MANAGEMENT SERVICES (MS)

Relevant Costing

THEORY

1. The process of evaluating financial data that change under alternative courses of action is called
a. Incremental analysis
b. Decision-making analysis
c. Contribution margin analysis
d. Cost-benefit analysis

2. Which of the following pairs of stages in the management decision-making process is properly sequenced?
a. Evaluate possible courses of action -> Make a decision
b. Review the actual impact of the decision -> Determine possible courses of action
c. Assign responsibility for the decision -> Identify the problem
d. Make a decision -> Assign responsibility for the decision

3. Relevant costs are

a. All fixed and variable costs
b. All costs that would be incurred within the relevant range of production
c. Past costs that are expected to be different in the future
d. Anticipated future costs that will differ among various alternatives

4. An opportunity cost is
a. A cost that may be shifted to the future with little or no effect on current operations
b. A cost that cannot be avoided because it has already been incurred unavoidable cost
c. The difference in total costs that results from selecting one alternative instead of another differential cost
d. The profit foregone by selecting one alternative instead of another

5. The term "differential cost" refers to

a. The profit foregone by selecting one alternative instead of another opportunity cost
b. A cost that continues to be incurred even though there is no activity fixed cost
c. A cost common to all alternatives in question and not clearly or practically allocable to any of the
alternatives
d. The difference in total costs that results from selecting one alternative instead of another

6. A cost incurred in the past that cannot be changed by any future action is a(n)
a. Opportunity cost
b. Sunk cost
c. Relevant cost
d. Avoidable cost

7. Irrelevant costs generally include

Sunk costs Historical costs Allocated costs ex: advertising

a. Yes Yes No
b. Yes No No
c. No No Yes
d. Yes Yes Yes

8. In a make-or-buy decision
a. Fixed costs that can be avoided in the future are relevant
b. Only variable costs are relevant
c. Only prime costs are relevant
d. Fixed costs that will continue regardless of the decision are relevant

9. In deciding whether to manufacture a part or buy it from an outside vendor, a cost that is relevant to the
short-run decision is:
a. Direct materials and direct labor
b. Variable overhead
c. Fixed overhead that will be avoided if the part is bought from an outside vendor
d. All of the above

Page | 1
 10. In considering a special order that will enable a company to make use of present idle capacity, which of
the following costs would be irrelevant?
a. Fixed factory overhead that can be avoided
b. Materials
c. Depreciation of the factory building if silent = irrelevant
d. Direct labor

11. The minimum selling price that should be acceptable in a special-order situation, assuming with excess
capacity, is equal to total
a. Production cost WITH EXCESS CAPACITY = GENERAL RULE :
b. Variable production cost ALL VC AND FOHA
c. Variable costs
d. Production cost plus a normal profit margin

12. The opportunity cost of making a component part in a factory with excess capacity for which there is no
alternative use is
a. The total manufacturing cost of the component WITHOUT EXCESS CAPACITY =
b. The total variable cost of the component GR + OPPORTUNITY COST
c. The fixed manufacturing cost of the component
d. Zero

13. A company is deciding whether or not to replace some old equipment with new equipment. Which of the
following is not considered in the incremental analysis?
a. Annual operating cost of the new equipment
b. Annual operating cost of the old equipment DIFFERENCE OF A & B IS RELEVANT
c. Net cost of the new equipment RELEVANT
d. Book value of the old equipment sunk cost

14. A manager is attempting to determine whether a segment of the business should be eliminated. The focus
of attention for this decision should be on
a. The net income shown on the segment's income statement
b. Sales minus total expenses of the segment
c. Sales minus total direct expenses of the segment SM = SALES - VC - AFC
d. Sales minus total variable expenses and avoidable fixed expenses of the segment

15. The costs incurred prior to the split-off point are referred to as
a. Separable costs
b. Split-off costs
c. Joint product costs
d. Joint costs

16. When a scarce resource, such as space, exists in an organization, the criterion that should be used to
determine production is
a. Contribution margin per unit
b. Selling price per unit HIGHEST CM PER SCARCE RESOURCE
c. Contribution margin per unit of scarce resource
d. Total variable costs of production
CM
CM/SR = (SP - VC) / SCARCE
LABOR HRS, MINS, MACHINE HRS

Relevant Costing/ Incremental Analysis

- tool used by management for decision making
-will be presented by different alternatives (best cause of action)

TYPES OF ALTERNATIVES:
1. MAKE OR BUY
2. ACCEPT OR REJECT SPECIAL ORDER
3. RETAIN OR REPLACE EQUIPMENT
4. RETAIN OR ELIMINATE UNPROFITABLE SEGMENT/ PRODUCT
5. SELL IMMEDIATELY OR PROCESS FURTHER
6. WHICH PRODUCTS TO PRODUCE GIVEN SCARCE RESOURCES
Page | 2
 PROBLEM
1, MAKE OR BUY - TOTAL RELEVANT COST AND SAVINGS
Use the following for the next two (2) questions:

1. Pinnacle Company needs 10,000 units of a certain part to be used in its production cycle. The following
information is available concerning the unit product cost:

Direct materials ........................................... P 6 Relevant: GR:

Direct labor ................................................. 24
1. ALL VARIABLE COST
Variable manufacturing overhead ................. 12 (DM, DL,VOH, VS&A)
Fixed manufacturing overhead ..................... 15 2.FIXED COST- AVOIDABLE
Unit product cost ......................................... P57

A supplier has offered to supply Pinnacle’ entire annual requirements of the part for P53 each. If it buys
the part from the supplier instead of making it, it will have no other use for the facilities and 60% of the
fixed manufacturing overhead would continue. In deciding whether to make or buy the part:
Make:
Question 1: The total relevant costs to make the part internally are:
DM: 6
a. P342,000 DL: 24
b. P480,000 VOH: 12
c. P530,000 FOH-A 6 --> 15 x 60%
d. P570,000 RC 48
Units 10,000
Question 2: The best alternative course of action is to: Total RC to make = 480,000
a. Make, P20,000 savings
b. Buy, P20,000 savings Make vs Buy
c. Make, P50,000 savings 48 vs 53 = 5 savings x 10,000 units = 50,000 savings
d. Buy, P50,000 savings

MAKE OR BUY -DIFFERENTIAL COST

2. ABC Company manufactures components for use in producing one of its finished products. When 12,000
units are produced, the full cost per unit is P35, separated as follows:

Direct materials P5
Direct labor 15
Variable overhead 10
Fixed overhead 5

XYZ Company has offered to sell 12,000 components to ABC for P37 each. If ABC accepts the offer, some
of the facilities currently being used to manufacture the components can be rented as warehouse space
savings for P40,000. However, P3 of the fixed overhead currently applied to each component would have to be
covered by ABC’s other products. unavoidable

What is the differential cost to ABC Company of purchasing the components from XYZ?
a. P8,000 Make Buy
b. P20,000 DM 5 Selling Price 37
c. P24,000 DL 15 Units 12,000
d. P44,000 VOH 10 RC-buy 444,000
FOH-A 2 --> 5-3 Less: savings (40,000)
RC 32 x 12,000 units RC-buy 404,000
RC = 384,000

Make 384,000
Buy 404,000
Differential cost 20,000

Page | 3
 MAKE OR BUY- OUT OF POCKET COST AND MONTHLY COST
3. ABC Company uses production of large diesel engines. The cost to manufacture one unit of engine is
presented below:

Direct materials P2,000

Materials handling (20% of direct material cost) 400
Direct labor 16,000
Manufacturing overhead (150% of direct labor) 24,000
Total manufacturing cost P42,400
variable cost
Materials handling, which is not included in manufacturing overhead, represents the direct variable costs of
the receiving department that are applied to direct materials and purchased components on the basis of
their cost. ABC’s annual manufacturing overhead is one-third variable and two-thirds fixed. An outside
vendor has offered to supply at a unit price of P30,000.

Question 1: If ABC purchases 10 units from the outside vendor, the capacity ABC used to manufacture these
parts would be idle. Should ABC decide to purchase the parts, the out-of-pocket cost per unit would:
Make
a. Decrease P6,400 DM 2,000
Buy
b. Increase P3,600 Selling price 30,000
MH 400
MH (30K x 20%) 6,000
c. Increase P9,600 DL 16,000
cost to buy 36,000
VOH 8,000 --> 24K x 1/3
d. Decrease P4,400 cost to make 26,400
Savings : 36,000 - 26,400 = 9,600 increase in cost

Question 2: Assume ABC is able to rent all idle capacity for P50,000 per month. If ABC decides to purchase
the 10 units from outside vendor, ABC’s monthly cost would: savings

a. Increase P46,000 Make Buy:

26,400 x 10 units 36,000 x 10 = 360,000 - 50,000 savings = 310,000
b. Decrease P64,000
cost to make = 264,000
c. Increase P96,000
Cost increase = 310,000 - 264,000 = 46,000
d. Decrease P34,000
2. ACCEPT OR REJECT SPECIAL ORDER
4. The Marker Division of ABC, Inc. produces a high-quality white board markers. Unit production costs
(based on capacity production of 10,000 units per year) follow:
with excess capacity ---> Apply GR : ALL VC; FOH-A= relevant
Direct material P50
Direct labor 20 without excess capacity ---> GR plus Opportunity Cost "foregone CM"
Overhead (20% variable) 10

Other information:
Selling price 100
SG&A costs (40% variable) 15
WITH EXCEESS CAPACITY
Question 1: Assume, for this question only, that the Marker Division is operating at a level of 7,000 units
per year. What is the minimum price that the division would consider on a "special order" of 1,000 units
to be distributed through normal channels? DM 50
a. P 78 Max Capacity 10,000 DL 20
Operating 7,000 VOH 2 ---> 10 x 20%
b. P 95 Excess capacity 3,000 VSGA 6 ---> 15 x 40%
c. P 100 Cost 78
APPLY GENERAL RULE existing
d. P 81
WITHOUT EXCESS CAPACITY - GR + OPPORTUNITY COST
Question 2: Assume, for this question only, that the Marker Division is producing and selling at capacity.
What is the minimum selling price that the division would consider on a "special order" of 1,000 units on
which no variable period costs would be incurred?
a. P 100 Opportunity cost = SP -VC (existing)
DM 50
b. P 72 DL 20
OC= 100 - 78
c. P 81 VOH 2 OC = 22
VC + OC = RC
d. P 94 VSGA ----> no period cost in problem
cost 72 special order 72 + 22 = RC
94 = RC
Question 3: Assume, for this question only, that the Marker Division is presently operating at a level of
8,000 units per year. Accepting a "special order" on 2,000 units at P88 will
a. Increase total corporate profits by P4,000 Max capacity 10,000
b. Increase total corporate profits by P20,000 produce 8,000
c. Decrease total corporate profits by P14,000 Excess 2,000
d. Decrease total corporate profits by P24,000
price 88
ACCEPT SPECIAL ORDER - WT EXCESS VC 78 ---> relevant cost
CM 10 x 2,000 units = 20,000 increase
Page | 4
5. A company is currently operating at a loss of P15,000. The sales manager has received a special order for
5,000 units of product, which normally sells for P35 per unit. Costs associated with the product are: direct
material, P6; direct labor, P10; variable overhead, P3; applied fixed overhead, P4; and variable selling
expenses, P2. The special order would allow the use of a slightly lower grade of direct material, thereby
lowering the price per unit by P1.50 and selling expenses would be decreased by P1.

If it wants this special order to increase the total net income for the firm to P10,000, what sales price must
be quoted for each of the 5,000 units?
a. P 23.50
DM (6 - 1.5 ) 4.5 NET LOSS (15,000)
b. P 24.50 INCOME 10,000
c. P 27.50 DL 10
VOH 3 INCREASE 25,000
d. P 34.00 DIVIDE 5,000 units
VSE (2 -1) 1
RC 18.5 Addtl SP =5

18.5 + 5 = 23.5 Relevant : a) future cost

b) incremental cost
REPLACE OR RETAIN EQUIPMENT
6. A company is trying to decide whether it should keep its existing machine or purchase a new one that has
technological advantages (which translate into cost savings) over the existing machine. Information on
each machine follows:
Old machine New machine
Original cost sunk cost P9,000 P20,000
Accumulated depreciation sunk cost 5,000 0
Annual cash operating costs 9,000 4,000 = 5,000 relevant
Current salvage value of old machine 2,000
Salvage value in 10 years 500 1,000
Remaining life 10 yrs. 10 yrs.

Question 1: The P4,000 of annual operating costs that are common to both the old and the new machine
are an example of a(n)
a. Sunk cost
b. Irrelevant cost
c. Future avoidable cost
d. Opportunity cost

Question 2: The P9,000 cost of the original machine represents a(n)

a. Sunk cost
b. Future relevant cost
c. Historical relevant cost
d. Opportunity cost

Question 3: The P20,000 cost of the new machine represents a(n)

a. Sunk cost
b. Future relevant cost
c. Future irrelevant cost
d. Opportunity cost

Question 4: The incremental cost to purchase the new machine is

a. P 11,000
b. P 20,000 purchase price 20,000
c. P 13,000 salvage value-old (2,000)
d. P 18,000 Incremental cost 18,000

Page | 5
 7. ABC Industries, Inc. has an opportunity to acquire a new equipment to replace one of its existing
equipment. The new equipment would cost P900,000 and has a five-year useful life, with a zero terminal
disposal price. Variable operating cost would be P1 million per year. new equipment cost
irrelevant
The present equipment has a book value of P500,000 and a remaining life of 5 years. Its disposal price
now is P50,000 but would be zero after 5 years. Variable operating costs would be P1,250,000 per year.
Considering the 5 years in total, the company should: old equipment cost
a. Replace due to P400,000 advantage purchase price (900,000) outflow
b. Not replace due to P150,000 disadvantage SV- old 50,000 inflow
c. Replace due to P350,000 advantage Savings (1M-1.25)x5 yrs 1,250,000 inflow
d. Not replace due to P100,000 disadvantage Net amount 400,000 advantage
4. RETAIN OR ELIMINATE UNPROFITABLE SEGMENT OR PRODUCT
8. AB Corporation currently operates two divisions which had operating results last year as follows:

Division A Division B
Sales............................................................ P600,000 P300,000
Variable costs .............................................. 310,000 200,000 Segment Margin = Sales -VC - AFC
Contribution margin ..................................... 290,000 100,000 if positive = retain
avoidable Traceable fixed costs .................................... 110,000 70,000 if negative = eliminate
Unavoidable Allocated common corporate costs ............... 90,000 45,000 ex ACCC is advertising
Net operating income (loss) .......................... P 90,000 (P 15,000)

Since the Division B also sustained an operating loss in the prior year, the president is considering the
elimination of this division. Division B's traceable fixed costs could be avoided if the division were
eliminated. The total common corporate costs would be unaffected by the decision. If the Division B had
been eliminated at the beginning of last year, the operating income for last year would have been:
a. P 15,000 higher
b. P 30,000 lower
Segment margin
c. P 45,000 lower
Sales (B) 300,000
d. P 60,000 higher VC (200,000)
AFC (70,000)
-------------------------------
SM 30,000 positive =should retain

if B is eliminated = operating income will lower by 30,000

9. ABC Corporation’s branch reported the following results of operations for the period just ended:

Sales P2,500,000
Less: Variable expenses 1,000,000
Contribution margin 1,500,000
Less: Fixed expenses
Salaries and wages P750,000
Insurance on inventories 50,000
Depreciation on equipment 325,000 unavoidable since it still use in other branch
Advertising 500,000 1,625,000
Profit (Loss) (P125,000)

The management is contemplating dropping the branch due to the unfavorable operating results. If this
would happen, one employee will have to be retained with an annual salary of P150,000. The equipment will
be transferred to another branch. The branch should unavoidable

a. Not be dropped due to foregone overall income of P850,000 Sales 2,500,000

b. Be dropped due to forgone overall income of P325,000 VC ( 1,000,000)
S&W (600,000) ---> 750 - 150
c. Not be dropped due to foregone overall income of P25,000 Insurance (50,000)
d. Be dropped due to overall operational loss of P25,000 SM = 850,000

Page | 6
 Joint cost : from start to split off point
5. SELL IMMEDIATELY OR PROCESS FURTHER Joint cost = sunk cost= irrelevant
10. A company manufactures three chemicals (A, B, and C) from a joint process. The three chemicals are in
industrial grade form at the split-off point. They can either be sold at that point or processed further into
premium grade. Costs related to each batch of this chemical process is as follows:

A B C
Sales value at split-off point .......................... P16,000 P12,000 P5,000
Allocated joint costs ..................................... P 6,000 P 6,000 P6,000
Sales value after further processing............... P20,000 P18,000 P9,000
Cost of further processing............................. P 5,000 P 3,000 P2,000

For which product(s) above would it be more profitable for the company to sell at the split-off point rather
than process further?
a. A only Process Further only if Incremental revenue > Incremental cost
increase of selling price further processing cost
b. C only JC
c. A and C only -------- further processing cost
/--------/--------------------------
d. B and C only Split off A B C
point Incremental Revenue 16- 20 = 4 12-18 = 6 5 - 9 = 4
Incremental cost (5) (3) (2)
---------------------------------------------------------------
= (1) 3 2
Sell @ split off FP FP

11. Two products, X and Y emerge from a joint process. Product X has been allocated P9,600 of the total joint
costs of P12,000. A total of 9,000 units of product X are produced from the joint process. Product X can
be sold at the split-off point for P13 per unit, or it can be processed further for an additional total cost of
P54,000 and then sold for P18 per unit.

If product X is processed further and sold, what would be the effect on the overall profit of the company
compared with sale in its unprocessed form directly after the split-off point?
a. P 18,600 less profit
b. P 108,000 more profit
c. P 600 more profit
d. P 9,000 less profit
SP@SPLIT OFF 13
SP@FP 18
Increase 5 x 9,000 units = 45,000 incremental revenue
(54,000) incremental cost
= (9,000) sell immediately @ Split off point

6. WHICH PRODUCTS TO PRODUCE GIVEN SCARCE RESOURCES "limited" --> DL hrs, Machine hrs
12. The constraint at ABC Corporation is time on a particular machine. The company makes three products
that use this machine. Data concerning those products appear below:

A B C
Selling price per unit ......................... P192.00 P542.66 P222.84
Variable cost per unit........................ P158.72 P420.54 P167.76
Minutes on the constraint ................. 3.20 8.60 3.60
Market demand (units) 100 150 200

Assume that the total available minutes is 2,150 minutes, determine the best combination of the products
to produce. Produce the products WITH HIGHEST
a. 150 units of C, 100 units of B, 20 units of A CONTRIBUTION MARGIN PER SCARCE
b. 100 units of C, 50 units of B, 50 units of A RESOURCE
c. 200 units of C, 150 units of B, 44 units of A
d. 200 units of C, 150 units of B, 100 units of A
A B C
CM (SP - VC) 33.28 122.12 55.08
divide: scarce /3.20 /8.60 /3.60
(mins on the constraints) =10.4 14.2 15.3
CM/ SR 3rd 2nd 1st to produce (highest)

TOTAL AVAILABLE MINUTES = 2,150 mins

Product C (200 units x 3.6) (720) C= 200
Product B (150 x 8.6) (1,290) B= 150
remaining for A = 140 mins / 3.2 mins = 44 units A= 44
Page | 7