S/N Relevant Costs for Decision Making.

Special Order
1 Albertine Co. manufactures and sells trophies for winners of athletic and other events. Its
manufacturing plant has the capacity to produce 16,000 trophies each month; current
monthly production is 12,800 trophies. The company normally charges $113 per trophy.
Cost data for the current level of production are shown below:
Variable costs:
Direct materials .......................... $614,400
Direct labor ................................. $256,000
Selling and administrative .......... $35,840
Fixed costs:
Manufacturing ............................ $294,400
Selling and administrative .......... $94,720

The company has just received a special one-time order for 1,200 trophies at $61 each. For
this particular order, no variable selling and administrative costs would be incurred. This
order would also have no effect on fixed costs.
Required: Should the company accept this special order? Why?

Answer:
Only the direct materials and direct labor costs are relevant in this decision. To make the
decision, we must compute the average direct materials and direct labor cost per unit.

Particular Total Per Unit

Direct materials $614,400 48
Direct labor $256,000 20
Total Cost (Monthly) $8,70,400 68
Current monthly production 12,800

Average direct materials and direct labor cost per unit .... $68

Since price on the special order is $61 per trophy and the relevant cost is $68, the company
would suffer a loss of $7 per trophy. Therefore, the special order should not be accepted.

2 Adamyan Co. manufactures and sells medals for winners of athletic and other events. Its
manufacturing plant has the capacity to produce 15,000 medals each month; current monthly
production is 12,750 medals. The company normally charges $120 per medal. Cost data for
the current level of production are shown below:
Variable costs:
Direct materials ...................................... $624,750
 Direct labor ............................................. $306,000
Selling and administrative ...................... $15,300
Fixed costs:
Manufacturing ........................................ $506,175
Selling and administrative ...................... $123,675

The company has just received a special one-time order for 700 medals at $83 each. For this
particular order, no variable selling and administrative costs would be incurred. This order
would also have no effect on fixed costs.
Required: Should the company accept this special order? Why?

Answer:
Only the direct materials and direct labor costs are relevant in this decision. To make the
decision, we must compute the average direct materials and direct labor cost per unit.
Particular Total Per Unit
Direct materials $624,750 49
Direct labor $306,000 24
Total Cost (Monthly) $930,750 73
Current monthly production 12,750

Average direct materials and direct labor cost per unit ... $73

Since price on the special order is $83 per medal and the relevant cost is only $73, the
company would earn a profit of $10 per medal. Therefore, the special order should be
accepted.

3 Pilgrim Corporation makes a range of products. The company's predetermined overhead rate
is $23 per direct labor-hour, which was calculated using the following budgeted data:

Variable manufacturing overhead ............. $200,000

Fixed manufacturing overhead .................. $375,000
Direct labor-hours ...................................... 25,000

Management is considering a special order for 800 units of product N89E at $69 each. The
normal selling price of product N89E is $88 and the unit product cost is determined as
follows:
Direct materials ........................................... $28.00
Direct labor .................................................. .22.50
Manufacturing overhead applied ................. 34.50
Unit product cost ......................................... $85.00

If the special order were accepted, normal sales of this and other products would not be
 affected. The company has ample excess capacity to produce the additional units. Assume
that direct labor is a variable cost, variable manufacturing overhead is really driven by direct
labor-hours, and total fixed manufacturing overhead would not be affected by the special
order.

Required: If the special order were accepted, what would be the impact on the company's
overall profit?

Answer:
Direct materials, direct labor, and variable manufacturing overhead are relevant in this
decision. Fixed manufacturing overhead is not relevant since it would not be affected by the
decision. The variable portion of the manufacturing overhead rate is computed as follows:

Variable manufacturing overhead $200,000

÷ Direct labor-hours 25,000
= Variable portion of the predetermined overhead rate $8.00

The direct-labor hours per unit for the special order can be determined as follows:

Manufacturing overhead applied $34.50

÷ Predetermined overhead rate $23.00
= Direct labor-hours 1.50
Consequently, the variable manufacturing overhead for the special order would be:

Variable portion of the predetermined overhead rate $8.00

× Direct labor-hours 1.50
= Variable manufacturing overhead $12.00

Putting this all together:

Special order price ........................................................... $69.00

Variable costs:
Direct materials ............................................................ $28.00
Direct labor ................................................................... 22.50
Variable manufacturing overhead ................................ 12.00
Total variable cost ........................................................... 62.50

Contribution margin ........................................................ $ 6.50

× Units ordered ................................................................ 800
= Total increase in profit from the special order ............. $5,200
Make or Buy Decision
4 Bulan Inc. makes a range of products. The company's predetermined overhead rate is $20
per direct labor-hour, which was calculated using the following budgeted data:

Variable manufacturing overhead ............. $140,000

Fixed manufacturing overhead .................. $560,000
Direct labor-hours ...................................... 35,000

Component T6 is used in one of the company’s products. The unit product cost of the
component according to the company’s cost accounting system is determined as follows:

Direct materials .........................................$ 45.00

Direct labor .................................................. 32.00
Manufacturing overhead applied ................. 40.00
Unit product cost ........................................$117.00

An outside supplier has offered to supply component T6 for $101 each. The outside supplier
is known for quality and reliability. Assume that direct labor is a variable cost, variable
manufacturing overhead is really driven by direct labor-hours, and total fixed manufacturing
overhead would not be affected by this decision. Bulan chronically has idle capacity.

Required: Is the offer from the outside supplier financially attractive? Why?
Answer:
Direct materials, direct labor, and variable manufacturing overhead are relevant in this
decision. Fixed manufacturing overhead is not relevant since it would not be affected by the
decision. The variable portion of the manufacturing overhead rate is computed as follows:

Variable manufacturing overhead .................................... $140,000

÷ Direct labor-hours ......................................................... $35,000
= Variable portion of the predetermined overhead rate .... $4.00

The direct-labor hours per unit for the special order can be determined as follows:

Manufacturing overhead applied ... $40.00

÷ Predetermined overhead rate ...... $20.00
= Direct labor-hours ...................... 2.00

Consequently, the variable manufacturing overhead for the special order would be:
Variable portion of the predetermined overhead rate ........ $4.00
× Direct labor-hours .......................................................... 2.00
= Variable manufacturing overhead .................................. $8.00

Putting this all together:

Direct materials ...............................…...... $45.00
Direct labor ...........................................…... 32.00
Variable manufacturing overhead .......…….. 8.00
Total variable cost ..................................…..$85.00

Since the outside supplier has offered to sell the component for $101.00 each, but it only
costs the company $85.00 to make the component internally, this is not a financially
attractive offer.
 Make or Buy Decision with Opportunity Cost
5 Fothergill Company makes 40,000 units per year of a part it uses in the products it
manufactures. The unit product cost of this part is computed as follows:
Direct materials ......................................... $23.40
Direct labor ................................................ .22.30
Variable manufacturing overhead ...........…. 1.40
Fixed manufacturing overhead ................… 24.60
Unit product cost ....................................... $71.70
An outside supplier has offered to sell the company all of these parts it needs for $59.20 a
unit. If the company accepts this offer, the facilities now being used to make the part could
be used to make more units of a product that is in high demand. The additional contribution
margin on this other product would be $352,000 per year.

If the part were purchased from the outside supplier, all of the direct labor cost of the part
would be avoided. However, $21.90 of the fixed manufacturing overhead cost being applied
to the part would continue even if the part were purchased from the outside supplier. This
fixed manufacturing overhead cost would be applied to the company's remaining products.
Required:
a. How much of the unit product cost of $71.70 is relevant in the decision of whether to
make or buy the part?
b. What is the net total dollar advantage (disadvantage) of purchasing the part rather than
making it?
c. What is the maximum amount the company should be willing to pay an outside supplier
per unit for the part if the supplier commits to supplying all 40,000 units required each year?
Answer:
a. Relevant cost per unit:
Direct materials ...................................$23.40
Direct labor .......................................... 22.30
Variable manufacturing overhead ....... 1.40
Fixed manufacturing overhead ............ 2.70
Relevant manufacturing cost ............... $49.80

b. Net advantage (disadvantage):

Manufacturing cost savings ................. $1,992,000
Additional contribution margin .....…...... 352,000
23,44,000
Cost of purchasing the part ...............…. (2,368,000)
Net advantage (disadvantage) .............. .$ (24,000)

C. Maximum acceptable purchase price:

 Manufacturing cost savings ................. $1,992,000
Additional contribution margin ........... 352,000
Total benefit ......................................... $2,344,000
Number of units ................................... 40,000
Benefit per unit .................................... $58.60

Adding and Dropping Product Line and other Segment

6 Lakeshore Tours Inc., operates a large number of tours throughout the United States. A
study has indicated that some of the tours are not profitable, and consideration is being given
to dropping these tours in order to improve the company's overall operating performance.
One such tour is a two-day Battlefields of the French and Indian Wars bus tour. An income
statement from one of these tours is given below:
Ticket revenue
(100 seats × 45% occupancy × $80 ticket price) ... $3,600 100%
Less variable expenses ($24 per person) .................. 1,080 30%
Contribution margin ................................................. 2,520 70%
Less fixed tour expenses:
Tour promotion .....................................................$620
Salary of bus driver ............................................... 400
Fee, tour guide ....................................................... 825
Fuel for bus............................................................ 100
Depreciation of bus ............................................... 400
Liability insurance, bus ......................................... 250
Overnight parking fee, bus .................................... 50
Room and meals, bus driver and tour guide .......... 75
Bus maintenance and preparation ......................... 325
Total fixed tour expenses ................................................... 3,045
Net operating loss ..................................................... $ (525)
Dropping this tour would not affect the number of buses in the company's fleet or the
number of bus drivers on the company's payroll. Buses do not wear out through use; rather,
they eventually become obsolete. Bus drivers are paid fixed annual salaries; tour guides are
paid for each tour conducted. The “Bus maintenance and preparation” cost above is an
allocation of the salaries of mechanics and other service personnel who are responsible for
keeping the company's fleet of buses in good operating condition. There would be no change
in the number of mechanics and other service personnel as a result of dropping this tour. The
liability insurance depends upon the number of buses in the company's fleet and not upon
how much they are used.

Required:
a. Prepare an analysis showing what the impact will be on company profits if this tour is
discontinued.
b. The company's tour director has been criticized because only about 50% of the seats on
the company's tours are being filled as compared to an average of 60% for the industry. The
tour director has explained that the company's average seat occupancy could be improved
considerably by eliminating about 10% of the tours, but that doing so would reduce profits.
Do you agree with the tour director's conclusion? Explain your response.

Answer:
a. Contribution margin lost if the tour is discontinued ........ $(2,520)
Less tour costs that can be avoided if the tour is discontinued:
Tour promotion ............................................................ $620

Fee, tour guide .............................................................. 825

Fuel for bus ................................................................... 100
Overnight parking fee, bus ........................................... 50
Room and meals, bus driver and tour guide ................. 75
1,670

Net decrease in profits if the tour is discontinued ........... $ 850

b. The elimination of tours with occupancy rates lower than the industry average would
improve the overall average seat occupancy for the company as a whole. This action could
reduce company profits in two ways. First, the tours that are eliminated could have a
contribution margin that is higher than the avoidable costs of the tour itself. This is the case
with the tour described in part 1 above. Eliminating these tours would reduce the company's
total contribution margin more than it would reduce total costs resulting in a decline in
profits. Second, these tours might be acting as “magnets' in that they may be drawing tourists
to other, more profitable tours being offered by the company