTS - Continue
processing joint products after the splitoff point so long as incremental revenues
from such processing exceed incremental
processing costs
Decision: Product A should be Processed
further.
Note: The $10,000 in joint costs (1/3 *
$30,000) will be the same regardless of
which alternative is selected, and hence is
not relevant to the decision.
1. Morrell Company produces several
products from the processing of krypton, a
rare mineral. Material and processing costs
total $30,000 per ton, one third of which is
allocable to product A. The amount of
product A received from a ton of krypton
can either be sold at the split-off point or
processed further at a cost of $13,000 and
then sold for $60,000. The sales value of
product A at the split-off point is $40,000.
Should product A be processed further or
sold at the split-off point?
Solution
Sales Value
Less: Additional Processing
Costs
Net Income Before Joint
Cost Allocation
Sold @
Split off Point
$40,000
Processed
Further
$60,000
13,000
$40,000
$47,000
2. Shelby Company produces three products, X, Y, and
Z. Cost and revenue characteristics of the three
products follow (per unit):
Product
X
Y
Z
Selling Price ……………………$80 $56 $70
Less variable expenses:
Direct materials ……………...24
15
9
Labor and Overhead …………24
27 40
Total variable expenses…...48
42 49
Contribution margin …………… $32 $14 $21
Contribution margin ratio ……… 40% 25% 30%
1
Other Information
Demand for the company’s products is very strong,
with far more orders on hand each month than the
company has raw materials available to produce. The
same material is used in each product. The material
costs $3 per pound, with a maximum of 5000 pounds
available each month. Which orders would you advise
the company to accept first, those for X, for Y, or for
Z? Which orders second? Third?
Solution
Relevant Costing Decision Rule
SCARCE RESOURCES – Total contribution
margin will be maximized by promoting those
products that promise the greatest Contribution
Margin in relation to the scarce resources of
the firm.
Note: The Key factor is not how much of a
X
Y
Z
(1) DM required per unit
$24
$15
$9
(2) Cost per pound
$3
$3
$3
(3) Pounds required per unit (1)÷(2) 8 lbs 5 lbs
3 lbs
(4) CM per unit
$32
$14
(5) CM per pound (4)÷(3)
$4/lb
$2.8/lb $7/lb
(6) Order of acceptance
2nd
3rd
scarce resource a product uses, but rather
how much of contribution margin the
product generates per unit of the scarce
resource.
$21
1st
3. For many years, Diehl Company has produced a small
electrical part that it uses in the production of its
standard line of diesel tractors. The company’s cost of
producing one part, based on a production level of
60,000 parts per year, is:
Per Part
Total
Direct Materials ………………….$ 4.00
Direct labor ……………………… 2.75
Variable overhead ……………….. 0.50
Fixed overhead, direct …………… 3.00
$180,000
Fixed overhead, common (allocated
on a basis of labor-hours)…….. 2.25
$135,000
Total cost per part ………………..$12.50
Other Information
An outside supplier has offered to supply the electrical
parts to the Diehl Company for only $10 per part. The
company has determined that one third of the direct
fixed costs represent supervisory salaries and other costs
that can be eliminated if the parts are purchased. The
other two thirds of the direct fixed costs represent
depreciation of special equipment that has no resale
value. The decision would have no effect on the
common fixed costs of the company, and the space
being used to produce the parts would otherwise be idle.
Show the dollar advantage or disadvantage of accepting
the supplier’s offer.
2
Solution
Relevant Costing Decision Rule
Make or Buy – For short-run decision making
purposes, fixed factory overhead costs applied to
a product are committed costs, the total amount of
which will be the same regardless of the
alternative chosen. Therefore, the outside
purchase price should be compared with internal
manufacturing costs that can be avoided if the
outside purchase is made. If avoidable costs are
less than the outside purchase costs then continue
to make internally.
4. Glade Company produces a single product. The cost of
producing and selling a single unit of this product at the
company's normal activity level of 8,000 units per month is:
Direct Material………………………………. $2.50
Direct labor.………………………………….
3.00
Variable overhead.…………………………... 0.50
Fixed overhead.……………………………… 4.25
Variable selling and administrative expenses.. 1.50
Item
DM
DL
V – FOH
F – FOH (direct)
F – FOH (common)
Outside Purchase Price
Total Cost
Net advantage to make
vs. alternative
Differential Costs
Cost per
Part
$4.00
2.75
0.50
3.00
2.25
Make
$4.00
2.75
0.50
1.00
n/a
$8.25
Buy
$0
0
0
0
0
$10.00
$10.00
$1.75
Other Information
The normal selling price is $15 per unit. The company’s
capacity is 10,000 units per month. An order has been
received from an overseas source for 2,000 units at a
price of $12 per unit. This order would not disturb
regular sales. If the order is accepted, by how much will
monthly profits be increased or decreased? (The order
would not change the company's total fixed costs.)
Fixed selling and administrative expenses.….. 2.00
Relevant Costing Decision Rule
Special Orders – If special transactions will not
affect normal sales, the decision to accept or reject
can be based entirely on whether or not the
transaction will make a contribution in excess of
the incremental costs that it generates. This
decision rule assumes the existence of excess
capacity.
Solution
Incremental Sales
$12.00
Incremental Costs
DM
$2.50
DL
3.00
V – FOH
0.50
V – S&A
1.50
Total
7.50
Incremental Profits
$ 4.50
$4.50 x 2000 units = $9,000 increase in Profits
3
Note: The fixed costs are not relevant to the
decision, since they will not change in total
amount regardless of whether the special order
is accepted or rejected.
5. Refer to the data from question 4 shown below. Assume
that the company has 500 units of this product left over from
last year, which are inferior to the current model. The units
must be sold through regular channels at reduced prices.
What unit cost figure is relevant for establishing a minimum
selling price for these units? Explain.
Direct Material……………………………….
Direct labor.………………………………….
Variable overhead.…………………………...
Fixed overhead.………………………………
Variable selling and administrative expenses..
Fixed selling and administrative expenses.…..
Relevant Costing Decision Rule
Disposing of Obsolete Inventories –All prior
costs of producing or acquiring the inventory are
sunk costs for the purpose of this decision. The
only relevant amounts are the future incremental
costs and revenues of these actions.
$2.50
3.00
0.50
4.25
1.50
2.00
Solution
The relevant cost figure is the $1.50 (the
variable selling & administrative costs). All
other variable costs are sunk, since the units
have already been produced. The fixed costs
would not be relevant, since they will not
change in total regardless of the price charged
for the left-over units.
4