Question

11-30 Relevant Cost Exercises Each of the following situations is independent:
a. Make or Buy Terry Inc. manufactures machine parts for aircraft engines. CEO Bucky Walters
is considering an offer from a subcontractor to provide 2,000 units of product OP89 for $120,000.
If Terry does not purchase these parts from the subcontractor, it must continue to produce them
in-house with these costs:

Cost per Unit
Direct materials $28
Direct labor 18
Variable overhead 16
Allocated fixed overhead 4

Required
1. What is the relevant cost (per unit, rounded to 2 decimal places) to make the product internally?
2. What is the estimated increase or decrease in short-term operating profit of producing the product
internally versus purchasing the product from a supplier? (Round your answer to nearest whole dollar.)
3. What strategic considerations likely bear on this make-vs.-buy decision?

b. Disposal of Assets A company has an inventory of 2,000 different parts for a line of cars that
has been discontinued. The net book value (NBV) of this inventory is $50,000. The parts can be
either re-machined at a total additional cost of $25,000 and then sold for $30,000, or the parts can
be sold as-is for $2,500.
Required What should the company do? Include both financial and strategic considerations.

c. Asset Replacement An uninsured boat costing $90,000 was wrecked the first day it was used.
It can be either sold as-is for $9,000 cash and replaced with a similar boat costing $92,000 or
rebuilt for $75,000 and be brand new as far as operating characteristics and looks are concerned.

Required What should be done? Include a consideration of both financial and strategic factors.

d. Profit from Processing Further Deaton Corporation manufactures products A, B, and C from
a joint process. Joint costs are allocated on the basis of relative sales value of the products at the
split-off point. Additional information for Deaton Corporation follows:

A B C Total
Units produced 12,000 8,000 4,000 24,000
Joint costs $144,000 $ 60,000 $36,000 $240,000
Sales value before additional processing 240,000 100,000 60,000 . 400,000
Additional costs for further processing 28,000 20,000 12,000 60,000
Sales value if processed further 280,000 120,000 . 70,000 470,000
Final PDF to printer

Required
1. Define the following terms: joint production process, joint production costs, separable processing costs,
and split-off point.
2. What is the impact on short-term operating income of processing each of the three products (A, B,
and C) beyond the split-off point? Round each answer to nearest whole dollar.
3. Why do accountants allocate joint/common costs to individual products in a joint manufacturing process?

e. Make vs. Buy (Sourcing Decision) Eggers Company needs 20,000 units of a part to use in
producing one of its products. If Eggers buys the part from McMillan Company for $90 instead
of making it, Eggers will not use the released facilities in another manufacturing activity.
Forty percent of the fixed overhead will continue irrespective of CEO Donald Mickey’s decision.
The cost data are as follows:

Cost to make the part:
Direct materials $35
Direct labor 16
Variable overhead 24
Fixed overhead . 20
$95

Required
1. Determine which alternative is more attractive to Eggers, and by what amount.
2. What strategic factors might bear upon the ultimate decision?

f. Short-Term Product-Mix Decision DVD Production Company produces two basic types of
video games, Flash and Clash. Pertinent data for DVD Production Company follow:

*Based on direct labor hours: 4 direct labor hours (DLHs) per unit of Flash and 2 DLHs per
unit of Clash.

Flash Clash
Sales price $250 $140
Costs
Direct materials 50 . 25
Direct labor (@ $25/hr.) 100 50
Variable factory overhead* 50 25
Fixed factory overhead* 20 10
Marketing costs (all fixed) 10 10
Total costs $230 $120
Operating profit $ 20 $ 20

The DVD game craze is at its height so that either Flash or Clash alone can be sold to keep the plant
operating at full capacity. However, labor capacity in the plant is insufficient to meet the combined
demand for both games. Flash and Clash are processed through the same production departments.
Required
1. What is the meaning and importance of the statement that “Flash and Clash are processed through the
same production departments”?
2. Which of the two products should be produced? Briefly explain your answer.

g. Special-Order Pricing Barry’s Bar-B-Que is a popular lunch time spot. Barry is conscientious
about the quality of his meals, and he has a regular crowd of 600 patrons for his $5 lunch. His variable
cost for each meal is about $2, and he figures his fixed costs, on a daily basis, are about $1,200. From
time to time, bus-tour groups with 50 patrons stop by. He has welcomed them because he has capacity
to seat 700 diners in the average lunch period, and his cooking and wait staff can easily handle the
additional load. The tour operator generally pays for the entire group on a single check to save the wait
staff and cashier the additional time. Due to competitive conditions in the tour business, the operator
is now asking Barry to lower the price to $3.50 per meal for each of the 50 bus-tour members.
Required
1. What is the incremental profit (loss) per bus-tour meal? Should Barry accept the bus-tour offer?
2. What if the tour company were willing to guarantee 200 patrons (or four bus loads) at least once a month
for $3.00 per meal? What is the incremental profit (loss) for each meal? Is the offer financially attractive?

Answer 1

Part 1: relevant cost Relevant costs are costs that are incurred to make a product. Variable costs are relevant costs as they can be avoided by not producing the product However fixed costs are sunk costswhich should not be considered for decision making process. Fixed costs are irrelevant costs except avoidable fixed costs In the current scenario, let us assume allocated fixed costs are unavoidable fixed costs.Therefore they are irrelevant costs. Relevant cost per unit Direct materials Direct labor Variable overhead Cost per unit Amount $28.00 $18.00 $16.00 $62.00 part 2: Internal production versus purchasing option Total costs to produce OP89 in-house = ($28 + $18 + $16)/unit x 2,000 units = $124,000 Total costs to purchase the units from subcontractor = $120,000 Saving $124,000 $120,000 S4,000 By producing internally Terry Inc. incur a loss of S4,000 per 2000units.

Part 3 : Strategic considerations bear on make or buy decision If Terry inc. outsource to save costs, then it may loose skilled employees and results unemployment. Outsourcing may also create higher chance of design leakage and cost information leakage. So, Terry should consider any other alternatives to use available capacity. Other factors to be considered by Terry are reliability, quality,capacity utilization of subcontractor, financial condition