Relevant Costing Short Term Non Routine Decisions
Relevant Costing Short Term Non Routine Decisions
Relevant Costing Short Term Non Routine Decisions
Lecture Handout
SHORT-TERM NON-ROUTINE DECISIONS
OVERVIEW
Decisions are made to make things happen or not happen. Decisions are made in all facets of our life
and same apply to business or organization.
Decisions may be strategic, tactical or operational. It is the process of studying and evaluating two or
more available alternatives leading to a final choice. For business entities, management usually
chooses the option that maximizes company profit. Right decisions are vital in ensuring the success of
a company or organization.
LEARNING OBJECTIVES
At the end of the lesson, students should be able to:
1. Differentiate routinary from non-routinary
2. Classify relevant from irrelevant costs in decision making
3. Give examples of short-term non-routine decisions
4. Present relevant cost and quantitative analysis in different situations involving short-term non
routine decisions.
DISCUSSION
DECISION MAKING
DECISION MAKING – is the process of making choices from at least two alternatives by identifying
a problem, gathering information and evaluating alternative solutions. For business entities,
management usually chooses the option that maximizes company profit.
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TYPES of COSTS COMMONLY ASSOCIATED WITH DECISION MAKING
NOTE: Differential (incremental) costs, avoidable costs, opportunity costs and out-of-pocket costs are usually considered
relevant in decision making while sunk and unavoidable costs are considered irrelevant.
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OTHER TERMINOLOGIES ASSOCIATED WITH SHORT-TERM NON-ROUTINE DECISIONS
• MAKE OR BUY
A part may be outsourced from a supplier based on the following reasons:
o Lack of technology, man labor hours, machine hours, systems expertise and financing
money
o Unprofitable operations
o Savings
The total relevant cost of each option should be taken when deciding to make or buy a part.
Whichever option gives a lower relevant cost would be a better alternative, assuming no
other quantitative factors are to be considered.
SAMPLE PROBLEM:
HYBE Corporation must decide whether it must continue to produce an engine component or buy it
from PLEDIS Philippines for P 2,500 each. The demand for the coming year is 20 units. The costs of
producing a single unit of the engine component are as follows:
If HYBE buys the components, the facility now used to make the components can be rented out to
another firm for P 9,000.
REQUIRED:
A) Should BMW make or buy the components?
COST MAKE COST BUY
Price per
Direct materials 1,400.00 2,500.00
unit
Total cost
Direct labor 600.00 for 20 50,000.00
units
Factory Overhead Additional
300.00 9,000
(1000*30%) Income
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Total relevant cost per unit 2,300.00 Net 41,000.00
Unit Cost
Total cost for 20 units
46,000.00 per unit 2,050.00
BMW should just buy the engine component from third party. The effect of buying the
component on company’s profitability is greater than if the entity will continue producing the
component.
If regular sales are lost due to the acceptance of special order, the lost contribution margin should be
deducted from incremental profit which may be determined as
If there is no alternative use of the capacity, the incremental profit (loss) is the difference between
incremental sales and incremental costs and expenses.
The incremental profit (loss) from the special sales should be compared with the best benefit that may
be derived from the alternative use of the capacity to get the net advantage or disadvantage from
accepting the special sales order.
SAMPLE PROBLEM
The manufacturing capacity of JK Corporations facilities is 50,000 units of a product a year. A
summary of operating results for the year end December 31,2023 is as follows.
A distributor company has offered to buy 12,000 units at 90 per unit during 2023. Assume that
all of the corporation’s costs would be at the same levels and rates in 2023 as to 2022.
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Incremental Cost (12,000*55) 660,000.00
Incremental Profit 420,000.00
The company should accept the special order since there is incremental profit.
Note: Fixed costs and expenses are irrelevant
b. The corporation can rent out the idle capacity for 200,000
Answer:
Incremental CM) 420,000.00
Rent Income 200,000.00
Incremental Profit 220,000.00
Since the incremental income from the accepting the special order is greater than
renting out the facility, the company should accept the special order.
c. The corporation can use the idle capacity to produce a new product that could contribute
600,000 in the contribution margin.
Answer:
Incremental Profit 420,000.00
Contribution Margin of New
product 600,000.00
Net Advantage of rejecting the
order -180,000.00
Contribution margin Px
Less: avoidable fixed costs and expenses x
Segment margin x
Sales x
less: Variable costs x
Manufacturing Margin x
Less: Variable expenses x
Contribution Margin x
Less: Controllable direct fixed cost and
expenses x
Controllable Margin x
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Less: Non controllable direct fixed cost and
expenses x
Segment Margin x
Less: Indirect (allocated) fixed cost and
expenses x
Operating Income x
SAMPLE PROBLEM
Jin company plans to discontinue a division with a P 200,000 contribution margin. Overhead allocated
to the division is P500,000, of which P50,000 cannot be eliminated. Should Francis Company
discontinue the division?
Answer:
The controllable margin is computed as follows:
Contribution Margin P200,000.00
Less: Avoidable cost (500,000-50,000) 450,000.00
Controllable Segment Margin 250,000.00
The segment should be discontinued. Doing such the loss will be eliminated and the profit will
increase by 250,000.
SAMPLE PROBLEM
Tarlac Corporation produces three main products. Its production and costs data are given below:
X Y Z
Units sales price after further processing 300.00 550.00 220.00
Units sales price before further processing 250.00 530.00 190.00
Cost of further processing 120,000.00 65,000.00 190,000.00
Units produced and sold 2,000.00 4,000.00 7,500.00
Total joint cost 140,000.00
Answer:
X Y Z
Units sales price after further processing 300.00 550.00 220.00
Units sales price before further processing 250.00 530.00 190.00
Cost of further processing 120,000.00 65,000.00 190,000.00
Units produced and sold 2,000.00 4,000.00 7,500.00
Additional unit price 50.00 20.00 30.00
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Incremental Sales 100,000.00 80,000.00 225,000.00
Incremental Cost 120,000.00 65,000.00 190,000.00
Increase/Decrease in profit -20,000.00 15,000.00 35,000.00
SAMPLE PROBLEM:
SVT Company produces and sells 140,000 units monthly except for the month of July and
August when the number of sales declines to 10,000 per month. If the management temporarily
shut down the following will be incurred:
▪ Security and maintenance amounting to 220,000 per month
▪ Restarting the business operation will cost 300,000
▪ The business incur 24M fixed cost annually and is allocated per month. This fixed
cost is expected to drop by 60% during the months that the operation is shutdown.
Required:
a. How much is the total shut down cost?
Answer:
Allocated fixed Cost 1,600,000.00 24,000,000*(2/12)*0.4
Security and insurance 440,000.00 220,000*2
Restart up Cost 300,000.00
2,340,000.00
Answer:
Fixed Cost less
Quantity Sold = Shutdown Cost
Unit Contribution
Margin
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2,340,000)
120
= 13833.33333
To check:
Contribution Margin = 1,660,000.00 (13,833.3333333333*120)
Less: Fixed Cost and
Expenses 4,000,000.00
loss from continuing -2,340,000.00
Shut down Cost 2,340,000.00
Note: Shutdown point is where loss from continuing equals the shutdown cost
c. Continue or Shutdown?
SVT should continue because there is ad advantage of continuing the business. The loss to
be incurred if the operation will shutdown is greater than the loss if the operation will
continue.
• SCRAP OR REWORK
There are products that do not meet the standard production specifications. In deciding whether to
sell as a scrap or rework, the profit from reworking should be compared with the profit of selling as
a scrap without regard to the past costs of producing the product.
SAMPLE PROBLEM:
A company has 5,000 obsolete cutting supplies carried in inventory at a manufacturing cost of P 40
per unit. If the toys are reworked for P8 per unit, they could be sold for P12 per unit. If the toys are
scrapped, they could be sold for a total of P15,800.
Required:
1. Should the company sell the cutting supplies as scrap or rework?
Answer: REWORK
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Note: The manufacturing cost of P40 per unit is a sunk cost.
Contribution Margin per hour= Unit Contribution Margin/ Hours per Unit
SAMPLE PROBLEM
Kapos Company produces products A, B and C. One machine is used to produce the products. The sales
demands, contribution margins and time on the machine (in hours) are as follows:
There are 2,400 hours available on the machine during the week. Total fixed cost is P 3,000.
REQUIRED
What is the best product combination that maximizes the weekly contribution?
a. 90 units of A; 0 unit of B; 150 units of C
b. 50 units of A; 80 units of B; 150 units of C
c. 100 units of A; 80 units of B; 100 units of C
d. 100 units of A; 80 units of B; 150 units of C
Answer:
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