No. 125 Brgy.

San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : icarecpareview@[Link]

MS10-07: INCREMENTAL ANALYSIS

“Managerial accountants identify, analyze, interpret and communicate information to management to support them
in their functions (e.g. planning, leading, organizing and controlling). Management accountants help management
in analyzing decision problems particularly on its potential financial impact to the company. However, it must be
noted that management are also confronted daily with various concerns which do not necessarily require special
analysis.”

DECISION MAKING PROCESS

The decision-making process can be summarized by the following steps:

PROBLEM DECIDE

DEVELOP DEVELOP EVALUATE

KNOW CRITERIA
FRAMEWORK FRAMEWOR DECISIONS
OPTIONS

However, decisions made must be subject to careful assessment and evaluation in order to know
whether the decision making process is effective (that is leading to favorable results).

REVIEW OF COST CONCEPTS USED IN DECISION MAKING

1. Relevant Cost – cost that are used in decision making
2. Irrelevant Cost - cost that are not used in decision making
3. Differential Cost – amount of cost that differs between alternatives
4. Sunk Cost – historical cost
5. Marginal Cost – cost of producing one additional unit
6. Out-of-pocket cost – cost that require cash outflow
7. Opportunity Cost – cost of income foregone
8. Avoidable cost – costs that can be eliminated if a certain alternative has been chosen
9. Unavoidable cost – costs that exists between two alternatives

CHARACTERISTICS OF INFORMATION USED IN DECISION MAKING

Information used in decision making must be relevant, accurate, and timely. Relevant information
are those that have future impact and are different between alternatives. Simply put, these are
future differential cost. The term future and differential means that sunk (historical) or not
differential cost are irrelevant.

TOTAL(FULL) APPROACH VERSUS INCREMENTAL(DIFFERENTIAL) APPROACH

The total (full) approach in relevant costing considers both relevant and irrelevant items. The
goal under the total approach is to compare the net income before and after the decision. On the
other hand, the incremental approach (differential approach) focuses only on the cost that differs
among alternatives, thus, irrelevant costs are already ignored.

DISCUSSION OF VARIOUS SPECIAL DECISION SITUATIONS

SPECIAL SALES ORDER (ACCEPT OR REJECT SPECIAL ORDER)

A special sales order can be sales made at a different price (usually lower as compared to regular
selling price) or with different specifications. The analysis of this decision may be done using the
total approach or the incremental approach.

Decision Making Framework (Incremental Analysis):

General Rule With Excess Capacity Without Excess Capacity
Incremental Revenue Special Sales Special Sales
Less: Incremental Cost Additional variable cost due Additional variable cost due to
to special order special order

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Opportunity cost: Foregone

contribution margin to
accommodate special order
Change in profit Profit (Loss) Profit (Loss)

Evaluation of Decision Framework

For academic purposes, if the special sales order will result in profit, the company should accept
the order. In actual practice, qualitative factors should be given due consideration.

Qualitative Factors to Consider:

Management should consider whether the special sales order will affect regular operations and
will also become a repeat business.

OUTSOURCING DECISION (PURCHASE OR MANUFACTURE/MAKE OR BUY)

An outsourcing decision is a situation where management is contemplated whether it is better to
manufacture the product or purchase it from an outside supplier.

MANUFACTURE PURCHASE
Avoidable variable cost had the company Total purchasing cost, including other
decided to purchase the product incidental cost (e.g. material handling)
Avoidable fixed cost had the company decided
to purchase the product
Avoidable incremental cost had the company
decided to purchase the product
Opportunity Cost from income from use of
released resources
Total Cost to Manufacture Total Cost to Purchase

Evaluation of Decision Framework

For academic purposes, the alternative with lower cost shall be chosen over the other. In actual
practice, qualitative considerations must be considered such as employee layoffs, supplier loyalty
and etc.

ADD OR DROP A SERVICE, PRODUCT, OR DEPARTMENT

Companies are confronted with decisions to add, drop, or retain a particular segment, division,
or product line. Management is concerned whether the company will become better off by (1)
dropping the segment, (2) retaining the segment, or (3) adding a segment.

Decision-making Framework: (Drop or Retain) Decision-making Framework: (Add or Do not Add)

Avoidable revenues XXX Additional revenues XXX
Avoidable variable cost XXX Less: additional variable cost XXX
Additional segment contribution XXX
Segment contribution XXX Less: Additional fixed cost XXX
Less: Additional income XXX Less: Lost income XXX
Less: Avoidable fixed cost XXX Segment Margin XXX
Segment Margin XXX

Evaluation of Decision Framework

If the segment has a positive segment margin, retaining or adding the segment is preferred.
Otherwise, dropping the segment is a more profitable decision. Take note that the segment
margin is the amount contributed by the segment in covering common fixed costs. In actual
practice, various qualitative factors shall be considered such as market perception, employee
layoffs, etc.

SELL AS IS OR PROCESS FURTHER

Management wants to know whether further processing a product already capable of being sold
will make the company better off. In this decision problem, we are tasked to know if selling it as
is will be more profitable than selling it after further processing.

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Decision making framework:

Incremental Selling Price XXX
Less: Incremental Cost XXX
Net Benefit/Loss XXX

Evaluation of Sell as is or Process Further

If the resulting incremental selling price after further processing is greater than incremental cost
to process further, then the company should process further.

UTILIZATION OF SCARCE RESOURCES AND PROFITABLE PRODUCT COMBINATION

In this decision scenario, management wants to know which combination of products will be most
profitable provided the scarcity of the resources.

Decision making framework:

CM/unit XXX
Divided: Scarce resourse/unit XXX
CM/Scarce resource XXX

Evaluation of utilization of scarce resources

The product with a higher contribution margin with scarce resource must be produced first subject
to any market limitation.

CONTINUE OR SHUTDOWN OPERATIONS

In this decision scenario, management wants to know whether temporarily shutting down their
operations for a certain period of time will be more profitable than continuing operations.

Decision making framework:

SHUTDOWN CONTINUE
Revenue Revenue
Variable Cost Variable Cost
Contribution Margin Contribution Margin
Fixed Cost Fixed Cost
Net Loss Net Loss

Evaluation of Continue or Shutdown

If the net loss under shutdown is lower than continue, the company should shut down operations.

COMMON PROBLEMS ENCOUNTERED IN INCREMENTAL ANALYSIS

• Ignoring qualitative considerations in decision making
• Lack of consideration for the element of uncertainty
• Giving too much importance on sunk costs
• Lack of consideration given to opportunity cost
• Misleading unitized fixed cost information

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 No. 125 Brgy. San Sebastian
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MS10-07: QUIZZER IN INCREMENTAL ANALYSIS (PART1)

Discussion problems
Answer each of the requirements correctly. Show your computations in good form.

1. Cost Classification (Relevance in Decision Making): Indicate the proper classification of costs as
to relevance in decision making:
a. Slow-moving inventory purchased last year.
b. The cost of including one extra child in a day-care center.
c. The management of a condominium building uses 5,000 square feet of space in the building
for its own administrative functions. This space could be rented out for P150,000.
d. The cost of building an automated assembly line in a factory is P850,000; a manually
operated assembly line would cost P250,000. What economic term is used to describe the
P600,000 variation between these two amounts?
e. The cost of president’s salary which will be paid even if a certain division is dropped.
f. Supervisor’s salary which will not be paid if the manufacturing process is discontinued.
g. Refer to the preceding question and assume that the firm is currently building the assembly
line for P700,000. What economic term is used to describe the P700,000 construction cost?

2. General Concepts (Total and Incremental Approach): An employee of Kalinaw Corporation has
found some partially completed units of Model C in a dusty corner of the warehouse. A job ticket
attached to the units indicates that a total of P750,000 in manufacturing costs have been used to bring
the materials to this point in the manufacturing process. The units can be sold in their current condition
for P200,000 to a scrap metal dealer. If Morgan spends P250,000 to complete the units, they could be
sold for P600,000. Answer the following:

a. What are the sunk costs?

b. What should Kalinaw do?

3. General Concepts (Total and Incremental Approach): Intel Chemical Co. recently received an
order for a product it does not normally produce. Since the company has excess production capacity,
management is considering accepting the order. In analyzing the decision, the assistant controller is
compiling the relevant costs of producing the order. Production of the special order would require
8,000 kilograms of theolite. Intel does not use theolite for its regular product, but the firm has 8,000
kilograms of the chemical on hand from the days when it used theolite regularly. The theolite could
be sold to a chemical wholesaler for P14,500. The book value of the theolite is P2 per kilogram. Intel
could buy theolite for P2.40 per kilogram.
a. What is the relevant cost of theolite for the purpose of analyzing the special order decision?
b. Intel’s special order also requires 1,000 kilograms of genatope, a solid chemical regularly used
in the company’s products. The current stock of genatope is 8,000 kilograms at a book value
of P8.10 per kilogram. If the special order is accepted, the firm will be forced to restock
genatope earlier than expected, at a predicted cost of P8.70 per kilogram. Without the special
order, the purchasing manager predicts that the price will be P8.30, when normal restocking
takes place. Any order of genatope must be in 5,000 kilograms. What is the relevant cost of
genatope?

4. Special Order Decision: Idol Company produces a single product. The variable cost of producing and
selling this product is P54 and the fixed cost of producing and selling totals P892,000. The normal
selling price of the product is P90 per unit. Feeling Ispesyal, a first-time customer, bargains to buy
3,000 units of your product at a very low price of P60. The capacity of your process is 40,000 units.

Required: Solve each case independently:

a. Suppose the company only produces and sells only 37,000 units. Will you accept the order?
Assuming the customer bargains further, what is the minimum price you are willing to give?
b. Suppose the company only produces and sells only 40,000 units. Will you accept the order?
Assuming the customer bargains further, what is the minimum price you are willing to give?
c. Suppose the company currently produces and sells 38,500 units. Will you accept the order?
Assuming the company bargains further, what is the minimum price you are willing to give?
d. Suppose the company produces and sells only 37,000 units. However, Feeling Ispesyal wants
its logo to be printed on the product and such request will require a special equipment (to be
used solely for the order) amounting to P12,000. If Feeling Ispesyal wants to bargain further,
what is the lowest acceptable price for you?

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 No. 125 Brgy. San Sebastian
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Telephone : (043) 723 8412
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5. Outsourcing Decision: Making Company manufactures 8,000 units of a product and incurs direct
material, P10.00, direct labor, P4.00, and manufacturing overhead, P8.00. Of the total manufacturing
overhead, 62.5% is considered variable and the remaining is considered fixed. A certain supplier offered
to sell the product for P20 each, including P2 delivery charge per unit.

Required: Solve each case independently:

a. How much is the total cost of the company to manufacture the product? How much is the total
cost of the company to purchase the product? Will you make or buy? How much is your savings
(loss)? Give your comments on the behavior of fixed cost . Rework your solution using the
incremental approach. How much is the maximum price you are willing to pay the supplier?
b. Suppose that fixed cost amounting to P10,000 pertains to supervisor’s salary and the remaining
is common fixed costs. If the company decides to purchase, the supervisor will be retrenched.
Will you make our buy? How much is your savings (loss)? How much is the maximum price
you are willing to pay?
c. Suppose that fixed costs is composed of P10,000 supervisor’s salary and P14,000 depreciation.
If the company decides to purchase, the supervisor will be retrenched and the machine will
not be used. Will you make our buy? How much is your savings? How much is the maximum
price you are willing to pay?
d. Suppose that fixed costs is composed of P5,000 supervisor’s salary and remaining is common
fixed cost. Once the company stops manufacturing the part, it can produce 1,000 units of
another product which can be sold for P19.59 (at a contribution margin of 25%). Will you
make our buy? How much is your savings (loss)? How much is the maximum price you are
willing to pay?

6. Segment Decisions: Dibisyon Corporation has three product lines: Dibidi, Bisidi, and Kaset. Results
of the past year are as follows:
Bisidi Dibidi Kaset
Units sold 1,000 2,000 2,000
Sales P45,910.00 P148,200.00 P68,500.00
Variable cost 34,432.50 94,848.00 60,280.00
Contribution margin 11,477.50 53,352.00 8,220.00
Fixed costs* 10,432.00 22,325.00 10,625.00
Net income (loss) P 1,045.50 P31,027.00 (P2,405.00)

*The fixed cost deducted from each of the division contains allocated fixed cost amounting to P17,882
based on number of units sold. The remaining fixed costs are direct to each division. The owner of
Dibisyon Corporation is contemplating of dropping Kaset in order to increase overall profit.

Required
a. Prepare the segmented income statement for Dibisyon Corporation.
b. Prepare the new segmented income statement if Kaset Division is dropped. How much is the
change in profit? Should you drop Kaset Division? Comment on the change in profit and
segmented income statement.
c. Suppose Bisidi sales will increase by 25% and Dibidi sales will decrease by 10% if Kaset is
dropped, what will be the change in net income? Should you drop Kaset?

7. Product Mix Decision: The Marquee Company manufactures two products using a single
production process in which the main constraint is machine hours. The economic data are given
below:

Product M Product Q
Selling price per unit P10 P15
Variable cost per unit P7 P11
Machine hours per unit 1 hour 2 hours

Product M Product Q
Market limitation (in units) 100,000 62,000

The company has 200,000 machine hours available to manufacture the two products. The fixed cost of
the company is P200,000.

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 No. 125 Brgy. San Sebastian
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Required: How much is the net income under the following independent assumptions:
1. If Product M is produced first followed by Product Q?
2. If Product Q is produced first followed by Product M?
3. Prepare an incremental analysis to determine the optimum product mix.
4. Assuming the company can rent a machine that will provide additional 10,000 machine hours for
P10,000, should the company accept the offer? What is the maximum price the company can pay
for an additional machine hour?

8. Joint Product Decision: The Magkasama Company makes two products, Agad and Isip Muna, in a
joint process. At the split-off point, 60,000 units of product Agad and 70,000 units of product Isip
Muna are available each month. Monthly joint production costs total P200,000. Product Agad can be
sold at the split-off point for P3.20 per unit. Product Isip Muna can be either sold at the split-off point
for P2.60 per unit or it can be processed further and sold for P5.80 per unit. If product Isip Muna is
processed further, additional processing costs of P2.30 per unit will be incurred.

Required: Solve each case independently.

Case 1: Suppose fixed overhead costs will not be affected,

d. What is the net income if both products are sold as is?
e. What is the net income if Isip Muna is processed further?
f. How much is the increase (decrease) in income?
g. Comment on the nature of joint costs.
h. What would the unit selling price of product Isip Muna need to be at the split-off point in order
for Magkasama to be economically indifferent between selling Isip Muna at split-off or
processing Isip Muna further before sale?

Case 2: Suppose a P45,000 special equipment is required in order to process Isip Muna further.
a. Should the company process further?
b. How much is the increase (decrease) in net income?
c. At what number of units, will the company be economically indifferent to process further?

9. Shutdown Decision: Baterya Company normally produces and sells 480,000 units of a single
product per year named Energized. Energized is the most reliable battery used in by both consumer
and corporate clients. The selling price is P30 per unit, variable costs are P20 per unit, fixed
manufacturing overhead costs total P240,000 and fixed selling costs total P48,000 per month.

One of the extraordinary machines used by the company was accidentally damaged and requires
significant number of months to repair. There are no other sources of this machine and reparation of
damages is the only possible option for the company. Due to this breakdown, the capacity, production,
and sales of Baterya Corporation will temporarily drop to 10,000 units per month.

Baterya Company estimates that the repair will last for about two months. After the repair, sales of
Baterya should revert to 480,000 per year. Because of the significant drop in sales, however,
management is thinking about shutting down its operations while the machine is being repaired for the
two months. If the company opts to shut down its plant, the following changes will happen:
i. Fixed manufacturing overhead costs can be reduced by P40,000 per month.
ii. Fixed selling costs can be reduced to P28,000 per month.
iii. Start-up costs at the end of the shut down period would total P12,000.

Required:
i. What is the normal 2-month income of the company?
j. What is the 2-month net income during the repair period?
k. What is the 2-month net income during the shutdown period?
l. What is the shutdown point? Explain the relevance of the shutdown point.

10. Pricing Decisions: Presyohan Corporation has the following costs:

Direct materials P30

Direct labor 15
Variable overhead 5
Fixed overhead 10
Variable S&A expense 8
Fixed S&A expense 2
Total P70
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Presoyhan has capital invested of P200,000 and Sales volume of 2,000 units. Desired markup is at
10%. Calculate the different variation of prices based on desired markup.

11. Pricing Decisions: Primera Company sells a product in a competitive marketplace. Market analysis
indicates that their product would probably sell at P280.00 per unit. Primera management desires a
profit equal to a 20% rate of return on invested assets of P14,000,000. They anticipate selling 50,000
units. Their current full cost per unit for the product is P250 per unit.
a. What is the amount of profit per unit?
b. What is the target cost per unit if they meet the market dictated price and management’s
desired profit?

MULTIPLE CHOICE THEORIES

Choose the letter of the correct answer.

1. The amount of increase or decrease in revenue that is expected from a particular course of
action as compared with an alternative is termed:
a. manufacturing margin
b. contribution margin
c. differential cost
d. differential revenue

2. An important qualitative factor to consider regarding a special order is:

a. The variable costs associated with the special order.
b. The avoidable fixed costs associated with the special order.
c. The effect the sale of special order units will have on the sale of regularly priced units
d. The incremental revenue from the special order.

3. Which of the following is not relevant to a make or buy decision?

a. P10,000 of direct labor used to manufacture the parts.
b. P30,000 of depreciation on the plant used to manufacture the parts.
c. The supervisor’s salary of P25,000 that will be avoided if the part is purchased from an
outside supplier.
d. P15,000 in rent from leasing the production space to another company if the part is
purchased from an outside supplier.

4. A firm can continue to manufacture a component or buy the component from an outside supplier
and rent the firm’s unused manufacturing facilities to another company. If the firm continues to
manufacture the component instead of buying it from an outside supplier, the rent the firm could
receive for its manufacturing facilities is:
a. sunk cost
b. an opportunity cost
c. an avoidable cost
d. an incremental cost

5. Which of the following costs are relevant to a make or buy decision?

a. original cost of the production equipment
b. annual depreciation of the equipment
c. the amount that would be received if the production equipment were sold
d. the cost of direct materials purchased last month and used to manufacture the
component.

6. The ship hit an iceberg and sank. In deciding whether or not to salvage the ship, its book value
is:
a. a relevant cost
b. a sunk cost
c. an opportunity cost
d. a discretionary cost

7. Which of the following statements is true when making a decision between two alternatives?
a. Variable costs may not be relevant when the decision alternatives have the same activity
levels.
b. Variable costs are not relevant when the decision alternatives have different activity
levels.
c. Sunk costs are always relevant
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d. Fixed costs are never relevant

8. Which of the following items would be classified as resources acquired as used and needed?
a. salaried employees
b. depreciation on building
c. fuel to generate electricity internally
d. lease on machinery

9. If there is excess capacity, the minimum acceptable price for a special order must cover:
a. variable costs associated with the special order
b. variable and fixed manufacturing costs associated with the special order
c. variable and incremental fixed costs associated with the special order
d. variable costs and incremental fixed costs associated with the special order plus the
contribution margin usually earned on regular units.

10. If a firm is at full capacity, the minimum special order price must cover:
a. variable costs associated with the special order
b. variable and fixed manufacturing costs associated with the special order
c. variable and incremental fixed costs associated with the special order plus foregone
contribution margin on regular units not produced
d. variable costs and incremental fixed costs associated with the special order.

11. What cost concept used in applying the cost-plus approach to product pricing includes only
desired profit in the "markup"?
a. Product cost concept
b. Variable cost concept
c. Sunk cost concept
d. Total cost concept

12. Firms may be asked to accept a special order of their product for a reduced price if:
a. it can be concealed from the government
b. excess capacity exists
c. the order is small
d. the plant is producing at maximum capacity.

13. All of the following should be considered in a make or buy decision except
a. cost savings
b. quality issues with the supplier
c. future growth in the plant and other production opportunities
d. the supplier will make a profit that would no longer belong to the business

14. The target cost approach assumes that:

a. markup is added to total cost
b. the selling price is set by the marketplace
c. markup is added to variable cost
d. markup is added to product cost

15. Which of the following costs is not relevant to a special order decision?
a. The direct labor costs to manufacture the special order units.
b. The variable manufacturing overhead incurred to manufacture the special order units.
c. The portion of the cost of leasing the factory that is allocated to the special order.
d. All of the above costs are relevant.

16. In making a special order decision, management should:

a. compute a reasonable sales price for items not normally produced.
b. consider additional overhead cost.
c. consider normal and relevant costs.
d. All of the above.

17. Costs which are always relevant in decision making are those costs which are:
a. variable.
b. avoidable.
c. sunk.
d. fixed.

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18. Which of the following costs is generally considered irrelevant in decision making process?
a. Direct labor
b. Direct materials
c. Fixed factory overhead
d. Variable factory overhead

19. The salary you would otherwise earn by working during weekend rather than attending the CPA
review is a good example of
a. A sunk cost
b. An opportunity cost
c. An incremental cost
d. An out-of-pocket cost

20. An opportunity cost is usually:

a. Relevant, but is not part of traditional accounting records.
b. Not relevant, but is part of traditional accounting records.
c. Relevant, and is part of traditional accounting records.
d. Not relevant, and is not part of traditional accounting records.

21. In a make-or-buy decision, the relevant costs include variable manufacturing costs as well as
a. Depreciation costs
b. General office costs
c. Avoidable fixed costs
d. Factory management costs
22. Relevant or differential cost analysis
a. Considers only variable costs as they change with each decision alternative.
b. Considers all variable and fixed costs as they change with each decision alternative.
c. Takes all variable and fixed costs into account to analyze decision alternatives.
d. Allows the decision maker to group all types of costs together to facilitate decision.

23. What is the opportunity cost of making a component part in a factory with excess capacity for
which there is no alternative use?
a. The total manufacturing cost of the component
b. The variable cost of the component
c. The fixed cost of the component
d. Zero

24. When discussing the pitfalls to be avoided in decision-making, four reminders usually emerge.
Which is NOT one of those reminders?
a. Ignore sunk costs.
b. Beware of allocated fixed costs; identify the avoidable costs.
c. Pay special attention to identifying and including opportunity costs.
d. Do not overlook the time value of money in short-run decisions.

25. Which one of the following is not a common mistake in a decision-making process?
a. Considering sunk costs as relevant.
b. Considering opportunity cost, an imputed cost, being relevant.
c. Considering fixed costs as avoidable fixed costs.
d. Unitizing fixed costs.

MULTIPLE CHOICE PROBLEM SOLVING

Choose the letter of the correct answer.

1. Thanos Fabricators, Inc. estimates that 60,000 special components will be used in the manufacture
of a specialty steel window for the whole next year. Its supplier quoted a price of P60 per
component. Thanos prefers to purchase 5,000 units per month, but its supplier could not guarantee
this delivery schedule. In order to ensure availability of these components, Thanos is considering the
purchase of all the 60,000 units at the beginning of the year. Assuming Thanos can invest cash at
8%, the company’s opportunity cost of purchasing all the 60,000 units at the beginning of the year is
a. P144,000
b. P132,000
c. P150,000
d. P264,000
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2. Seamus & Company has 24,000 defective units of a product that cost P8 per unit to manufacture,
and can be sold for P4 per unit. These units can be reworked for P2 per unit and sold at their full
price of P12 each. If Seamus reworks the defective units, how much incremental net income will
result?
a. P72,000
b. P48,000
c. P144,000
d. P 96,000

3. Torrey Pines is studying whether to outsource its Human Resources (H/R) activities. Salaried
professionals who earn P390,000 would be terminated; in contrast, administrative assistants who
earn P120,000 would be transferred elsewhere in the organization. Miscellaneous departmental
overhead (e.g., supplies, copy charges, long distance) is expected to decrease by P30,000, and
P25,000 of corporate overhead, previously allocated to Human Resources, would be picked up by
other departments. If Torrey Pines can secure needed H/R services locally for P410,000, how much
would the company benefit by outsourcing?
a. P10,000 c. P35,000.
b. P130,000. d. P155,000.
4. Green Company produces Product A and sells it for P18.00. The following cost data apply:
Type of Cost Per Unit
Direct materials (3 lb. x P1.50) P4.50
Direct labor 6.45
Variable overhead 1.35
Fixed overhead 1.50
Variable selling expense 1.10
Fixed selling expense 2.20
P17.10
Green has thought of marketing a new Product B with the same cost structure as Product A except that
the price will be P15.60. Green Company currently has the plant capacity necessary for this expansion.
Because of the cost structure, Green Company will find the production and sale of Product B in the short
run to be
a. Not profitable at any price.
b. Not profitable unless the price can be raised to P17.10.
c. Profitable to produce and sell Product B in the short run at the price of P15.60.
d. Not profitable at P15.60 because the fixed selling expense and fixed manufacturing overhead
will not be covered by the price.

5. A manufacturer has been approached by a new customer who wants to place a one-time order for a
component similar to one that the manufacturer makes for another customer. Existing sales will not be
affected by acceptance of this order. The manufacturer has a policy of setting its targeted selling price
at 60% over full manufacturing cost. The manufacturing costs and the targeted selling price for the
existing product are presented as follows.

Direct materials P2.30

Direct labor 3.60
Variable manufacturing overhead (applied at 75% of
direct labor cost) 2.70
Fixed manufacturing overhead (applied at 150% of direct
labor cost) 5.40
Total manufacturing cost P14.00
Markup (60% of full manufacturing cost) 8.40
Targeted selling price P22.40

The manufacturer has excess capacity to produce the quantity of the component desired by the new
customer. The direct materials used in the component for the new customer would cost the manufacturer
P0.25 less than the component currently being made. The variable selling expenses (packaging and
shipping) would be the same, or P0.90 per unit. Under these circumstances, the minimum unit price at
which the manufacturer would accept the special order is one exceeding
a. P8.35 b. P14.00 c. P9.25 d. P14.80
10 | P a g e JBUGAT AN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : icarecpareview@[Link]

For the next four items: The Best Company makes a single product called a Mario. The company has the
capacity to produce 40,000 Mario per year. Per unit costs to produce and sell one Mario at that activity
level follows:

Direct materials .................... P20

Direct labor ........................ 10
Variable manufacturing overhead ..... 5
Fixed manufacturing overhead ........ 7
Variable selling expense ............ 8
Fixed selling expense ............... 2

The regular selling price for one Mario is P60. A special order has been received at Best from the Worst
Company to purchase 8,000 Mario next year at 15% off the regular selling price. If this special order were
accepted, variable selling expense would be reduced by 25%. However, Best would have to purchase a
specialized machine to engrave the Worst name on each Mario in the special order. This machine would
cost P12,000 and it would have no use after the special order was filled. The total fixed costs, both
manufacturing and selling, are constant within the relevant range of 30,000 to 40,000 Mario per year.
Assume direct labor is a variable cost.

6. If Best can expect to sell 32,000 Mario next year through regular channels and the special order is
accepted at 15% off the regular selling price, the effect on net operating income next year due to
accepting this order would be a:
A. P52,000 increase B. P80,000 increase C. P24,000 decrease D. P68,000 increase

7. If Best can expect to sell 32,000 Mario next year through regular channels, at what special order price
from Worst should Best be economically indifferent between either accepting or not accepting this
special order?
A. P51.00 B. P48.20 C. P42.50 D. P39.60

8. If Best can expect to sell 37,960 Mario next year through regular channels and the special order is
accepted for 15% off the regular selling price, the effect on net operating income next year due to
accepting this order would be a:
A. P33,320 increase B. P33,320 decrease C. P35,480 decrease D. P35,480 increase

9. If Best can expect to sell 40,000 Mario next year through regular channels, at what special order price
from Worst should Best be economically indifferent between either accepting or not accepting this
special order?
A. P60.00 B. P21.00 C. P61.50 D. P59.50

10. Block Company uses 40,000 units of a part in its production process. The costs to make a part are: direct
material, P12; direct labor, P25; variable overhead, P13; and applied fixed overhead, P30. Block has received
a quote of P55 from a potential supplier for this part. If Block buys the part, 70 percent of the applied fixed
overhead would continue. Block Company would be better off by
A. P2,200,000 to buy B. P2,360,000 to make C. P160,000 to buy D. P160,000 to make

“Always believe that you are gifted because confidence drives success and excellence” –
Anonymous

11 | P a g e JBUGAT AN/JSARIPADA