RELEVANT COSTING – LECTURE NOTES 1
PROBLEM SET 1: IDENTIFICATION OF RELEVANT ITEMS
Ely, a computer manufacturer, has in its inventory P80,000 worth of disk-drive housings for a
computer line that is now obsolete. The housings can be re-machined to fit a newer line at a cost
of P15,000 and then sold for P33,000. Ely’s other alternative is to sell the housings as scrap for
P12,000.
Requirement/s: What do you suggest Ely do? Show supporting computations
PROBLEM SET 2
Carrie owns a ladies’ clothing line. She was recently offered the position of store manager at
Marie’s, a large retail chain store. Working at Marie’s would allow Carrie to earn an annual salary
of P500,000. She knows that she can sell the net assets of her business for 1,150,000 but is
certain whether to sell the business and manage Marie’s or to continue operating her own store.
She intends to put the proceeds in the bank and earn a legal interest of 12%. An income
statement of Carrie from her own business appears below:
Revenue from sales 2,250,000
Cost of Goods sold 1,350,000
Gross Profit 900,000
Operating Expenses:
Rent 72,000
Employee Wages 170,000
Utilities 36,400
Supplies 5,600
Advertising 14,500
Professional Fees 11,500
Insurance 14,500 325,500
Net Income 575,500
Requirement: How much will be the advantage or disadvantage of accepting the job offer at
Marie’s?
RELEVANT COSTING – LECTURE NOTES 2
PROBLEM ET 3 MAKE OR BUY
JV Industries is considering making its own motor castings (used as a component in its job
assemblies), which it currently purchases for P20,50 per unit. This purchase price does not
include the ordering, receiving and inspection costs, which JV estimates to be P2 per unit. JV
feels that can manufacture the 6,500 required units at a lower cost than it pays by purchasing
externally. The relevant costs per unit in producing are as follows:
Direct materials 6.25
Direct labor 10.00
Variable overhead 5.00
Fixed Overhead* 2.50
*This fixed overhead per unit is currently set as P4.50.
Requirements:
1. How much is the net advantage (disadvantage) of making the part instead of buying them?
2. Assuming that if JV continues to buy the motor casting from the outside supplier, it can make
use of the idle capacity of the plant to manufacture a new product (4,800 units). Direct
materials, labor, and variable overhead per unit will cost P10, 12.25, and 5 respectively.
However, additional quality control costs will have to be employed since this product will be
exported and the Philippine government has been known to be strict before the seal of quality
is attached to the label. The quality control costs will amount to P2.30 per unit and P10,000.
At how much should the new product be sold in order that JV may decide any between the
making of the motor casings and buying them?
PROBLEM 4 MAKE OR BUY DECISIONS
At normal operating volume of 10,000 units cost to manufacture Part G77 is
Direct materials P 2.00
Direct labor 2.50
Manufacturing overhead:
Variable 1.00
Fixed 2.00
Total unit cost P 7.50
Requirement:
Assuming an offer has been received to supply Part G77 at P6.50 per unit. Should the company
make or buy the part?
RELEVANT COSTING – LECTURE NOTES 3
PROBLEM SET 5 ADDING OR DROPPING PRODUCT SEGMENTS
Bubbly Products Company produces and markets three products. The following income
statement based on last year’s operation shows the profitability of each product line:
Shampoo Conditioner Shampoo & Conditioner
(2-in-1)
Sales in unit 100,000 15,000 200,000
Sales in pesos P400,000 P300,000 P150,000
Cost of Sales - variable 150,000 140,000 70,000
Cost of Sales - fixed* 100,000 60,000 50,000
Operating Expenses - variable 60,000 40,000 30,000
Operating Expenses - fixed* 40,000 30,000 10,000
Profit (loss) P 50,000 P 30,000 (P10,000)
*These costs are expenses common to all products are shown at their apportioned amounts.
Management is considering dropping ”2-in-1 product” from its line because it has consistently
shown a loss.
Requirements:
1. Should “2-in-1 product” be eliminated?
2. Assuming the facilities now utilized by “2-in-1 product” can be rented out for P30,000 per
annum, should “2-in-1 product” be eliminated?
3. Assuming that eliminating “2-in-1 product” the sales of “shampoo product” will increase by
20% in volume. And the customers buying “2-in-1” will switch back to the conditioner
product, thereby increasing the sales in units by half the unit sales of “2-in1 product”, should
“2-in-1 product” be eliminated?
4. Assume that only the “Cost of Sales - fixed” is avoidable, should the “2-in-1 product” be
eliminated?
PROBLEM SET 6 SELL NOR OR PROCESS FURTHER
The ABC Corporation manufactures a single product which it sells to other manufacturers who
process it further for ultimate sales to consumers. At normal monthly operating volume of 10,000
units, the unit selling price and unit cost under present operations are:
Unit selling price P20
Unit costs:
Variable expenses 10
Fixed expenses 5
Total unit cost 15
Net profit per unit P 5
RELEVANT COSTING – LECTURE NOTES 4
Management is considering the possibility of further processing the product itself and selling it to
ultimate consumers. The additional costs of further processing are estimated as follows:
Variable expenses P 5 per unit
Fixed expenses P15,000 per month
After further processing, the product can be sold at P28 per unit. No additional investment in
productive facilities is required.
Requirements:
1. Should the company process the product further, or should it continue selling it as is now
done?
2. Assuming that in the second manufacturing phase, the units will be subjected to a reduction
resulting to a 7% decrease in units, how much will be the incremental effect on ABC’s income
should the company decide to process the product further?
PROBLEM SET 7 SPECIAL SALES PRICING OR DIFFERENTIAL PRICING
Margie Company is operating at 60% of its plant capacity, with a production at this level of
P50,000 units. At this volume, the unit cost to make and sell its single product is:
Direct materials P 3.00
Direct labor 1.00
Factory overhead:
Variable 2.00
Fixed 3.00
Selling and administrative:
Variable 2.00
Fixed 1.00
Total unit cost to make and sell P12.00
An offer has been received from a foreign supplier to purchase 10,000 units at P10.00 per unit.
Management hesitates to accept this offer because the price is less than the full cost to make
and sell as computed above.
If the order is accepted, fixed overhead will not increase since the company will make use of its
remaining plant capacity.
Variable selling expenses will be reduced by P1.00 since it is not necessary to sell through
regular channels. Present sales will not be affected.
RELEVANT COSTING – LECTURE NOTES 5
Requirements:
1. Should the order be accepted?
(Decision Rule: In Differential costing, as long as the incremental revenue (IR) selling price
per unit) is above the computed differential cost per unit (DC) plus opportunity costs (OC)
arising from the alternatives use of idle capacity, ACCEPT as long as the regular market will
not be affected.)
2. How much benefit will Margie derive if she sells to the foreign supplier?
PROBLEM SET 8 UTILIZATION OF SCARCE RESOURCES; MARKET CONSTRAINTS
1. Assume that a company manufactures two products:
Product X Product Y
Unit selling price P10 P20
variable costs 6 10
Units produced per hour 3 1
Production capacity is insufficient to meet sales demand. Management wants to know which
product to push in order to maximize profits.
Requirement:
Which is more profitable of the two products?
2. Assume the following per-unit data for products D, E, and F:
D E F
Contribution Margin P5 P8 P7
Hours required to
process
each unit of product 1 2 3
Market limit (units) 30,000 20,000 none
The products can be produced in any combination. Plant capacity is 100,000 hours. Fixed
overhead amount to P250,000
Requirements:
1. Rank the products as to profitability.
2. How much will the new profit be if the optimum production mix is implemented?
RELEVANT COSTING – LECTURE NOTES 6
PROBLEM SET 9 SHUTDOWN OR CONTINUE OPERATIONS
The M Corporation manufactures and sells a single product. At normal capacity of 100,000 units
per annum, the unit cost of manufacturing the product is:
Direct materials P2.20
Direct labor 2.80
Variable manufacturing overhead 1.20
Fixed manufacturing overhead 2.00
Total production cost per unit P8.20
Variable selling and administrative expenses amount to P0.80 per unit. Fixed selling and
administrative costs are P40,000 annually.
Due to increasing competition, the company expects to be able to sell only 40,000 units at a
reduced selling price of P10 each, next year.
The company is reorganizing its operations to be able to regain a competitive position. In the
meantime, the management is faced with the problem of whether to shut down completely or
continue limited operations at a loss.
In the event of a shutdown, it is expected that all fixed overhead can be reduced by about one-
fourth. Additional costs of shutting down the plant for one year are estimated at P15,000.
Requirements:
a. How much will be the advantage or disadvantage of M if it decides to shutdown its operations
temporarily?
b. Compute the shutdown point in units of product.
PROBLEM SET 10 REPLACEMENT OF MACHINE, NO TIME VALUE CONCEPT OF MONEY
Assume that a business is considering the disposal of several identical machines having a total
book value of P100,000 and an estimated remaining life of five years. The old machines can be
sold for P25,000, currently being depreciated at P10,000. They can be replaced by a single high
speed machine at a cost P250,000. The new machine has an estimated useful life of five years
and no residual value. Analyses indicate an estimated annual reduction in variable manufacturing
costs from P225,000 with the old machine to P150,000 with the new machine. No other changes
in the manufacturing costs or the operating expenses are expected.
RELEVANT COSTING – LECTURE NOTES 7
Requirements:
1. How much is the net differential decrease in company costs over the 5 years if the new
machine will be purchased?
2. Assume that instead of P150,000, the annual costs of the new machine operation is P250,000
and that a tax rate of 32% is considered, how much will be the net change in annual cash flow
arising from the machine replacement? Will you recommend the replacement of the old
machine?
PROBLE SET 11 LEASE OR OPERATE
The M Co., manager of an office building, is considering putting in certain concessions in the
main lobby. An accounting study produces the following estimate, on an average annual basis:
Sales of merchandise P49,000
Salaries P 7,000
Licenses and payroll taxes 200
Cost of merchandise sold:
Beginning inventory P 2,000
Purchases 40,000
Available P42,000
Ending inventory 2,000 40,000
Share of heat, light, etc. 500
Prorated building depreciation 1,000
Concession advertising 100
Share of company administrative expense 400
Profit (loss) (200)
The investment in equipment, which would last 10 years, would be P2,000.
As an alternative, a catering company has offered to lease the space for P750 to the M. Co. Heat
and light are to be furnished by the office building at no additional charge.
Requirement/s:
What is your advice to the M. Co.?
RELEVANT COSTING – LECTURE NOTES 8
PROBLEM SET 12 SPECIAL ORDERS
Showie C, a manufacturer of shoes, has been asked to sell 1,000 pairs of rubber shoes to a
discount sporting goods shop for P1,000 a pair. Showie would not put its name on this special
order, and the dealer would therefore sell the shoes below their normal retail price. The capacity
for Showie C. is 25,000 pairs of shoes per year. The company’s sales forecast for this year,
excluding the special order, is 20,000 pairs at a selling price of P1,437.5 per unit. Showie’s
budgeted income statement is:
Budgeted Income Statement
Per Unit Total
Sales in pesos (20,000 pairs) P1,437.50 28,750,000.00
Cost of Sales:
Direct Materials P375.00 7,500,000.00
Direct Labor 311.00 6,220,000.00
Factory overhead (60% fixed) 344.50 6890,000.00 20,610,000.00
Selling and administrative
(including 12% commission on regular sales) 275.00 5,500,000.00
Profit (Loss) 132.00 2,640,000.00
Requirement:
If Showie decides to accept the special order, by how much would its income increase or
decrease?
