Garrison (Asian Edition) Practice Exam Chapter 14

Print these pages. Answer each of the following questions, explaining your answers or showing your work, as appropriate, and then compare your solutions to those provided at the end of the practice exam. 1. The management of Bernese Company is considering whether one of the departments in its retail stores should be eliminated. The contribution margin in the department is $150,000 per year. Fixed expenses allocated to the department are $130,000 per year. It is estimated that $120,000 of these fixed expenses will be eliminated if the department is discontinued. Part (a) Which costs, if any, are irrelevant to this decision?

Part (b) If the department is eliminated, what will be the impact on the companys overall net operating income?

2. Warren Company, which manufactures a single product, is operating at full capacity of 20,000 units per month. The follow unit costs relate to the manufacture of this product: Manufacturing: Direct materials Direct labor Variable overhead Fixed overhead !elling and administrative: Variable Fixed $2.00 4.00 1.00 1. 0 ".00 1.200

The company has 100 units left over from last year which have small defects and which will have to be sold at a reduced price as scrap. This would have no effect on the company's other sales. The variable selling and administrative costs would have to be incurred to sell the defective units. What cost is relevant as a guide for setting a minimum price on these defective units?

3. Composite Company produces 2,000 parts per year, which are used in the assembly of one of its products. The unit product cost of these parts is: Variable manufacturing cost Fixed manufacturing cost $nit %roduct cost $#4 "# $100

The part can be purchased from an outside supplier at $80 per unit. If the part is purchased from the outside supplier, two-thirds of the fixed manufacturing costs can be eliminated. Part (a) What costs, if any, are relevant to this decision? Which costs are irrelevant?

Part (b) What would the annual impact on the companys net operating income be as a result of buying the part from the outside supplier?

4. Ginger Company sells its product for $42 per unit. The companys unit product cost based on the full capacity of 400,000 units is as follows: Direct materials Direct labor Manufacturing overhead $nit %roduct cost $ 10 12 $"0

A special order offering to buy 40,000 units has been received from a foreign distributor. The only selling costs that would be incurred on this order would be $6 per unit for shipping. The company has sufficient idle capacity to manufacture the additional units. Two-thirds of the manufacturing overhead is fixed and would not be affected by this order. Assume that direct labor is an avoidable cost in this decision. In negotiating a price for the special order, what is the minimum acceptable selling price per unit?

5. Wriggly Company is a small family business that produces wooden plaques and trophies: !elling %rice %er unit Variable cost %er unit *ontribution margin %er unit *ontribution margin ratio &la'ues $1 12 $ # "", (ro%hies $1) $ + 4+,

The company only has one machine, a sander, to sand the wood that is used for the plaques or the trophies. Generally, the wood required for each plaque takes 0.25 hour to sand, while the word required for each trophy takes 0.50 hour to sand. Based on the constraint related to the machine time, which product should be emphasized if only limited machine time is available-

GNBCY Practice Exam Solutions Chapter 14

1 Part (a) Solution (!earnin" #$%ecti&e 1)' (he common fixed costs of $10.000 /or $1"0.000 0 $120.0001 are irrelevant to this decision. Part (a) Solution (!earnin" #$%ecti&e ()' *M that 2ould be lost if de%artment is discontinued 3ess fixed costs that can be avoided if de%artment is discontinued 4ncrease /decrease1 in net o%erating income $/1)0.0001 120.000 $ /"0.0001

5ased on this information alone. because the com%an67s net o%erating income 2ould decrease b6 $"0.000 %er 6ear. management should not eliminate this de%artment. ( Solution (!earnin" #$%ecti&e ))' 8 relevant cost is a cost that differs bet2een alternatives in a decision0ma9ing situation. !ince the variable selling and administrative ex%enses of $".00 %er unit 2ould need to be incurred to sell the defective units. the6 are relevant to the decision and should be used as a guide for setting the minimum %rice on these defective units. :ote that none of the other %er unit costs 2ould be relevant as a guide for setting the minimum %rice on the defective units. (he four t6%es manufacturing costs listed above are sun9 costs /i.e.. a cost that has alread6 been incurred and that cannot be changed b6 an6 decision made no2 or in the future1 and. as such. are not relevant to this decision. (he fixed selling and administrative ex%enses is a common fixed cost /i.e.. a cost that su%%orts the o%erations of more than one segment of an organi;ation and is not avoidable in 2hole or in %art b6 eliminating an6 one segment1 and. as such. are not relevant to this decision.1 ) Part (a) Solution (!earnin" #$%ecti&e ))' (he %roduct costs related to ma9ing the %arts that can be eliminated are the variable manufacturing costs /$#4 %er unit1 and t2o0thirds of the fixed manufacturing costs /2<" x $"# = $241 for a total of $ /or $#4 > $241 %er unit. (hose are the costs that are relevant to the ?ma9e@ decision. (he cost that is relevant to the ?bu6@ decision is the %urchase %rice of $ 0 %er unit. !ince one0third of the fixed manufacturing costs cannot be eliminated. the6 are irrelevant to this decision.

Part ($) Solution (!earnin" #$%ecti&e ))' (he annual im%act on the com%an67s net o%erating income as a result of bu6ing the %art from the outside su%%lier is determined as follo2s: &roduction ?*ost@ %er $nit $ #4 "# $100 $#4 $ $ 0 /241 $)# $12 .00 0 $1#.000 $1#0.000 /4 .0001 $112.000 &er $nit Differential *osts Ma9e 5u6 $#4 (otal Differential *ostsA2.000 $nits Ma9e 5u6 $12 .00 0

Variable manufacturing costs Fixed manufacturing costs Butside %urchase %rice Fixed manufacturing costs eliminated (otal cost Difference in favor of %urchasing 4

Solution (!earnin" #$%ecti&e 4)' (he minimum acce%table selling %rice %er unit is determined as follo2s: Direct materials Direct labor Variable manufacturing overhead /$12 x 1<"1 Variable selling costs /shi%%ing1 Minimum selling %rice $ 10 4 # $2

Solution (!earnin" #$%ecti&e *)' (o evaluate a situation 2here there is a constrained resource /?bottlenec9@1. the contribution margin %er unit of constrained resource should be calculated. Chile at first it a%%ears the tro%hies should be em%hasi;ed based on the data given above. 2hen the contribution margin %er machine hour is com%uted. it a%%ears the %la'ues should be em%hasi;ed. as follo2s: *ontribution margin /*M1 %er unit Machine hours %er unit /MD1 *M %er machine hour /*M E MD1 &la'ues (ro%hies $ # $ + .2) .)0 $ 24 $ 14

4n other 2ords. for each hour of machine time. the 2ood for four %la'ues can be sanded 2ith a *M of $# %er %la'ue. for a total of $24 *M %er machine hour. 8lternativel6. for each hour of machine time. the 2ood for t2o tro%hies can be sanded 2ith a *M of $+ %er tro%h6. for a total of $14 *M %er hour of machine time. !o 2ith limited machine time. the %la'ues should be em%hasi;ed since more *M %er machine hour 2ill be reali;ed.

Essa+ ,uestions

F1. Giambalvo *om%an6 %roduces a single %roduct. (he cost of %roducing and selling a single unit of this %roduct at the com%an6Hs normal activit6 level of 40.000 units %er month is as follo2s: Direct materials ............................................... Direct labor ...................................................... Variable manufacturing overhead ................... Fixed manufacturing overhead ........................ Variable selling I administrative ex%ense ...... Fixed selling I administrative ex%ense .......... $" . 0 $F.+0 $2."0 $1 .10 $1.+0 $ . 0

(he normal selling %rice of the %roduct is $ 1.10 %er unit. 8n order has been received from an overseas customer for ".000 units to be delivered this month at a s%ecial discounted %rice. (his order 2ould have no effect on the com%an6Hs normal sales and 2ould not change the total amount of the com%an6Hs fixed costs. (he variable selling and administrative ex%ense 2ould be $0.20 less %er unit on this order than on normal sales. Direct labor is a variable cost in this com%an6. Je'uired: a. !u%%ose the com%an6 has am%le idle ca%acit6 to %roduce the units re'uired b6 the overseas customer and the s%ecial discounted %rice on the s%ecial order is $+)."0 %er unit. 56 ho2 much 2ould this s%ecial order increase /decrease1 the com%an6Hs net o%erating income for the monthb. !u%%ose the com%an6 is alread6 o%erating at ca%acit6 2hen the s%ecial order is received from the overseas customer. Chat 2ould be the o%%ortunit6 cost of each unit delivered to the overseas customerc. !u%%ose the com%an6 does not have enough idle ca%acit6 to %roduce all of the units for the overseas customer and acce%ting the s%ecial order 2ould re'uire cutting bac9 on %roduction of 1.000 units for regular customers. Chat 2ould be the minimum acce%table %rice %er unit for the s%ecial order8ns2er: a. Variable cost %er unit on normal sales: Direct materials ................................................ Direct labor ...................................................... Variable manufacturing overhead .................... Variable selling I administrative ex%ense ...... $" . 0 F.+0 2."0 1.+0

Variable cost %er unit on normal sales Variable cost %er unit on s%ecial order: :ormal variable cost %er unit ........................... Jeduction in variable selling I admin. ........... ............Variablecost%erunitons%ecialorder

$)2.)0 $)2.)0 0.20 $)2."0

!elling %rice for s%ecial order $ +)."0 Variable cost %er unit on s%ecial order ............... )2."0 ..........$nitcontributionmarginons%ecialorder 2".00 :umber of units in s%ecial order ......................... ".000 .......4ncrease/decrease1inneto%eratingincome $#F.000 b. (he o%%ortunit6 cost is Kust the contribution margin on normal sales: :ormal selling %rice %er unit .................................. $ 1.10 Variable cost %er unit on normal sales .................... )2.)0 $nit contribution margin on normal sales .............. $2 .#0 c. Minimum acce%table %rice: $nit contribution margin on normal sales ............. $2 .#0 Dis%laced normal sales .......................................... 1.000 3ost contribution margin dis%laced sales ............... $ 2 .#00 (otal variable cost on s%ecial order ....................... 1)#.F00 $1 ).)00 :umber of units in s%ecial order ............................ ".000 Minimum acce%table %rice on s%ecial order .......... $#1. "

F2. &ilgrim *or%oration ma9es a range of %roducts. (he com%an6Hs %redetermined overhead rate is $2" %er direct labor0hour. 2hich 2as calculated using the follo2ing budgeted data: Variable manufacturing overhead ............. $200.000 Fixed manufacturing overhead .................. $"+).000 Direct labor0hours ...................................... 2).000 Management is considering a s%ecial order for 00 units of %roduct : FL at $#F each. (he normal selling %rice of %roduct : FL is $ and the unit %roduct cost is determined as follo2s: Direct materials ........................................... $2 .00 Direct labor .................................................. 22.)0 Manufacturing overhead a%%lied ................. "4.)0 $nit %roduct cost ......................................... $ ).00 4f the s%ecial order 2ere acce%ted. normal sales of this and other %roducts 2ould not be affected. (he com%an6 has am%le excess ca%acit6 to %roduce the additional units. 8ssume that direct labor is a variable cost. variable manufacturing overhead is reall6 driven b6 direct labor0hours. and total fixed manufacturing overhead 2ould not be affected b6 the s%ecial order. Je'uired: 4f the s%ecial order 2ere acce%ted. 2hat 2ould be the im%act on the com%an6Hs overall %rofit3evel: Dard 3B: 4 !ource: *4M8. ada%ted

8ns2er: Direct materials. direct labor. and variable manufacturing overhead are relevant in this decision. Fixed manufacturing overhead is not relevant since it 2ould not be affected b6 the decision. (he variable %ortion of the manufacturing overhead rate is com%uted as follo2s: Variable manufacturing overhead $200.000 E Direct labor0hours 2).000 = Variable %ortion of the %redetermined overhead rate $ .00 (he direct0labor hours %er unit for the s%ecial order can be determined as follo2s: Manufacturing overhead a%%lied $"4.)0 E &redetermined overhead rate $2".00 = Direct labor0hours 1.)0 *onse'uentl6. the variable manufacturing overhead for the s%ecial order 2ould be: Variable %ortion of the %redetermined overhead rate $ .00 M Direct labor0hours 1.)0 = Variable manufacturing overhead $12.00 &utting this all together: !%ecial order %rice ........................................................... Variable costs: Direct materials ............................................................ Direct labor ................................................................... Variable manufacturing overhead ................................ (otal variable cost ........................................................... *ontribution margin ........................................................ M $nits ordered ................................................................ = (otal increase in %rofit from the s%ecial order ............. $#F.00 $2 .00 22.)0 12.00 #2.)0 $ #.)0 00 $).200

F". 8dam6an *o. manufactures and sells medals for 2inners of athletic and other events. 4ts manufacturing %lant has the ca%acit6 to %roduce 1).000 medals each monthN current monthl6 %roduction is 12.+)0 medals. (he com%an6 normall6 charges $120 %er medal. *ost data for the current level of %roduction are sho2n belo2: Variable costs: Direct materials ...................................... Direct labor ............................................. !elling and administrative ...................... Fixed costs: Manufacturing ........................................ !elling and administrative ...................... $#24.+)0 $"0#.000 $1)."00 $)0#.1+) $12".#+)

(he com%an6 has Kust received a s%ecial one0time order for +00 medals at $ " each. For this %articular order. no variable selling and administrative costs 2ould be incurred. (his order 2ould also have no effect on fixed costs. Je'uired: !hould the com%an6 acce%t this s%ecial order- Ch63evel: Medium 3B: 4 !ource: *M8. ada%ted 8ns2er: Bnl6 the direct materials and direct labor costs are relevant in this decision. (o ma9e the decision. 2e must com%ute the average direct materials and direct labor cost %er unit. Direct materials ............................................................... $#24.+)0 Direct labor ...................................................................... "0#.000 (otal ................................................................................. $F"0.+)0 *urrent monthl6 %roduction ............................................ 12.+)0 8verage direct materials and direct labor cost %er unit ... $+" !ince %rice on the s%ecial order is $ " %er medal and the relevant cost is onl6 $+". the com%an6 2ould earn a %rofit of $10 %er medal. (herefore. the s%ecial order should be acce%ted.

F4. 8lbertine *o. manufactures and sells tro%hies for 2inners of athletic and other events. 4ts manufacturing %lant has the ca%acit6 to %roduce 1#.000 tro%hies each monthN current monthl6 %roduction is 12. 00 tro%hies. (he com%an6 normall6 charges $11" %er tro%h6. *ost data for the current level of %roduction are sho2n belo2: Variable costs: Direct materials .......................... $#14.400 Direct labor ................................. $2)#.000 !elling and administrative .......... $"). 40 Fixed costs: Manufacturing ............................ $2F4.400 !elling and administrative .......... $F4.+20 (he com%an6 has Kust received a s%ecial one0time order for 1.200 tro%hies at $#1 each. For this %articular order. no variable selling and administrative costs 2ould be incurred. (his order 2ould also have no effect on fixed costs. Je'uired: !hould the com%an6 acce%t this s%ecial order- Ch63evel: Medium 3B: 4 !ource: *M8. ada%ted 8ns2er: Bnl6 the direct materials and direct labor costs are relevant in this decision. (o ma9e the decision. 2e must com%ute the average direct materials and direct labor cost %er unit. Direct materials ................................................................ $#14.400 Direct labor ....................................................................... 2)#.000 (otal .................................................................................. $ +0.400 *urrent monthl6 %roduction ............................................. 12. 00 8verage direct materials and direct labor cost %er unit .... $# !ince %rice on the s%ecial order is $#1 %er tro%h6 and the relevant cost is $ # . the com%an6 2ould suffer a loss of $+ %er tro%h6. (herefore. the s%ecial order should not be acce%ted.