Relevant Costing

1.0 Make or Buy

1.1 Temple, Inc. produces several models of grandfather clocks. An outside supplier has
offered to produce the economy clocks for Temple for $350 each. Temple needs 1,200
clocks annually. Temple has provided the following unit costs for its economy model:
Unit Cost
Direct materials

$ 100

Direct labor

120

Variable overhead

80

Fixed overhead (40% avoidable)

150

Prepare an incremental analysis which shows the effect of the make or buy decision.

1.2 Hernandez, Inc. manufactures 3 models of picture frames. Hernandez Corporation

manufactures 5,000 frames per year. The unit cost to produce a metal frame follows:
Direct Materials

$6

Direct Labor

Variable Overhead

Fixed Overhead (70% unavoidable)

Total

$20

A local company has offered to supply Hernandez the 5,000 metal frames it needs for
$16 each.Create an incremental analysis for the make or buy decision.

1.3 Calc, Inc. owns a machine that produces baskets for the gift packages the company
sells. The company uses 800 baskets in production each month. The costs of making
one basket is $4 for direct materials, $3 for variable manufacturing overhead, $2 for

direct labor and $5 for fixed manufacturing overhead. The unit cost is based on the
monthly usage of 800 baskets. The company determined that 30% of the fixed
manufacturing overhead is avoidable. An outside supplier has offered to sell Calc the
baskets for $12 each, and can supply all the units it needs. Prepare an incremental
analysis to determine if Calc should buy the component from the supplier?

2.0 Accept or Reject

2.1 The following estimated costs were provided by Narb Company:
Direct material ($20/unit)

$240,000

Direct labor ($12/hr. * .25 hrs./unit)

36,000

Variable manufacturing overhead

18,000

Allocated fixed overhead costs ($2.50/unit)

30,000

Total

$324,000

Narb received an order for 2,500 units from a new customer with whom Narb is anxious
to do business. This customer would like to spend $26 per widget. Narb has the
capacity to produce the additional units. Prepare an incremental analysis to determine if
Narb should accept the order.

2.2 Tenchavez Company makes and sells 12,000 pairs of running shoes each year.
The cost of making one pair of these shoes is
Direct material

$ 11

Variable manufacturing overhead

Direct labor

Fixed manufacturing overhead

The fixed overhead costs are unavoidable. Tenchavez allocates fixed overhead costs
based on its annual capacity of 15,000 pairs it is able to make. An overseas company
recently offered to buy 3,000 pairs of shoes at $21 per pair. Regular customers buy

shoes

from

Tenchavez

at

$30

per

pair.

How much is incremental income if Tenchavez accepts the special order?

2.3 Darnell Inc. budgeted 5,000 widgets for production during 2004. Fixed factory
overhead is allocated using ABC. The following estimated costs were provided:

Direct material ($80/unit)

$400,000

Direct labor ($22/hr. * 2 hrs./unit)

220,000

Variable
($8/unit)

manufacturing

Fixed
factory
($53.80/unit)

overhead40,000

overhead

costs269,000

Total

$929,000

Cost per unit = $185.80

Darnell received an order for 400 units from a new customer in a country in which
Darnell has never done business. This customer would like to spend $160 per widget.
Darnell has capacity to produce 5,500 units. Should Darnell accept the order? Support
your work with an incremental analysis.

3.0 Drop Segment

3.1 Parrino has three product lines in its retail stores: books, videos, and music. The
allocated fixed costs are based on units sold and are unavoidable. Results of the fourth
quarter are presented below:
Books

Music

Videos

Total

Units sold

1,000

2,000

2,000

5,000

Revenue

$24,000

$48,000

$34,000

106,000

Variable departmental costs

15,000

22,000

23,000

60,000

Direct fixed costs

3,000

6,000

5,000

14,000

Allocated fixed costs

4,400

8,800

8,800

22,000

Net income (loss)

$ 1,600

$11,200

($2,800)

$10,000

Demand of individual products is not affected by changes in other product lines.

Prepare an incremental analysis of the effect of dropping the Video product line.
3.2 Morley, Inc. has three product lines in its retail stores: putters, drivers, and sinkers.
The allocated fixed costs are based on units sold and are unavoidable. Results of May
follow:
Putters

Drivers

Sinkers

Total

Units sold

500

1,000

1,000

2,500

Revenue

$24,000

$48,000

$34,000

106,000

Variable departmental costs

15,000

22,000

23,000

60,000

Direct fixed costs

3,000

6,000

5,000

14,000

Allocated fixed costs

4,000

8,000

8,000

20,000

Net income (loss)

$ 2,000

$12,000

($2,000)

$12,000

Demand of individual products is not affected by changes in other product lines.

Prepare an incremental analysis of the effect of dropping the sinkers product line.
3.3 Huxley Sports Company sells logo sports merchandise and does custom screen
printing. They are trying to decide whether or not to continue screen printing. The
following information is available for the segments. Assume that all direct fixed costs
could be avoided if a segment is dropped and that the total common fixed costs would
remain unchanged if the screen printing were dropped.

Screen
Printing

Apparel
Sales

Sales

$120,000

$420,000

Variable costs

72,000

220,000

Contribution margin

48,000

200,000

Direct fixed costs

32,000

70,000

Allocated common fixed costs 20,000

70,000

Net income

$60,000

($4,000)

Assume that more space will be allocated to apparel sales if screen printing is dropped.
This will allow apparel sales to increase by 25%. What is the impact on profits of the
proposed change?
4.0 Sell or Process Further
4.1 Product A and B are produced in a joint process. At split-off point, Product A is
complete whereas product B can be process further. The following additional
information is available:
Product

Quantity in Units

5,000

10,000

$10

$2.5
$5
$20,000

Selling Price Per Unit:

At Split-Off
If Processed Further
Costs After Split-Off

Perform sell-or-process-further analysis for product B.

4.2 Chai Wan Limited has a farm in Shenzhen which grows and processes chicken.
Each chicken is disassembled into three main parts: breasts, wing and thigh. Every
month it produces 50,000 pounds of breasts, 20,000 pounds of wings and 30,000
pounds of thighs at joint costs of $150,000. The company currently allocates the joint
costs based on the physical measurement basis.

The company is considering whether to further process the joint products by taking a
frying process to sell fried chicken breasts, wings and thighs.
The following information is also provided.
Parts

Breasts
Wings
Thighs

Selling
price
per pound of
the
fried
products
$15
$8
$10

Further
Selling
price
processing
per pound at
costs
per split-off point
pound
$5
$23
$3
$15
$4
$13

Required:
Should the chicken breasts, wings and thighs be further processed?
5.0 Retain or Replace Asset
5.1 Chai Wan Limited is considering replacing a printing machine with a new model,
which is more efficient than the existing one for its magazine publishing business.
Datafor the existing (old) machine and the replacement (new) machine are as follows:
Purchased Cost
Estimated Useful Life
Current Age
Remaining
Useful
Life
Accumulated
Depreciation
Carrying Amount
Current
Disposal
Value
Terminal
Disposal
Value
Annual
Operating
Costs

New Machine
$2,000,000
5 years
2 years
3 years

Old Machine
$1,200,000
3 years
0 years
3 years

$800,000

N/A

$1,200,000
$60,000

N/A
N/A

$10,000

$0

$1,000,000

$550,000

Required:
Advise Chai Wan Limited whether to retain or replace the old machine.
6.0 Minimum or Maximum bid price

Marcus Fibers, Inc., specializes in the manufacturing of synthetic fibers that the
company uses in many products such as blankets, coats, and uniforms for police and
fire fighters. Marcus has been in the business since 1975 and has been profitable every
year since 1983. The company uses a standard cost system and applies overhead on
the basis of direct labor hours.
Marcus has recently received a request to bid on the manufacture of 800,000 blankets
scheduled for delivery to several military bases. The bid must be started at full cost per
unit plus a return on full cost of no more than 9 percent after income taxes. Full cost has
been defined as including all variable costs of manufacturing the product, a reasonable
amount of fixed overhead and reasonable incremental administrative costs associated
with the manufacture and sale of the product. The contractor has indicated that bids in
excess of 25 per blankets are not likely to be considred.
In order to prepare the bid for the 800,000 blankets, Andrea Lighter, cost accountants,
has gathered the following information about the cost associated with production of the
blankets.
Direct materials
Direct labor
Direct machine costs
Variable overhead

1.50 per pound of fibers

7.00 per hour
10,000 per blankets
3.00 per direct labor hour

Fixed Overhead
Incremental Administrative Costs
Special Fee
Material usage
Production rate
Effective tax rate

8.00 per direct labor hour

2,500 per 1,000 blankets
0.50 per blanket
6 pounds per blanket
4 blankets per DLH
40%

Required:
What would be the minimum price per blanket that Marcus Fibers, Inc, could bid
without reducing the companys net income?
7.0 Pricing Decision
7.1 Medical Supply Company has an opportunity to enter a foreign market in
which price competition is keen. An attraction of the foreign market is that
demand there is greatest when demand in the domestic market is quite low;
thus idle production facilities could be used without affecting domestic
business
.
An order for 1,000 units is being sought at a below normal price in order to
enter this market. Shipping costs for this order will amount to 410 per unit,
while total costs of obtaining the contract (marketing costs) will be 22,000.
No other variable marketing costs would be required on this order. Domestic

business would be unaffected by this order. What minimum unit price should
Medical Supply Company consider for this order of 1,000 units?
7.2 A proposal is received from an outside contractor who will make and ship
1,000 hydraulic hoist units per month directly to Medical Supplys customers
as orders are received from Medical Supplys sales staff. Medical Supplys
fixed marketing costs would be unaffected, but its variable marketing costs
would be cut by 20% for these 1,000 units produced by the contractor.
Medical Supplys plant would operate at two thirds of its normal level, and
total allocated fixed manufacturing costs would be cut by 30%. What in-house
unit cost should be used to compare with the quotation received from the
supplier?