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Cost Management Measuring, Monitoring and Motivating Performance 2nd Edition By Susan K. Wolcott – Test Bank
Chapter 2: The Cost Function
Learning Objective | True / False | Multiple Choice | Matching | Exercises | Short Answer | Problems |
1: What are different ways to describe cost behavior? | 1-5 | 1-14, 60-66
S: 75-83 |
1, 2 | 6-9,13 | 1, 6 | 2, 3, 6, 8, 9 |
2: What process is used to estimate future costs? | 6-10, | 15-22 | 4, 6, 8, 9, 10 | |||
3: How are engineered estimates, account analysis, and two-point methods used to estimate cost functions? | 11-14 | 23-31, 33, 34, 38, 39, 59
W: 104 |
1-5, 7, 8 10 | 4, 11 | 3, 5 | |
4: How does a scatter plot assist with categorizing a cost? | 15,16 | 35-37, 40
W: 94 |
7 | |||
5: How is regression analysis used to estimate a mixed cost function? | 17-19 | 32, 43-56
S: 86-90 W: 95, 96 |
3 | 11, 14 | 4, 11 | 1, 2, 6, 7 |
6: How are cost estimates used in decision making? | 21-23 | 41, 42, 57, 58
W: 105 |
2, 4, 10-13, 15 | 2-5, 8-10 | 1-9 |
S: Questions from the study guide
W: Questions from web quizzes on the student web site
Level of Complexity* | True / False | Multiple Choice | Matching | Exercises | Short Answer | Problems |
Foundation: Repeat or paraphrase information; Reason to single correct solution; Perform computations; etc. | All | All | All | 1-12, 13 | 1-8, 11 | 1-7, 9 |
Step 1: Identify the problem, relevant information, and uncertainties | 4, 10-13, 15 | 3, 4, 9, 10 | 1-4, 7-9 | |||
Step 2: Explore interpretations and connections | 8 | 1, 5, 6, 8 | ||||
Step 3: Prioritize alternatives and implement conclusions | ||||||
Step 4: Envision and direct strategic innovation |
*Based on level in Steps for Better Thinking (Exhibit 1.10, textbook p. 16):
Note: Step 1, 2, 3, and 4 questions in this test bank are intentionally open-ended and subjective, giving students the opportunity to demonstrate skills such as judgment, reasoning, identification of uncertainties, identification or analysis of pros and cons, and so on. Therefore, student answers may not exactly match those shown in the solutions.
True / False
- Steel used in the production of automobiles would generally be classified as a direct cost.
- Traceability can be used as a criterion to differentiate direct and indirect costs.
- Textbook costs are an opportunity cost of earning a college degree.
- Salaries and wages you could earn while in college constitute a sunk cost.
- Learning curves lead to greater productivity over time.
- Past costs are irrelevant for both decision making and predicting future costs.
- Past costs are relevant for decision making, but irrelevant for predicting future costs.
- Past costs are irrelevant for decision making, but may be relevant for predicting future costs.
- The first step in estimating a cost function for relevant costs is to select a cost estimation technique.
- Categorizing costs by their behavior is one step in estimating relevant costs for a cost object.
- Managers should be trained in engineering to calculate an engineered cost estimate.
- Reviewing the pattern of a cost over time is a critical step in determining an engineered cost estimate.
- The high-low method is a specific application of the two-point method of cost estimation.
- The high-low method frequently distorts a cost function because it uses too many data points to make an estimate.
- A scatter plot provides helpful information about the relationship between a cost and a potential cost driver.
- Preparing a scatter plot is a requirement before applying the two-point method of cost estimation.
- Regression analysis is classified as simple or multiple depending upon the number of dependent variables to be estimated.
- Simple regression analysis produces an equation of the form: Y = a + bX + e.
- In regression analysis, the Adjusted R-square statistic is used to evaluate how well the cost driver explains the behavior in the cost.
- Uncertainties and information quality are evaluated when determining relevant costs, then not considered again.
- Estimates of future costs are most useful in long term budgeting.
- Regression analysis usually provides a higher quality cost function than the high-low method.
- Changes in cost behavior over time are one source of uncertainty in estimating future costs.
Multiple Choice
- When the cost object is a unit produced, lubricating oil for production machines would be a(n)
- Direct cost
- Indirect cost
- Sunk cost
- Opportunity cost
- When the cost object is a unit produced, straight-line depreciation on manufacturing equipment would be a
Variable Cost Fixed Cost Direct Cost
- No Yes No
- Yes No No
- Yes No Yes
- Yes No Yes
- Fixed costs per unit
- Vary inversely with changes in volume
- Change regardless of changes in volume
- Will not change over the relevant range
- Increase with an increase in volume
- Mixed costs
- Consist of fixed and variable costs
- Are constant in total
- Consist of the variable portion of all costs
- Have a constant per-unit value
- Mixed costs
- Vary with production in direct proportion to volume
- Vary with production but not in direct proportion to volume
- Do not vary with production
- Include only different types of fixed costs
- The relevant range is defined as
- The period of time over which costs do not change
- The volume of production over which the cost assumptions hold
- The volume of production over which step-wise fixed costs increase
- The time period in which the level of production does not change
- Which of the follow is not an assumption when estimating a cost function over the relevant range of activity?
- Mixed costs will change in total
- Mixed costs will change per unit
- Variable costs will be constant in total
- Fixed costs will be constant in total.
Use the following data for the next 6 questions:
Janice’s Kennel and Pet Spa is located in a small town in central California. The company employs three pet attendants, four pet groomers and two front office staff who book appointments and keep records. The spa provides a range of services for dogs and cats including boarding, grooming, and obedience training. The grooming area includes a small retail section that carries dog and cat food, pet supplies, and toys.
- If the cost object is cost per day of boarding, which of the following is a direct cost?
- Pet food
- Front office staff salaries
- Grooming supplies
- Depreciation on shelving and equipment used in the grooming and retail area
- If the cost object is the total cost of the grooming product line, which of the following is an indirect cost?
- Front office staff salaries
- Labor cost of employees who groom pets
- Cost of grooming supplies
- Depreciation on grooming tables
- Which of the following is a sunk cost for any cost object related to Janice’s Kennel and Pet Spa?
- Cost of the automobile Janice is planning to buy for pet transportation
- Cost of existing computer equipment used to keep company records
- Cost of annual wages for full-time employees
- Cost of rent for the next period
- Assume Janice’s Kennel and Pet Spa is currently boarding ten pets. The cost of food to board one more pet is best described as a
- Fixed cost
- Marginal cost
- Sunk cost
- Mixed cost
- Which of the following is the best example of a discretionary cost for Janice’s Kennel and Pet Spa?
- Pet food
- Facility rent
- Wages of pet groomers
- Professional travel for Janice
- Janice’s relevant range of activity would best be measured in terms of:
- The number of staff she employs
- The number of pets she services
- The maximum amount of pet food she can buy each month based on the current budget
- The number of parking spaces available in the parking lot
- Discretionary costs reflect
- The costs that managers incur to purchase new production machines when the old machines need replacing
- Decisions about the maximum amount that will be spent next period for activities such as travel and marketing
- Decisions about the amount of variable costs that will be incurred next period
- The costs that managers incur to pay overtime when production levels are high
- Which of the following statements is true?
- Past costs are always relevant for decisions and are often useful in estimating future cost behavior
- Past costs are always relevant for decisions, but are rarely useful in estimating future cost behavior
- Past costs are never relevant for decisions, nor are they useful in estimating future cost behavior
- Past costs are never relevant for decisions, but are often useful in estimating future cost behavior
- The best source for determining historical costs is usually
- The Internet
- Interviews with managers
- The company’s accounting information system
- Financial statements
- Which of the following statements is false?
- Information for some costs cannot easily be obtained from the accounting information system.
- Useful cost information is rarely available from the accounting information system.
- The accounting system design affects the availability of useful cost information.
- The nature of cost information affects its usefulness for decision making.
- In most accounting information systems, costs are often recorded and coded so they can be summarized based on different
- Cost drivers
- Cost objects
- Volumes of activity
- Independent variables
- Past cost information, although accurate in predicting future costs, may be
- Unavailable
- Irrelevant
III. Outdated
- I and II only
- II and III only
- II only
- I, II, and III
- Managers go through a series of questions to decide whether to use past costs to estimate future costs. Which of the following questions is least likely to be one of them?
- Is the cost relevant to the decision?
- Is the cost highly discretionary?
- Is the cost an engineered estimate?
- Is the cost expected to change?
- Estimating a cost function using past cost data to help determine future costs is useful if
- Past costs are irrelevant and highly discretionary
- Past costs are irrelevant and not discretionary
- Past costs are relevant and highly discretionary
- Past costs are relevant and not discretionary
- After estimating a past cost function, managers
- May need to update it for future changes.
- Have all of the information they need to predict future costs
III. May or may not use it to estimate future costs.
- I only
- II only
- II and III only
- I and III only
Use the following data for the next 3 questions.
Liva Company wants to develop a cost function for its maintenance costs to estimate such costs for the coming year. The following data are available:
Direct Maintenance
Month Labor Hours Costs Incurred
January 4,000 $ 900
February 6,500 1,325
March 7,000 1,500
April 5,500 1,150
- Using the high-low method, what is the variable maintenance cost per direct labor hour?
- $1.00
- $0.10
- $0.20
- $1.50
- Using the high-low method, what is the fixed maintenance cost?
- $500
- $300
- $200
- $100
- Using the high-low method, what is the cost function for maintenance costs?
- $500 + $1.00 per direct labor hour
- $300 + $1.50 per direct labor hour
- $100 + $0.20 per direct labor hour
- $200 + $0.10 per direct labor hour
- The major disadvantage of the high-low method is that
- It uses the two most extreme data points in determining a cost function
- It is difficult to calculate
- It is difficult to understand
- It involves more judgmental factors than do other methods
Use the following data for the next 3 questions.
Cosby Company is attempting to develop the cost function for repair costs. The following past data are available:
Machine Hours Repair Costs
4,800 $6,385
3,400 4,585
4,000 5,285
5,900 7,085
- Using the high-low method, what is the variable repair cost per machine hour?
- $0.15
- $1.00
- $4.00
- $5.00
- Using the high-low method, what is the fixed repair cost?
- $1,185
- $850
- $475
- $565
- Using the high-low method, what is the estimated repair cost for 4,500 machine hours?
- $5,785
- $5,585
- $5,685
- $5,985
Use the following data for the next 2 questions.
Milano Company has an average overhead cost per hour of $10.50 at 3,500 machine hours, and at 3,000 hours it is $11.25. The company managers wish to estimate the overhead cost function.
- What is the variable overhead cost per machine hour?
- $1.00
- $2.00
- $6.00
- $8.00
- What is the fixed overhead cost?
- $15,750
- $36,750
- $21,000
- $18,000
- Assuming that a cost is mixed and linear, and that past cost behavior is expected to continue into the future, which of the following is mostly likely the best technique for estimating future costs?
- Engineered estimate of cost
- Two-point method
- Scatter plot
- Regression analysis
- Managers analyze production activities and assign costs based on the estimated amount of resources used when they use this method.
- A scatter plot
- The high-low method
- Regression analysis
- Engineered estimate of cost
- Reviewing cost behavior patterns over time from the accounting records and using that review to predict future costs best describes
- Regression analysis
- Scatter plots
- Analysis at the account level
- Two-point methods
- Which of the following techniques relies on visual analysis?
- Scatter plots
- Analysis at the account level
- High-low method
- Engineered estimate of cost
- A scatter plot is especially useful when managers wish to
- Compute a cost function
- Update a past cost function for future changes
- Study the relationship between a cost and a potential cost driver
- Analyze cost behavior when only one period of data is available
- The trend line from a scatter plot can be used to identify data points for
- The two-point method
- Analysis at the account level
- Engineered estimate of cost
- Regression analysis
- The high-low method is a specific application of this method of cost estimation
- Two-point
- Scatter plot
- Engineered estimate of cost
- Analysis at the account level
- Which of the following is the most valid criticism of the high-low method?
- It never produces accurate results
- It is mathematically too complex for most managers to comprehend
- It is a specialized case of the two-point method
- Data points might be outside the normal range of activity
- A manager might use this method to create a graph of cost behavior without any statistical techniques
- Engineered estimate of cost
- High-low method
- Scatter plot
- Regression analysis
- Which of the following cost estimation techniques makes assumptions about the data being analyzed?
- Analysis at the account level
- Two-point method
III. Regression analysis
- I only
- I and II only
- II and III only
- I, II, and III
- Which cost estimation technique is useful in all situations?
- Analysis at the account level
- Regression analysis
- Two-point method
- No one method is useful in all situations
- An organization’s accountant is estimating next period’s total overhead costs. She performed two regression analyses, one based on direct labor hours and the other based upon machine hours. The results were:
Total overhead = $150,000 + $4 x direct labor hours
Adjusted R-square = 0.65
Total overhead = $130,000 + $5 x machine hours
Adjusted R-square = 0.77
For the next period the accountant anticipates using 28,000 direct labor hours and 26,000 machine hours. Based upon this information, what is the best estimate for overhead for the next period?
- $262,000
- $260,000
- $254,000
- $270,000
- (Appendix 2A) Which of the following is not an assumption of linear regression analysis
- The error terms have a constant variance
- The error terms are independent
- A linear relationship exists between the dependent and independent variables
- There is a cause and effect relationship between the dependent and independent variables
- Which of the following are forms of regression analysis?
- Quantitative and qualitative
- Fixed and variable
- Simple and multiple
- Financial and managerial
- Simple regression analysis differs from multiple regression analysis based on the number of
- Cost drivers used
- Costs predicted
- Data points incorporated
- Personnel analyzing the data
- Simple regression minimizes the distance from each data point to
- A trend line
- The y-intercept
- The error term
- The x-axis
- Which of the following is an alternative name for a cost driver in a regression analysis?
- Dependent variable
- Independent variable
- Beta
- Error term
- Which of the following is an alternative name for the cost being predicted in a regression analysis?
- Dependent variable
- Independent variable
- Beta
- Slope
- Regression analysis works best when the relationship between costs and cost drivers is
- Positive and linear
- Linear and direct
- Positive and indirect
- Positive, linear, and indirect
- In a regression equation, fixed costs are represented by the
- Slope
- Intercept
- Error term
- Adjusted R-square coefficient
- In a regression equation, variable costs are represented by the
- Slope
- Intercept
- Adjusted R-square coefficient
- t-statistic
Use the following graphs for the next 2 questions.
- Which graph shows data that are more suitable for regression analysis?
- Graph A
- Graph B
- Neither Graph A nor Graph B
- Cannot be determined
- Simple regression analysis output produces a variety of information and statistics. Which of the following statistics provides information for fixed costs?
- T-statistic and p-value for the alpha coefficient
- T-statistics for alpha and beta coefficients
- Adjusted R-square
- P-values for alpha and beta coefficients
- Simple regression analysis output produces a variety of statistics. Which of the following statistics provides information for variable costs?
- Adjusted R-square
- P-values for alpha and beta coefficients
- T-statistic and p-value for the beta coefficient
- T-statistics for alpha and beta coefficients
- Simple regression analysis output produces a variety of statistics. Which of the following statistics best summarizes how well the cost driver explains the behavior of the cost?
- T-statistics for alpha and beta coefficients
- T-statistic and p-value for the alpha coefficient
- P-values for alpha and beta coefficients
- Adjusted R-square
- When estimating future costs, information quality is higher when
- Costs must be allocated
- The accounting system can trace relevant costs to a cost object
- The regression Adjusted R-square is near zero
- Most costs are fixed, rather than variable
- Past cost information might be too unreliable for future cost estimation because
- An organization has been operating too long in a stable environment
- The costs are primarily mixed
- A company has added a new product line
- Managers expect no changes in the cost function
- This method of estimating future costs can be used when only one period of data is available.
- Scatter plot
- High-low method
- Analysis at the account level
- Regression analysis
More Difficult Multiple Choice
These multiple choice questions require more complex computations or present information differently than in the textbook.
Use the following information for the next 3 questions.
Consider the following cost data for the cost object, number of machine setups. Each set of costs (A, B, and C) is from a different type of manufacturing operation and represents the cost behavior for the cost of that company’s machine setups.
Number of
Machine Setups Cost A Cost B Cost C
0 $ 0 $80 $ 5
10 20 79 37
20 40 82 66
30 60 78 91
40 80 81 123
50 100 79 154
- Cost A is best described as
- Fixed
- Variable
- Mixed
- Direct
- Cost B is best described as
- Fixed
- Variable
- Mixed
- Discretionary
- Cost C is best described as
- Fixed
- Variable
- Mixed
- Indirect
Use the following information for the next 3 questions.
Three different divisions of a toy manufacturing company are estimating costs for their human resources departments. Each division has a cost structure that is different from the other divisions’ and those structures are represented by the following cost behavior patterns (A, B, and C).
Number of
Employees Cost A Cost B Cost C
0 $ 0 $120 $118
25 50 118 180
50 100 123 245
75 125 124 296
100 200 119 360
- Which cost is best described as fixed?
- Cost A
- Cost B
- Cost C
- Cost B and Cost C
- Which cost is best described as variable?
- Cost A
- Cost B
- Cost C
- Cost A and Cost C
- Which cost is best described as mixed?
- Cost A
- Cost B
- Cost C
- Cost B and Cost C
- A firm has the capacity to produce 3,100 units per week. At 80% capacity, the average total cost per unit is $12.50 and the average variable cost per unit is $7.50. What is the total fixed cost per week, assuming the firm is still operating within its relevant range?
- $10,400
- $14,400
- $ 8,400
- $12,400
Multiple Choice from Study Guide
^{s}75. Fixed costs
- Do not vary in total within the relevant range
- Do not vary on a per-unit basis within the relevant range
- Vary on a per-unit basis in direct proportion to changes in the cost driver within the relevant range
- Vary in total as the cost driver changes within the relevant range
^{s}76. Variable costs
- Do not vary in total within the relevant range
- Do not vary on a per-unit basis within the relevant range
- Vary on a per-unit basis within the relevant range
- Both (a) and (c)
^{s}77. Which of the following could be defined as a cost object?
- A single unit of product in a manufacturing process
- A batch of products in a manufacturing process
- A business process, such as managing accounts receivable
- All of the above
^{s}78. Which of the following statements is false?
- A cost can be defined as a direct cost if the bookkeeping system can keep track of how much of the cost was consumed by the cost object
- Whether a cost is direct or indirect cannot be determined until the cost object has been defined
- If the cost object is a batch of 1000 units of production, then factory property taxes could be a direct cost if the bookkeeping system is detailed enough
- Some indirect costs might have been considered direct costs if a company had better technology for capturing information
^{s}79. The total cost of salaries of production supervisors, where 2 supervisors are needed for each 8-hour shift, where the relevant range is 0 units to the number of units that can be produced at full capacity using 2 8-hour shifts is a
- Fixed cost
- Variable cost
- Mixed cost
- Stepwise linear cost
^{s}80. The total cost of materials, where the supplier charges $9/lb if 0-1000 pounds are purchased, $8/lb if 1001-2000 pounds are purchased and $7 if 2001 or more pounds are purchased, is a
- Fixed cost
- Variable cost
- Mixed cost
- Stepwise linear cost
^{s}81. The rent on a store, where the landlord charges $1,200 per month plus a percentage of sales revenue, is a
- Fixed cost
- Variable cost
- Mixed cost
- Stepwise linear cost
^{s}82. The depreciation on a factory machine is a
- Fixed cost
- Variable cost
- Mixed cost
- Stepwise linear cost
^{s}83. Which of the following statements is true?
- Opportunity costs are never relevant for decision making
- Discretionary costs are never relevant for decision making
- Marginal costs are never relevant for decision making
- Sunk costs are never relevant for decision making
^{s}84. If firm A has a learning curve with 90% learning and firm B has a learning curve with 80% learning, then
- Firm A has more experienced workers
- Firm B will be more cost efficient over time
- Firm A workers learn more quickly
- Firm B has less experienced workers
^{s}85. A firm’s production is expected to show an 85% learning rate. The first unit took 200 hours to produce. The second unit will take
- 170 hours
- 140 hours
- 200 hours
- 289 hours
^{s}86. A high adjusted R-square for the regression of a cost against a cost driver indicates
- The predicted linear relationship between the cost and the cost driver is probably correct
- The relationship between the cost and the cost driver is probably linear
- The cost driver explains a high percentage of the variation of the cost
- The cost driver is statistically significant
^{s}87. A p-value of 1% for the intercept term in a regression of a cost driver against a cost indicates
- The true fixed costs are statistically significantly different from zero
- There is only a 1% chance the true fixed costs are zero
- The variable costs are immaterial in this cost function
- Both (a) and (b)
^{s}88. A p-value of 89% for the slope coefficient in a regression of a cost driver against a cost indicates
- The true variable costs are statistically significantly different from zero
- There is only an 11% chance the true variable costs are zero
- The relationship between the cost and the cost driver is nonlinear
- None of the above
^{s}89. The difference between simple regression and multiple regression is that
- Simple regression is easier to perform in Excel than multiple regression
- Simple regression is only performed once when estimating a cost function, whereas multiple regression is performed more than once
- Simple regression uses only one cost driver, whereas multiple regression uses more than one cost driver
- Simple regression is for estimating only one cost, and multiple regression is for estimating more than one cost
^{s}90. A regression of total selling expenses against number of units sold yields an intercept of 178,024 and a slope of 12.3. This indicates that
- Total fixed selling expenses are predicted to be $178,024.
- Variable selling expenses are predicted to be $12.30/unit.
- Total selling expenses are predicted to be $190,324 when 1000 units are sold
- All of the above
Multiple Choice from Web Quizzes (Available on Student Web Site)
^{w}91. If we are determining costs for a particular case at a law office, the cost of rent for the office would be
- A direct cost
- An indirect cost
- A mixed cost
- An irrelevant cost
^{w}92. If we want to estimate the cost of lumber for manufacturing chairs, the cost function most likely reflects
- Only a variable cost
- Only a fixed cost
- A mixed cost
- An irrelevant cost
^{w}93. Which one of following is not a reason to take into account the relevant range when estimating a cost?
- The cost function is nearly linear within a relevant range
- It is reasonable to assume that fixed costs remaining fixed in this range
- It is reasonable to assume that variable costs remain constant in this range
- We cannot make assumptions about linearity within a relevant range
^{w}94. If you create a scatter plot of a cost against a cost driver
- You gain information about whether there is a seeming relation between the cost and cost driver
- For all costs, you will have completed your analysis
- You gain no new information about the relationship between the cost and cost driver
- You will not need to perform regression analysis to estimate the cost function
^{w}95. In a regression analysis for estimating a cost function, t-statistics and their p-values do not provide information about
- Whether the cost and cost drivers are related
- How confident we can be that the intercept or slope coefficients are different from zero
- The amount of variation in cost that is explained by variation in the cost driver
- Whether the cost is totally fixed, totally variable, or mixed
^{w}96. In a regression analysis for estimating a cost function, the adjusted R-Square statistic provides information about
- The amount of variation in cost that is explained by variation in the cost driver
- The size of the slope coefficient
- Whether the cost is a fixed, variable, or mixed cost
- How confident we can be that the intercept or slope coefficients are different from zero
^{w}97. Marginal cost is
- The average cost per unit
- The incremental cost of the next unit
- Not relevant for decision making
- Constant even if the relevant range changes
^{w}98. All of the following are true about average cost per unit except
- Average cost equals variable cost per unit plus average fixed cost per unit
- Average costs are used in financial statements
- Average costs are usually irrelevant for decision making because they include a portion of fixed cost
- Average costs are usually good estimates of future costs
^{w}99. Opportunity costs are
- Benefits foregone from one project because another project is chosen
- Irrelevant
- The same as sunk costs
- Easy to value
^{w}100. Sunk costs are
- The same as opportunity costs
- Expenditures made in the past
- Relevant to decisions
- Difficult to value
^{w}101. Direct costs are
- Costs that need to be assigned but cannot be traced easily to cost objects
- Only variable costs
- Costs that can easily be traced to cost objects
- Only fixed costs
^{w}102. Indirect costs are
- Costs that need to be assigned but cannot easily be traced to cost objects
- Only variable costs
- Costs that can easily be traced to cost objects
- Only fixed costs
^{w}103. All of the following are examples of variable costs except
- The cost of tires if the cost object is the number of automobiles produced
- Professional labor cost when the cost object is the audit of a business
- The cost for wood in a baseball bat manufacturing company if the cost object is bats produced
- The cost to lease a manufacturing plant if the cost object is the product manufactured
^{w}104. All of the following are true about analysis at the account level except
- It is a method for separating fixed and variable costs
- It uses information from the general ledger
- It is a qualitative method for separating costs
- It requires very little judgment to determine cost behavior
^{w}105. All of the following are assumptions for developing and using a cost linear function except
- Past costs rarely need updating to be good predictors of future costs
- Operations are within the relevant range
- Variable costs remain constant within the relevant range
- Fixed costs remain fixed within the relevant range
^{w}106. The relevant range in cost accounting is the range over which
- Costs may fluctuate
- Cost relationships are valid
- Production may vary
- Relevant costs are incurred
^{w}107. (CMA) Cost drivers are
- Activities that cause costs to increase as the activity increases
- Accounting techniques used to control costs
- Accounting measurements used to evaluate whether or not performance is proceeding according to plan
- A mechanical basis, such as machine hours, computers time, size of equipment, or square footage used to assign costs to activities.
Matching
- ABC Manufacturing wants to determine whether its various product costs are direct or indirect, and variable or fixed. This information will be used to determine product unit costs. All employees are guaranteed a 40 hour work-week except factory employees, who are paid an hourly wage and can be sent home when there is no work. The following classification scheme has been developed:
- Direct variable cost
- Indirect variable cost
- Direct fixed cost
- Indirect fixed cost
Using the categories shown above, indicate how each of the following costs should be classified if the cost object is a single unit of product:
____ 1. Labor in the maintenance department
____ 2. Glue and tacks used in production
____ 3. Lubricating oil for production machines
____ 4. Salary of the plant accountant
____ 5. Oil used for monthly preventive maintenance on production machines
____ 6. Insurance on the plant machinery
____ 7. Hourly factory wages
____ 8. Wages in the materials receiving and handling department
____ 9. Taxes on plant equipment
____ 10. Shipping costs for direct materials
- Various terms are listed in the right-hand column below; several definitions are listed on the left. Match the appropriate term with each definition. Some of the lettered terms may be used more than once, while others may not be used at all. Each numbered definition has only one best response.
____ 1. A thing or activity for which managers measure costs
____ 2. Input or activity that causes changes in costs ____ 3. Analysis at the account level ____ 4. Cost incurred in the past ____ 5. Easily traced to individual cost objects ____ 6. Has a cause-and-effect relationship with costs ____ 7. Often estimated based on a budget established by management ____ 8. Often increase in a stepwise manner ____ 9. Benefits of the next best alternative that we forego when we make a decisions ____ 10. Represented mathematically as ____ 11. Scatter plots ____ 12. Span of activity for which cost behavior can be reliably predicted |
A. Cost driver
B. Cost estimation method C. Cost object D. Direct cost E. Fixed cost F. Indirect cost G. Opportunity cost H. Mixed cost I. Discretionary cost J. R-square statistic K. Relevant range L. Sunk cost |
- The steps for using regression analysis to estimate a cost function are listed below in random order. Correctly number the steps from 1 to 8.
____ Write the cost function.
____ Plot the cost for each potential cost driver.
____ Perform the regression analysis.
____ Generate a list of possible cost drivers.
____ Gather cost and cost driver data.
____ Evaluate the sign and significance of the cost function’s components.
____ Discard potential cost drivers that fail to explain a high proportion of variability in the cost.
____ Consider the behavior of the cost.
Exercises
- The average cost of producing 200 units is $82 for Alpha Company. If production increases by 300 units, the average cost falls to $61.
- What is the variable cost per unit?
- What is the fixed cost?
- What is the average cost of producing 250 units?
- Total fixed costs are $20,000 per month and last month total variable costs were $7,000 when total revenue was $28,000.
- Write the algebraic expression for this flexible budget for total cost.
- What assumptions are made for a linear cost function like this?
- The average cost to produce 10,000 units is $88.00, and the average cost to produce 15,000 units is $84.00.
- Develop a cost function for this cost.
- Estimate the average cost to produce 18,000 units.
- Total fixed costs are $25,000 per year. The variable cost per unit is $10.00 per unit up to 5,000 units per year and $7.50 per unit thereafter.
- Develop a cost function for this cost.
- What could cause the change in variable costs shown above? Explain
- List three assumptions that are made when developing these types of cost functions and give one reason that each assumption might not hold
- Strawser Company is developing a cost function for its maintenance costs using the high-low method. The following data have been collected for the past year:
Direct Labor Maintenance
Quarter Hours Costs Incurred
1 5,000 $ 745
2 6,500 820
3 7,000 850
4 8,000 1,000
Calculate the following amounts:
- The variable cost per direct labor hour
- The fixed cost
- The estimated total cost for 9,000 direct labor hours
- The estimated total cost for 6,000 direct labor hours
- Chabu’s managerial accountant, Yi-Fan, is classifying the company’s costs according to their behavior to prepare next year’s budget. Therefore, the cost object is the entire company. Chabu produces and sells aluminum beverage cans, such as those used for soft drinks. You may find the following facts about Chabu’s operation useful in responding to this problem:
- Production machines must be cleaned monthly, regardless of the amount of use.
- The more cans produced, the more lubrication is needed.
- Chabu’s monthly production and sales volume is usually at least 1,000 cans, but can be as much as 5,000 cans depending on demand.
- Material handling costs include depreciation on equipment and fuel for loaders.
- Cans are packaged into 100-unit groups prior to sale.
- Research and development costs vary between $10,000 and $10,500 per month
- The factory maintenance costs vary between $6,000 and $6,500 monthly.
- Chabu’s staff level is constant at 25 people, who are all paid salaries.
- Raw materials are purchased based on expected production levels.
- Sales commissions (based on a per-case amount) are included in marketing department costs.
Yi-Fan has classified the costs into three categories: fixed, variable, and mixed.
Place an X in the appropriate column of the table below to indicate the most likely behavior of each cost:
Fixed | Variable | Mixed | |
Oil to lubricate the machines | |||
Salary of the plant manager | |||
Annual subscription to a trade journal | |||
Vacation pay for salaried production employees | |||
Packaging materials | |||
Research and development | |||
Raw materials | |||
Material handling costs | |||
Marketing department costs | |||
Factory maintenance |
- The following data were obtained from the accounting information system of POC Corporation:
Production
Units Raw Materials Factory Manager
Month Produced Used Supplies Salary
January 60 $1,560 $550 $3,000
February 80 2,000 700 3,000
March 50 1,300 475 3,000
April 30 775 325 3,000
- Describe the behavior of each of the costs shown above as fixed, variable or mixed. You may wish to draw scatter plots or analyze the cost using your knowledge of costs and the actual variation in cost pattern from above (in other words, perform an informal analysis at the account level).
- Use the data for February and March and the two-point method to determine a cost function for any mixed cost(s).
- Use the high-low method to determine a cost function for any mixed cost(s).
- Consider the pairs of data presented below for 3 costs of USM Corporation:
Cost Driver A Cost A Cost Driver B Cost B Cost Driver C Cost C
0 1,200 0 0 0 600
80 1,380 130 1,735 110 890
175 1,495 130 1,735 209 1,200
244 1,475 314 5,488 325 1,500
377 1,390 422 6,987 457 1,700
462 1,500 507 8,723 560 2,000
- Using scatter plots or other informal methods such as studying the variation in cost compared to the variation in cost driver, describe the behavior of each cost.
- For each cost that you described above, give one example of a cost that would behave similarly. For variable and mixed costs, also identify the cost driver.
- (Appendix 2B) The managers of Web Design Services Company hired three recent college graduates. When they began preparing simple web pages, it took about ten hours to complete the first page. The supervisor believes a 90% learning rate is typical for this type of work. Note: ln(90%) / ln(2) = –0.152.
- Estimate the cumulative average time per page to prepare six web pages.
- Estimate the total time to prepare ten web pages.
- Stacy Kuh, the manager of the Ice Cream Igloo, has been told that to earn a reasonable profit she should price her products at 200% of the cost of ingredients. Ms. Kuh has gathered the following data on the cost of ingredients used to make a banana split.
- The distributor charges $12.00 for a dozen bananas; each banana split uses one banana.
- Ice cream costs $3.20 per gallon; each banana split uses two cups of ice cream.
- One gallon of ice cream equals thirty-two cups of ice cream.
- Stacy makes her own fruit toppings at a cost of $0.25 per tablespoon; each banana split uses six tablespoons of fruit toppings.
- Each banana split uses three tablespoons of premium chocolate sauce, which costs $0.25 per tablespoon.
- The cost of other miscellaneous ingredients, such as whipped cream and nuts, totals $0.05 per banana split.
- Calculate the cost of a banana split.
- List two factors that could cause these estimated costs to be inaccurate.
- Following are the results from two different simple regression analyses estimating the costs of the purchasing department using number of purchase orders and number of vendors as potential cost drivers.
Purchasing costs vs. Number of purchase orders | |||
Variable | Coefficient | t-statistic | p-value |
Intercept | 497.25 | 3.39 | 0.04 |
Number of purchase orders | 18.72 | 5.48 | 0.001 |
Adjusted R-square = 0.79 |
Purchasing costs vs. Number of vendors | |||
Variable | Coefficient | t-statistic | p-value |
Intercept | 691.15 | 1.45 | 0.25 |
Number of vendors | 115.88 | 2.75 | 0.15 |
Adjusted R-square = 0.53 |
- Which independent variable explains more of the variation in purchasing costs? Explain your choice.
- Choose the most appropriate cost driver and write the cost function.
- For an upcoming month, the number of vendors is estimated to be 150, while the number of purchase orders is estimated to be 340. Using the most appropriate cost driver, estimate the total cost for that month.
- List several uncertainties that could affect the accuracy of the cost function in estimating the cost for the upcoming month.
- NTQ Corporation manufactures and sells compact discs with music and nature sounds as relaxation and concentration tools.
- Describe why there is no single “correct” way to determine the cost of a compact disc.
- Identify three reasons why the cost of a compact disc might change or vary over time.
- (Appendix 2B) Bob and Andrea were recently hired as accountants for PTR Corporation. PTR uses an enterprise resource planning (ERP) system to coordinate its accounting, sales, and manufacturing operations. Bob and Andrea must learn to use the ERP system effectively to perform their job duties. Their supervisor expects a 70% learning curve to apply to that task.
- Define the concept of a “learning curve” in your own words.
- Identify two reasons why the rate of learning might be different than 70%.
- Eastwood Consulting rents a photocopy machine for a monthly rental of $100 plus $0.02 per copy. Photocopier usage varies from month to month depending primarily on the type and volume of consulting reports completed each month. Photocopier usage and cost data for the past several months are as follows:
Month Number of Copies Rental Cost
January 11,498 $330
February 14,649 392
March 12,719 354
April 10,347 307
May 16,114 422
June 12,648 353
The accountant for Eastwood Consulting would like to develop a budget for July’s photocopier rental cost. Would regression analysis be an appropriate technique for estimating the cost function? Why or why not?
- Total revenues for the month were $80,000. Total fixed costs were $40,000. Total variable costs were $20,000.
- Write the algebraic expression for the cost function.
- Describe the general assumptions of the cost function.
- Discuss reasons why a cost function might provide poor estimates of future costs.
Short Answer
- Write out the algebraic formula that represents a cost function, and explain each item in the equation.
- List the assumptions made when a linear cost function is developed.
- List one assumption made when a linear cost function is developed and describe a circumstance in which that assumption would not hold.
- A cost function estimated using regression analysis is more accurate than a cost function estimated using either the high-low method or the two-point method. Explain the differences among the three methods. As you discuss these differences, explain why regression analysis provides higher quality information.
- List and describe three methods for developing a cost function. List one pro and one con for each method.
- If the average cost decreases as volume of production increases, what kinds of costs are included in the cost function? Explain your reasoning.
- Explain how scatter plots are used in the process of developing cost functions.
- (Appendix 2A) One of the questions that needs to be asked before data from regression analysis is used to develop a cost function is whether the relationship between the cost and the cost driver is economically plausible. Explain what this means. In addition, give an example of a cost with one cost driver that would be economically plausible, and an example of one cost driver that would not be economically plausible.
- When estimating a cost function, accountants often begin with past cost information if it is available. Explain why accountants cannot be certain that past costs will provide a good estimate of future costs.
- Minh is a cost analyst for TRN Corporation. As part of his job, he must estimate the cost to manufacture wooden and metal computer desks. A recent cost analysis showed the cost of a wooden desk to be $130, while the cost of a metal desk was $107. Can Minh be confident that the cost to produce a wooden desk next period will be $130? Why or why not?
- Suppose you are a newly hired accountant for a television production studio. One of your first tasks is to estimate the costs of an upcoming episode of the studio’s hit unscripted show, “Who Wants to Be an Accountant?” Identify three potential methods for estimating the costs, and describe them.
Problems
- Here is the output from two regression models for overhead costs at a university using number of academic programs and number of students as potential cost drivers.
Number of academic programs
Adjusted R-square = 0.72
Intercept = 7,127.75 t-statistic = 2.14 p-value = .05
X1 variable = 240.64 t-statistic = 5.08 p-value = .001
Number of students
Adjusted R-square = 0.55
Intercept = 5,991.75 t-statistic = 1.18 p-value = .35
X1 variable = 3.78 t-statistic = 3.53 p-value = 0.01
- Develop a cost function for each potential cost driver.
- Compare the output for the two drivers. Choose the best cost driver for overhead costs and explain how you made that choice.
- Suppose you use the best cost function from part (b) to estimate overhead cost for the next semester. Why is it highly unlikely that the actual cost will be exactly the same as the cost you estimated?
- The new cost analyst in your accounting department has just received a computer-generated report that contains the results from a simple regression analysis. He was estimating the marketing department costs using volume of units sold as the cost driver. The summary results of the report appeared as follows:
Variable Coefficient t-statistic p-value
intercept 2,222.35 2.48 p<0.01
X1 12.44 1.39 p = 0.25
Adjusted R-square = 0.40
- Write an equation for total cost based upon the regression analysis.
- What does the Adjusted R-square tell you about the quality of information that would be produced using this cost driver? Explain.
- Is it economically plausible that volume of units sold could drive the costs of the marketing department? Explain.
- List two other cost drivers that the cost analyst could try and explain why they might be useful.
- Describe discretionary costs.
- Is it possible for marketing costs to be discretionary? Explain.
- Describe how to estimate a discretionary cost.
- Following are the income statements for Grandview Well-Child Clinic for the years 2004 and 2005:
2004 2005
Patient Visits 12,000 16,000
Revenue $216,000 $288,000
Costs:
Nurses Salaries 80,000 120,000
Vaccine and Syringes 60,000 80,000
Miscellaneous Supplies 19,000 22,000
Administration 50,000 50,000
Surplus $ 7,000 $ 16,000
A nurse was added as patient visits increased in 2005. This nurse can handle up to 4,000 additional patients in the next period. Miscellaneous supplies include the cost of supplies for medical records. Administration is primarily salary cost of the clinic director.
- Categorize each cost as fixed, variable, or mixed, and explain your categorizations.
- If you have categorized a cost as mixed, use the high-low method to separate out the fixed and variable portions.
- Develop a cost function for Grandview Well-Child Clinic.
- Predict the cost for 18,000 patients in 2006.
- List two factors that could affect patient volumes. Can the managers be certain that the volume of patients expected in 2005 will 18,000? Explain
- You work for a company that manufactures computer chips. You need to develop a cost function for maintenance cost, which consists of the cost for routine maintenance and repair of machines used to manufacture the chips.
- List the steps you would take to develop a cost function for predicting next year’s maintenance cost. The maintenance department head has suggested these three possible cost drivers: machine setups, labor hours, or machine hours. Include a detailed explanation of how you would determine the best cost driver among these three.
- You have developed the cost function and used it to develop part of next year’s budget. During the first few months of the year, you find that the estimate is off by several thousand dollars. Provide reasons why this could occur.
- Jackalope Ski Company manufactures snow skis in a highly automated assembly plant in Jackson Hole, Wyoming. The automated system is in its first year of operation, and management is still unsure of the best way to estimate the overhead costs of operation for budgetary purposes. The following cost and potential cost driver data were collected for the first six months of operations:
Month Machine Hours Total Overhead
January 4,560 $276,000
February 4,380 $273,600
March 4,680 $278,400
April 3,960 $270,000
May 3,900 $252,000
June 3,720 $240,000
- Compute a cost function using machine hours under the high-low method.
- Discuss how each of the following is likely to affect the quality of the cost functions you estimated in part (a). Do not perform any calculations.
1) Use of the high-low method
2) Newness of the automated system
- (Appendix 2A) Here are the results using regression analysis on maintenance and repair costs for the production machines in a manufacturing company. Two cost drivers were chosen: number of machine setups (X1) and machine hours (X2).
Variable Coefficient t-statistic p-value
intercept 70,324.15 2.81 p<0.01
X1 14.83 2.39 p <0.05
X2 2.07 2.24 p<0.05
Adjusted R-square = 0.87
- Write an equation for total cost based upon the regression analysis.
- What does the Adjusted R-square tell you about the quality of information that would be produced using this cost driver? Explain.
- Is it economically plausible that number of setups and machine hours could drive the costs of the maintenance and repair for the machines? Explain.
- Elliott is the vice-president of marketing for NYP Corporation. He has called upon you, a member of the accounting staff, to help him forecast future sales. A regression analysis, with sales as the dependent variable and number of credit clients as the independent variable, yielded the following results:
Variable Coefficient t-statistic p-value
Intercept 6911.45 3.45 0.01
Number of clients 1157.88 3.75 0.01
Adjusted R-square = 0.85
- Write out the revenue function for this regression.
- Identify two uncertainties associated with using the number of clients to predict sales.
- Managers might estimate a cost function for a variety of reasons including: budgeting, setting employee work schedules, or discontinuing a line of business. Consider the problem of predicting the future cost of fuel for a company’s fleet of automobiles.
- Identify three factors that might influence the actual future cost of fuel.
- Identify and explain two potential cost drivers for the cost of fuel.
- Suppose actual fuel costs turn out to be higher than estimated cost. Would this mean that an inappropriate estimation method was used? Explain.
- Coffee Cart sells a variety of hot and cold coffee beverages. Data for a recent month appear below:
Revenue $20,000
Costs:
Ingredients $7,800
Miscellaneous supplies (napkins, etc.) 1,200
Rent 1,000
Wages for part time employees 3,000
Cart attendant salary 5,000
Total costs 18,000
Profit $ 2,000
Part time employees are scheduled for busy times, but are sent home as soon as volumes drop enough to warrant it.
- Categorize each cost as fixed or variable and explain your choice.
- Create a cost function.
- Discuss three reasons why the cost function you estimated in part (b) might provide an inaccurate estimate for next month’s costs.
Answers
True / False
- T
- T
- F
- F
- F
- T
- F
- F
- F
- T
- T
- F
- F
- T
- F
- T
- F
- F
- T
- T
- F
- T
- T
Multiple Choice
- B
- A
- A
- A
- B
- B
- C
- A
- A.
- B
- B
- D
- B
- B
- D
- C
- B
- B
- D
- C
- D
- D
- C
- D ($1,500-$900)/(7,000-4,000)
- C VC=$0.20 per question #31; $900-(4,000×$0.20)
- A See questions #31 & #32
- B ($7,085-$4,585)/(5,900-3,400)
- A VC=$1.00 per question #34; $7,085-(5,900×$1)
- C $1,185+(4,500×$1)
- C 3,500×$10.50=$36,750; 3,000×$11.25=$33,750; ($36,750-$33,750)/(3,500-3,000)
- A VC=$6 per question #37; $36,750-(3,500×$6)
- 32. D
- D
- C
- A
- C
- A
- A
- D
- C
- D
- D
- B $130,000 + ($5 * 26,000)
- D
- C
- A
- A
- A
- B
- A
- A
- B
- A
- A
- C
- D
- B
- C
- C
- B
- A
- C
- B
- A
- C
- D 3,100 × 80% × ($12.50 – $7.50)
^{S}75. A
^{S}76. B
^{S}77. D
^{S}78. C
^{S}79. D
^{S}80. C
^{S}81. C
^{S}82. A
^{S}83. D
^{S}84. B
^{S}85. A 85% times 200 hours
^{s}86. C
^{s}87. D
^{s}88. D
^{s}89. C
^{s}90. D Total costs = $178,024 + ($12.30/units) x (1000 units sold)
^{W}91. B
^{W}92. A
^{W}93. D
^{W}94. A
^{W}95. C
^{W}96. A
^{W}97. B
^{W}98. D
^{W}99. A
^{W}100. B
^{W}101. C
^{W}102. A
^{W}103. D
^{W}104. D
^{W}105. A
^{W}106. B
^{W}107. A
Matching
- Cost classification
- D
- B
- B
- D
- D
- D
- A
- B
- D
- A
- Matching
- C
- A
- B
- L
- D
- A
- I
- E
- G
- H
- B
- K
- Regression analysis steps
8 | Write the cost function. |
4 | Plot the cost for each potential cost driver. |
5 | Perform the regression analysis. |
2 | Generate a list of possible cost drivers. |
3 | Gather data. |
6 | Evaluate the sign and significance of the cost function’s components. |
7 | Discard potential cost drivers that fail to explain a high proportion of variability in the cost. |
1 | Consider the behavior of the cost. |
Exercises
- Two-point method:
- Total cost = $20,000 + $7,000/$28,000 x total revenue
= $20,000 + 0.25 x total revenue
Assumptions: Sales mix, price, and variable cost remain constant, fixed costs remain fixed, and operations are in the relevant range. (Note: The assumption of constant sales mix is not introduced until chapter 3 of the textbook.)
- a. Total cost for 10,000 units = $880,000
Total cost for 15,000 units = $1,260,000
VC = ($1,260,000 – $880,000)/(15,000 – 10,000) = $76
Fixed cost for 15,000 units = $1,260,000 – $1,140,000 = $120,000
Total cost = $120,000 + $76Q.
- Total cost for 18,000 units = $1,488,000
Average cost = $82.67
- a. For production levels between 0 and 5,000 units, TC = $25,000 + $10Q
For production levels above 5,000 units, TC = $25,000 + ($10 x 5,000) + $7.50(Q-5,000)
TC = $37,500 + $7.50Q
- Often raw materials are discounted with volume purchases.
- Below are the three assumptions of this cost function, with examples of reasons why each assumption might not hold. Students may think of other examples.
Fixed costs remain fixed. Utilities and other types of fixed cost vary each month, but often not based on volume of production. There can also be unanticipated price changes or changes in discretionary spending.
Variable costs remain constant per unit. Volume discounts are often given, reducing variable costs after a certain level of purchases. There can also be unanticipated price changes.
Operations are in the relevant range. At the extremes of the range, that is very high or very low production levels, costs might be a little different than within those areas of the range where the organization has most experience. In addition, the relevant may be misspecified; operation volumes may increase or decrease to a level of activity in a different relevant range; or managers may make changes to operations or the cost structure.
- High-low method (Student answers may vary depending on rounding choices.)
- Cost classification
Fixed | Variable | Mixed | |
Oil to lubricate the machines | X | ||
Salary of the plant manager | X | ||
Annual subscription to a trade journal | X | ||
Vacation pay for salaried production employees | X | ||
Packaging materials | X | ||
Research and development | X | ||
Raw materials | X | ||
Material handling costs | X | ||
Marketing department costs | X | ||
Factory maintenance | X |
- Cost estimation methods
- Scatter plots
Description of cost behavior:
Cost of raw materials purchased is variable; total cost at zero volume appears to be zero, and the total cost appears to increase at a constant rate. The cost of raw materials most likely varies proportionately with the volume of production.
Cost of factory supplies is most likely mixed. Although the cost behavior is not visually obvious in the above scatter plot, the data for the cost indicate that the cost is higher at higher levels of production. Also, the cost appears to have a fixed component. Factory supplies often include a combination of fixed costs, such as janitorial supplies and light bulbs, and variable costs, such as lubrication for machinery.
Production manager salary is a fixed cost; it is constant across all levels of production. Production manager salaries usually do not vary with volume of production.
- Two-point method analysis for factory supplies
- High-low method analysis for factory supplies
- Scatter plots
- Graphs
Cost A varies in total amount, but the variation does not appear to be related to variation in volume of the cost driver. In addition, total cost is fairly high when volume of the cost driver is zero. It is most likely a fixed cost.
Cost B appears to vary proportionately with volume of the cost driver, and total cost is zero when volume of the cost driver is zero. It is most likely a variable cost.
Cost C appears to be higher for higher volumes of the cost driver, but total cost is not zero when volume of the cost driver is zero. It is most likely a mixed cost.
- Here are possible examples of each cost; students may think of other examples.
Cost A could be utilities, which are a fixed cost but vary due to factors such as weather that are unrelated to a cost driver.
Cost B could be direct labor or direct materials costs, which are driven by production volume.
Cost C could be factory maintenance costs, which are not zero when activity is zero, but increases with volume production or with machine hours.
- Learning curves
- 10 * 6^{-0.152} = 7.6 hours per page
- 10 * 10^{-0.152} = 7.0 hours per page
7.0 hours per page * 10 pages = 70 hours
- a. Engineered cost estimates
Bananas $1.00
Ice cream 0.20
Fruit toppings 1.50
Chocolate sauce 0.75
Miscellaneous 0.05
Total cost $3.50
- Here are several factors that could cause these estimated costs to be inaccurate; students will think of other factors. Employees could eat product, increasing costs. Any of the ingredient prices could change. Employees may not use the estimated portions, but include more or less of each ingredient. Consumer preferences could change so that no fruit toppings are used, or more chocolate sauce is requested.
- Regression analysis
- Number of purchase orders is the better independent variable, based on the higher Adjusted R-square statistic.
- Total purchasing costs = $497.25 + $18.72 x number of purchase orders
- $497.25 + $18.72 (340) = $6,862.05
- Here are several uncertainties that could affect accuracy of the cost function; students will think of other uncertainties. Normal variations could occur in the amount of resources devoted to purchases orders issued. An unanticipated salary increase could take place for purchasing employees. A new employee could be hired who cannot keep up with the work, so a temporary worker is brought in until the new worker is trained.
- NTQ Corporation
- Costs can be determined in a variety of ways, depending upon the purpose of the calculation. In addition, because biases, uncertainties, and management judgments come into play in cost determination, there is no single “correct” way to calculate the cost of a compact disc.
- The cost of a compact disc might change or vary because of:
Changes in raw material costs from bulk purchases, quality changes, or other factors
Degree of automation vs. labor employed in the production process
Changes in plant layout which reduce overhead costs
Changes in wage rates due to union negotiations and/or outsourcing jobs
Changes in type or cost of packaging materials
Changes in artists’ royalties
- Learning curves
- A learning curve explains how costs and/or time can change as workers gain experience in performing a specific task, such as using computer software or building a bridge.
- The learning curve rate might change or vary for several reasons, including: an incorrect initial estimate, a process being easier / more difficult to master than expected, workers “catching on” more quickly / more slowly than expected. External factors, such as documentation or conflicting priorities, may also impact a learning curve rate. Students may think of other reasons.
- Regression is useful for estimating a cost function when fixed and variable costs are unknown. In this problem, the accountant already knows the cost function (TC = $100 + $0.02*Number of copies), so there is no need to estimate the cost function using regression or any other estimation technique.
- a. TC = $40,000 + $20,000/$80,000 x total revenues = $40,000 + .25 x total revenues
- Fixed costs remain fixed, variable costs remain constant, operations are in the relevant range and sales mix remains constant. (Note: The assumption of constant sales mix is not introduced until chapter 2 of the textbook.)
- A cost function might provide poor estimates of future costs for the following reasons; students may think of others. The behavior of costs could change after a cost function is developed. For example, the cost of direct and indirect materials could change, labor rates could change, or operations could move out of the relevant range. The cost function may be misspecified because inappropriate estimation techniques were used. For example, a stepwise linear cost function might have been inappropriately estimated using regression analysis, or the high-low method might have been applied to usually high or low (i.e., outlier) data points.
Short Answer
- TC = F + V*Q. TC is total cost, that is, the total amount of cost that is being explained. F is fixed costs, which do not change with small changes in volumes of the cost driver. V is variable cost per unit of the cost driver, and that cost remains constant within the relevant range, but its total cost increases proportionately with increases in cost driver volumes. Q is the quantity of cost driver.
- Assumptions:
Fixed costs remain constant in total
Variable costs remain constant per unit of the cost driver
Operations in the relevant range
- Students are asked to list only one assumption and to describe a circumstance in which that assumption will not hold. Below are examples of circumstances for all 3 assumptions; students will think of other circumstances.
Fixed costs remain constant in total: Variable costs often decrease with volume because of discounts.
Variable costs remain constant per unit of the cost driver: Fixed costs change because they include utilities and so vary with weather or other factors that are unrelated to production volumes.
Operations in the relevant range: Business volumes might become unusually high or low due to changes in economic conditions, moving operations into a new relevant range.
- Regression analysis is a mathematical technique that incorporates all of the observations of cost and cost driver. The high-low and two-point methods use only two data points for cost with their corresponding data points for volume. Because regression incorporates many more data points, the trend line developed is likely to be a more accurate representation of cost. In addition, regression output allows one to evaluate the goodness of fit for different cost drivers, and that information is lacking with the other two methods. The high-low method is a special case of the two-point method and uses only the highest and lowest points, which may not be representative of ordinary operations, so it is the least accurate of the three methods.
- Below are examples of answers for this question; students will think of other pros and cons. Also see Exhibit 2.17.
Analysis at the account level is an examination of the accounting records to determine whether costs are fixed or variable. An advantage is that information is in the accounting system and can be accessed without further effort. A disadvantage is that is does not reflect anticipated changes in cost that would improve the cost function.
Engineering estimates of cost analyze the underlying activities and materials used to produce a good or service to develop the cost function. Engineering estimates can be very accurate because they consider current period resource use. However, it is time consuming and may overlook some fixed costs that need to be included in the cost function.
Regression analysis uses past cost data and a statistical method to develop a cost function. It is often used in conjunction with the analysis at the account level to specify mixed costs. Regression analysis provides the highest quality information, but it is more complex and requires knowledge of the spreadsheet program to perform. Students may have used the two-point method or high-low method as well.
- When average cost decreases, the cost function includes at least some fixed costs. As the fixed costs are spread over more units, the average cost per unit decreases. The cost function may or may not include variable costs.
- A scatter plot is used to increase understanding of cost behavior. For some data, scatter plots provide enough information so that the cost can be categorized. This would occur when the scatter plot shows that the cost is fixed, that is, either there is very little slope, or there is no apparent trend. However, if the scatter plot shows a trend line, then further analysis is needed to develop the cost function. This analysis could include regression or a two-point method.
- Economic plausibility means that there is an economic explanation for the relationship. For example, the cost of gasoline increases as more miles are driven. It is economically plausible, then, that miles driven would be an appropriate cost driver for transportation costs. Alternatively, number of employees is unlikely to be economically related to transportation costs because we do not know if all of the employees drive the cars, or what the relationship is between employees and transportation. Number of employees is much less likely than miles driven to have an economically plausible relationship with cost of gasoline.
- Using past cost information cannot completely eliminate the risk of errors in predicting future costs. Managers may be inexperienced or otherwise biased in their use and interpretation of past cost information. They may employ less-than-suitable cost estimation methods. Further, economic / human / production factors could change significantly, making past costs unrepresentative of future costs. Students may think of other factors.
- Minh cannot know for certain whether the costs of direct materials and labor have changed since the cost estimates were developed. In addition, overhead costs may have changed. It is possible, although unlikely, that the method of estimating costs could have changed. In addition, the volume of production affects the average cost, and if this cost is an average, it is based on an estimate of production for the period, and the exact amount of production will not be known until the end of the period. Students may think of other reasons.
- Cost estimation methods (students are required to identify only 3)
Analysis at the account level requires examination of accounting records and categorization of costs into fixed, variable, and mixed. Past costs are then used to predict future costs; however, the costs can easily be updated with expected input price changes.
The two point method requires a scatter plot of data, or at least two years’ observations. From the data, two points that are representative of normal operations are chosen, the slope (variable cost) is calculated, and then fixed cost is found.
The high-low method is a specific type of the two-point method in which the highest and lowest data points are chosen for the slope and intercept calculations.
Engineered estimates require an analysis of the underlying use of resources (direct materials and direct labor) to predict future costs.
Regression analysis is usually used with the analysis at the account level method, specifically for those costs that are not definitely identified as fixed or variable. This method uses many data points to fit a trend line with a mathematical calculation that minimizes the squared error of each observation.
Problems
- a. TC = $7,128 + $241 × number of academic programs.
TC = $3.78 x number of students. (T-statistic on the coefficient reflecting fixed costs (intercept) is not statistically significant, so we assume fixed cost is zero.)
- The R-square statistic is the highest for number of academic programs, so the cost function using its data would be the most accurate.
- Costs normally vary due to unpredictable changes in costs. For example, overhead costs probably include the costs of heating and cooling, which change with weather and utility rates, rather than with programs or students. In addition, historical cost information about university overhead may not be appropriate for predicting future costs. There is a high proportion of fixed costs that probably change over time, such as professors’ salaries, staff, and clerical salaries. In addition, universities sometimes have budget cut-backs, and professor and staff levels may be reduced. The regression analysis does not take these into consideration. Students will have thought of others.
- a. TC = $2,222 (Coefficient reflecting variable cost (slope) is statistically insignificant, so we set it at zero.)
- This cost driver, volume of units sold, does not explain very much of the variation in marketing department cost. The R-square is low at 0.40, suggesting that sales volumes only explains about 40% of the variation in cost. This cost function does a poor job of explaining past costs, and it is likely to perform even less well in estimating future costs.
- If there are sales commissions as part of the cost, then sales volumes would be a good cost driver for that portion of marketing costs. However, the problem does not specify whether this is a discretionary cost. Often marketing costs are discretionary costs.
- If the marketing department buys a lot of advertising, the number of ads or the number of times ads are run could be used as a cost driver. If the marketing department has a lot of employees and they are salaried, the number of employees could drive costs. Students will think of other potential cost drivers.
- Discretionary costs are decisions about the amount of cost to incur, and these are often made on an annual basis.
- Yes, marketing costs could be discretionary. These costs are usually set according to a budget, but can be cut back or increased in the middle of an accounting period. When profits are higher, it is likely that more is spent on marketing.
- Because discretionary costs are set by decision, accountants consult the decision makers and ask for an estimate of the cost for the next period.
- a. Nurses’ salaries and administration are two fixed costs. We use the most current month’s value to predict next month’s fixed cost. Therefore fixed costs are $170,000 ($120,000 + $50,000). Vaccine and syringes must be a variable cost because $60,000/12,000 = $5, and $80,000/16,000 = $5. It is logical to assume that vaccines and syringes would vary with the number of visits because many patients probably get vaccinations. Miscellaneous supplies are probably mixed because although the cost increases, it does not increase proportionately with volumes. Supplies probably include things like lab coats and computer related supplies that do not vary with patient volumes.
- VC = $22,000 – $19,000/16,000 – 12,000 = $3,000/4,000 = 0.75
Fixed costs: $22,000 = F + 0.75 x 16,000 è F = $10,000
- TC = ($120,000 + $50,000 + $10,000) + $5.75 x Q
- Total cost for 18,000 patients = $180,000 + $5.75 x 18,000 = $283,500
- Managers cannot know for certain the number of patients that will visit the clinic because they cannot know when a contagious illness will cause more children to become vaccinated. In addition, the birth rate could change. Costs change over time, and sometimes they change unexpectedly. For example, nurses’ salaries increase more rapidly when there is a shortage of nurses. Students will think of factors that could affect patient volumes.
- a. To develop a cost function, I first consider whether past costs would be relevant in predicting future costs. If there have been no major changes in the production line or technology, past costs are a good place to start. Next I pick those costs that are relevant to maintenance from the accounting records. This is not a discretionary cost, we incur it as part of operations, so I can use past information to develop a cost function to predict future costs, but I need to determine whether any changes in costs are expected. Then I can use these records and one of the techniques for estimating past costs, such as analysis at the account level. This could be a mixed cost, so I would also plot the cost against the three potential cost drivers. If a linear trend is apparent with one or more of these cost drivers, I would use regression analysis to determine whether one cost driver appears to be more accurate than the others. First I examine R-square and determine the cost driver that best explains the variation in cost. If none of the drivers have R-squares above about 70%, I may need to identify alternative drivers or consider whether the cost might be primarily fixed. If one cost driver has an R-square about or above 70%, I would analyze the t-statistics and p-values to determine the cost function.
- Many different factors can cause costs to be different than estimated. Below are some factors; students will think of others. It is impossible to perfectly predict future costs because the costs might change, production levels might vary, or other factors could alter the fixed or variable costs. For example, unanticipated volume discounts might be received. Operations could be more or less efficient than estimated because workers provide more or less effort. In addition, the cost function might be poorly estimated.
- a. Cost function for machine hours:
Variable cost = ($278,400 – $240,000)/(4,680 – 3,720) = $40
Fixed cost = $91,200
TC = $91,200 + $40 * machine hours
- 1) The high-low method generally reduces the quality of a cost function estimate because it uses only the highest and lowest values of the cost driver. These values may be atypical, resulting in a distorted cost function.
2) The cost and production data for this problem are from the first 6 months of operations with a new production system. When companies install new production systems, it often takes some time before costs and production activities stabilize. Therefore, the data in this problem might have low quality for estimating future costs. The quality of data depends on the nature of the production system, how quickly employees learn to use it, and whether engineers continue to make changes in the system as greater production experience is gained.
- a. TC = $70,324 + $14.83*number of setups + $2.07*machine hours.
- The R-square provides information about how well the variation in the cost drivers explains variations in cost. In this problem, the R-square is relatively high, so changes in the two drivers explain about 87% of the changes in cost.
- Both cost drivers are economically plausible. Some labor and supplies are needed when each new setup occurs, so maintenance costs would increase with number of setups. As machine hours increase, more repairs and oil and routine maintenance is needed, so these seem like they could cause variations in cost.
- a. Revenue = $6,911 + $1,158 x number of clients
- Here are some uncertainties associated with using the number of clients to predict sales; students will think of others. The average amount of revenue per client may change over time due to economic factors, competition, and customer preferences. The regression explains only 85% of the variation is past revenue, so it cannot be expected to predict future revenue perfectly.
- a. Here are several factors related to the cost of fuel; students may think of others.
Type of vehicle
Distance and / or speed driven
Preventive maintenance schedules
Price of fuel
Driving conditions
- Here are several possible cost drivers; students may think of others.
Number of miles driven
Type of fuel: diesel, regular unleaded, premium unleaded
Geographic location of fuel purchase: domestic, international
- The purpose of this question is to determine whether students understand that deviations from cost estimates can arise from factors other than use of an inappropriate estimation method. When predicting costs for the future, it is unlikely that actual costs are the same as the prediction. Changes in the costs and volumes of production affect the cost function. In addition, there may be changes in vehicle technology that affect efficiency, and costs could decrease. Student responses will vary.
- a. Ingredients are variable because we use them as we sell product.
Miscellaneous supplies are also variable
Rent is fixed
Wages for part time employees are variable
Store attendant salary is fixed.
- TC = ($1,000 + $5,000) + ($7,800 + $1,200 + $3,000)/$20,000 x total revenues
= $6,000 + 0.60 x total revenues
- There are many possible reasons why the cost function might provide an inaccurate estimate. Here are several possible reasons; students may think of others:
- Cost behavior may have been misclassified when creating the cost function
- Revenue might be an inappropriate cost driver for one or more of the variable costs
- Fixed costs might change from the prior month. For example, the cart attendant’s salary might be increased or a new rental agreement might be negotiated.
- Variable costs per dollar of revenue might change from the prior month. For example, the company might negotiate a lower cost for supplies such as napkins, or ingredient costs might fluctuate with food commodity prices.
- The cost function was estimated using only one month’s data, which might not be representative of the activities and costs for other months.
Chapter 4: Relevant Costs for Decision Making
Learning Questions | True / False | Multiple Choice | Matching | Exercises | Short Answer | Problems |
1. What is the process for identifying and using relevant information in decision making? | 1-5 | 1-10, 71-74, 81-83
W: 109, 110 |
||||
2. How is relevant quantitative and qualitative information used in special order decisions? | 6-10 | 11-22, 76, 77
S: 85-87, 92-95 W: 113, 114, 118, 120, 126 |
1 | 1, 7, 9 | 4, 5, 6 | |
3. How is relevant quantitative and qualitative information used in keep or drop decisions? | 11-15 | 23-32
S: 88, 96-98 W: 121, 123 |
1 | 8, 10 | 9, 10 | 1, 6 |
4. How is relevant quantitative and qualitative information used in outsourcing (make or buy) decisions? | 16-18 | 33-44, 78, 79
S: 84, 89-91 W: 122, 124, 125 |
1 | 2, 5, 6 | 7, 8 | 3 |
5. How is relevant quantitative and qualitative information used in product emphasis and constrained resource decisions? | 19-23 | 45-56, 80
S: 99-101, 104-108 W: 111, 112, 115-117, 119 |
1 | 3, 4 | 3 | 2, 4, 5 |
6. What factors affect the quality of operating decisions? | 4, 24-27 | 57-69, 75
S: 102, 103 |
2, 5, 7, 9, 10 | 4, 5, 7, 11 | 1, 3, 6 | |
7. |
S: Questions from the study guide
W: Questions from web quizzes on the student web site
Level of Complexity* | True / False | Multiple Choice | Matching | Exercises | Short Answer | Problems |
Foundation: Repeat or paraphrase information; Reason to single correct solution; Perform computations; etc. | All | All | All | All | 1, 2, 3, 8, 10 | 1, 2, 3, 4, 5, 6 |
Step 1: Identify the problem, relevant information, and uncertainties | 2, 5, 7, 9, 10 | 1, 3, 4, 5, 6, 7, 9, 11 | 1, 2, 3, 4, 6 | |||
Step 2: Explore interpretations and connections | 2 | |||||
Step 3: Prioritize alternatives and implement conclusions | ||||||
Step 4: Envision and direct strategic innovation |
*Based on level in Steps for Better Thinking (Exhibit 1.10, textbook p. 16):
Note: Step 1, 2, 3, and 4 questions in this test bank are intentionally open-ended and subjective, giving students the opportunity to demonstrate skills such as judgment, reasoning, identification of uncertainties, identification or analysis of pros and cons, and so on. Therefore, student answers may not exactly match those shown in the solutions.
True / False
- Because many management decisions are unique, managers cannot use a standard decision process for addressing them.
- Management decisions involve primarily decisions about long-term strategic plans.
- Management decisions rarely require analysis of qualitative factors.
- The effect of production practices on the environment is an example of a qualitative factor to be considered in a management decision.
- The process for making a management decision starts with identifying the decision type.
- An order from a new customer always constitutes a special order.
- Special order decisions are long-term decisions that may need to include the time value of money.
- If a service organization is at capacity, it would only accept a special order for service if it was priced at or above the price that regular customers pay for the service.
- A key aspect of special order decisions is being at least as well off after the decision as before it.
- If idle capacity exists, a special order must cover its full cost to be profitable.
- In multi-product firms, managers need to consider the effect on demand for other products when they make a keep or drop decision about one product.
- Average costs are appropriate to use when deciding whether to keep a product or product line.
- The general rule is to discontinue a service when its total fixed costs are less than its avoidable fixed costs.
- The general rule is to discontinue a product line when its total profit margin is greater than its avoidable fixed cost.
- The general rule is to discontinue a segment of the business when its total contribution margin does not cover avoidable fixed costs.
- The general rule for make or buy decisions is to choose the option with the lowest total cost.
- Opportunity costs are often relevant in make or buy decisions.
- Make or buy decisions are sometimes known as outsourcing decisions.
- Managers should always emphasize products with the highest total contribution margin.
- Emphasizing products with higher contribution margins assumes that fixed costs are unaffected by product mix.
- The number of lawnmowers available could be a constraint for a lawn care service.
- One way to deal with constrained resources is to spend money to alleviate them.
- When resources are constrained, managers should emphasize products and services that maximize the contribution margin per unit of constrained resource.
- Product quality is seldom a factor in make or buy decisions.
- Managers may outsource a service because they do not consider it a core competency.
- Rapid growth may require a company to outsource certain products or services.
- The accessibility and timeliness of information can affect decision quality.
Multiple Choice
- The process for making management decisions
- Is the same as the process for making routine decisions
- Involves qualitative techniques only
- Begins with identifying the type of decision
- Ignores qualitative factors
- In applying a relevant quantitative analysis technique to a decision, managers must
- Identify input variables
- Identify a dependent variable
- Not use estimates
- Interpret results in the most favorable way possible
- In nonroutine situations, managers must identify the type of decision to be made. Which of the following is not an example of a nonroutine operating decision?
- Make or buy
- Special order pricing
- Budgeting
- Managing limited resources
- Because many management decisions are unique, managers address them using a (an)
- Cookbook
- Process
- Information system
- Team
- The process for addressing management decisions begins with
- Applying relevant quantitative techniques
- Applying relevant qualitative techniques
- Questioning managers’ judgment
- Identifying the type of decision involved
- Nonroutine management decisions differ from routine decisions in that nonroutine decisions
- Ignore cash flows
- Consider cash flows
- Do not happen on a regular basis
- Involve small dollar amounts
- Sunk costs should be considered in
- Both routine and nonroutine operating decisions
- Neither routine or nonroutine operating decisions
- Routine decisions only
- Nonroutine operating decisions only
- Which of the following is the best definition of a qualitative factor?
- Factors related to product or service quality
- Factors that cannot be identified in a decision-making process
- Factors that are not valued in monetary terms
- Factors that are superior to quantitative factors in decision making
- A product emphasis decision may involve
- Sunk costs and opportunity costs
- Multiple resource constraints and sunk costs
- Multiple products and qualitative factors
- Sunk costs and qualitative factors
- Qualitative factors can be difficult to identify because
- They are not usually relevant in management decisions
- They are usually unimportant
- No set formula assures managers they have considered the important issues
- They are typically the same as sunk costs
Use the following data for the next 2 questions.
Wolff Co. sells product P at a price of $38 a unit. The per-unit cost data are: direct materials $8, direct labor $10, and overhead $12 (25% fixed and 75% variable). Wolff has sufficient capacity to accept a special order for 40,000 units just received. Selling costs associated with this order would be $3 per unit.
- The minimum selling price per unit should be
- $24
- $30
- $32
- $36
- At a selling price of $33 per unit, the operating income will
- Increase by $60,000
- Increase by $80,000
- Increase by $120,000
- Increase by $160,000
Use the following data for the next 2 questions.
Wagner Corporation can manufacture 490,000 tennis rackets a year at a variable cost of $15 per racket and fixed costs of $500,000. Wagner budgeted that it can sell 400,000 at $25 each. An additional order of 100,000 was received, but at a discount of 35% from the regular price.
- The relevant cost to Wagner of the special order is
- $1,500,000
- $1,450,000
- $1,625,000
- Some other amount
- If Wagner accepts the special order, income before taxes will
- Decrease by $100,000
- Increase by $125,000
- Increase by $25,000
- Some other amount
- Assume the following cost data:
Per-unit costs:
Direct material $6
Direct labor $4
Variable overhead $2
Variable selling $4
Fixed overhead $300
Fixed selling $400
A special order for 100 units is received. The buyer wants his name stamped on each unit. This will increase labor costs by $0.25 per unit and cost $300 for the stamping machine. What price must be charged to earn $300 on the special order?
- $1,925
- $1,775
- $2,225
- $2,075
- PRO Shops has a capacity of 45,000 units, and is currently producing and selling 40,000 at $25 a unit. The present cost structure, on a per unit basis, is:
Direct material $10
Direct labor 5
Variable overhead 3
Fixed overhead 4
An order for 7,000 units has been received from a Japanese company at a price of $20 per unit. If the order is accepted, profit will
- Decrease by $2,000
- Increase by $14,000
- Increase by $7,000
- Increase by $4,000
- The general rule for special orders is
- Profit should be greater after the special order than before it
- Only take special orders when excess capacity exists
- The organization should be as well off after taking the order as it was before taking it
- Ignore all fixed costs associated with the special order
- To make a decision about a special order, managers need to know whether
- The order replaces regular business
- The customer will buy the same product in the future
- The customer is a not-for-profit organization
- The order has a long-term strategic effect
- Sebastian is a manager at DLL Restaurant. He is considering accepting a special order from a neighborhood homeless shelter for 150 Thanksgiving meals. Which of the following is a relevant qualitative factor he should consider?
- The number of homeless who will be served
- His production capacity
- The potential publicity for his restaurant
- The price concerns of his competitors
- In making a special order decision, which of the following is a relevant fixed cost?
- Incremental fixed costs associated with current business
- Contribution margin of any current business replaced
- Depreciation on existing production equipment
- Incremental fixed costs associated with the order
- A company will only incur an opportunity cost for a special order when
- Current capacity is constrained
- The price of the order is less than its variable cost
- The cost of the order is greater than the average cost for current business
- Qualitative factors can be ignored
- Managers should accept a special order if its price is greater than the sum of
- All variable costs and all fixed costs
- All variable costs and all opportunity costs
- All fixed costs and all opportunity costs
- Variable costs, relevant fixed costs and opportunity costs
Use the following data for the next 2 questions:
Redmond Corporation is closing one of its divisions. Operating data on this division follows:
Sales $80,000
Variable costs 40,000
Overhead 40,000
Overhead consists of $30,000 in salary and $10,000 for rent and insurance. The salary is for the chief engineer, who will continue to work for Redmond even if the division is closed.
- Rent and insurance that will cease if the division is closed is an
- Unavoidable and irrelevant cost
- Unavoidable and relevant cost
- Avoidable and irrelevant cost
- Avoidable and relevant cost
- Assuming all overhead costs continue to be incurred even if the division closes, what will be the effect on overall company profits of closing the division?
- $10,000 decrease
- $40,000 decrease
- $40,000 increase
- $30,000 decrease
- The managers of Adamson Apple Co. are considering dropping one of their product lines. The product line typically has the following revenue and costs:
Sales $100,000
Variable costs 80,000
Contribution margin 20,000
Fixed costs 25,000
Operating loss $ (5,000)
If the product line is discontinued, $4,000 of the fixed costs would be avoided. Also, the freed-up capacity would generate $4,000 of additional contribution margin from the expansion of other product lines. If Adamson discontinues the product line, the effect on overall income will be
- $12,000 decrease
- $8,000 decrease
- $9,000 increase
- $3,000 increase
- Which of the following is an opportunity cost associated with dropping a business segment?
- The revenue given up
- The avoidable fixed costs
- The benefits from using excess capacity for something else
- The increase in employee morale
- Managers should discontinue a business if which of the following is less than the sum of relevant fixed costs and opportunity costs?
- Profit
- Variable cost
- Total cost
- Contribution margin
- Managers should discontinue a business if its contribution margin is less than the sum of
- Relevant fixed costs and opportunity costs
- Relevant fixed costs and sunk costs
- Relevant opportunity costs and sunk costs
- Relevant opportunity costs and profits
- In making a decision to drop a product line, variable costs are
- Always relevant
- Never relevant
- Usually relevant
- Usually sunk
- Yvonne and Ken own and operate Deluxe Housecleaning Service. Which of the following is a qualitative factor associated with dropping carpet cleaning from their current line of services?
- The timeliness with which they can provide other cleaning services
- The quality of their current carpet cleaning equipment
- The potential effect on demand for their other services
- The lost revenue from current customers
- If financial statement data are used to evaluate a decision to discontinue a business
- Average costs are often mistakenly included as relevant information
- Average costs are often correctly included as relevant information
- Qualitative factors are irrelevant
- Financial statement data is useless in this decision-making context
- In the decision to drop a product line, fixed costs are often classified as
- Avoidable or sunk
- Sunk or opportunity
- Product or period
- Incremental or avoidable
- A company manufactures chips used in the production of computers. The chips can be purchased for $50 each from an outside vendor. It costs the manufacturer $60 a chip to produce them, of which 25% is fixed overhead cost. What are the relevant costs for this decision? Based on these costs, which option should the company choose?
Relevant Costs
(Manufacture and Purchase) Decision
- $50 and $45 Manufacture
- $50 and $45 Purchase
- $45 and $40 Purchase
- $45 and $40 Manufacture
- N.G., Inc. currently buys 9,000 subcomponents from an outside supplier at $10 each. The company has excess capacity, which it sublets to another company for $20,000 per year. If the company were to use the idle capacity to produce the subcomponent internally, it would incur variable production costs of $6 per unit, and it would hire a new supervisor for $15,000 per year. Other fixed overhead costs would not change, but the average overhead cost per subcomponent unit would be $2. What is the advantage or disadvantage (in dollars) if N.G. makes the subcomponent instead of continuing to buy outside and subletting the excess capacity?
- $6,000 disadvantage
- $21,000 disadvantage
- $1,000 advantage
- $21,000 advantage
- In deciding whether to manufacture a part or buy it from an outside supplier, which of the following is an irrelevant cost?
- Direct labor
- Variable overhead
- Fixed overhead that will be avoided if the part is purchased from an outside supplier
- Fixed overhead that will continue even if the part is purchased from an outside supplier
- Which of the following statements about outsourcing is true?
- Outsourcing is the process of finding external suppliers
- Outsourcing is not very common in today’s business world
III. Outsourcing is used for manufactured goods, but not for services
- I only
- I and III only
- II and III only
- I, II, and III
- For manufacturers, outsourcing decisions are often known as
- Make or buy
- Routine
- Constrained resource decisions
- Special order decisions
- In an outsourcing decision, the general rule managers should follow is to
- Choose the option with the lowest relevant cost
- Maximize the use of constrained resources
- Outsource if the price is greater than the sum of variable costs and fixed costs
- Do not outsource if the cost is less than the sum of relevant fixed costs and opportunity costs
- In an outsourcing decision, fixed costs are
- Never relevant
- Relevant if they are greater than associated opportunity costs
- Relevant if the company is operating outside the relevant range
- Relevant if they can be avoided through outsourcing
- PQK Corporation produces and sells bookends. Its managers are considering whether to outsource the task of cutting the wood for the bookends to DLN Corporation. Which of the following is most likely to be a qualitative factor that managers will consider in making the decision?
- Cost of delivery
- Timeliness of delivery
- Whether DLN will outsource the delivery process
- Depreciation on DLN’s fleet of delivery trucks
- Financial institutions often consider outsourcing their information technology functions internationally. Which of the following are qualitative factors that should managers consider in the decision?
- Potential language barriers
- Political stability
III. The tax cash flows
- I only
- II and III only
- I, II, and III
- I and II only
- In general, a company should outsource if the cost to buy is
- Less than the sum of variable costs and fixed costs
- Less than the relevant variable costs.
- Greater than or equal to (variable costs + relevant fixed costs – opportunity costs)
- Less than or equal to (variable costs + relevant fixed costs – opportunity costs)
- Which of the following is an opportunity cost that should be considered in an outsourcing decision?
- Avoidable fixed costs
- Benefits from alternate uses of released capacity
- Unavoidable fixed costs
- Employee morale
- Managers should generally consider opportunity costs in both “keep or drop” and “make or buy” decisions. Which of the following is an opportunity cost they should consider in both situations?
- Avoidable fixed costs
- Benefits from alternate uses of released capacity
- Depreciation on new machinery
- Market share
Use the following data for the next 2 questions:
Amsat Company has equipment that is in high demand, but has a limited amount of time available. The equipment can be used to produce a number of different products. The following data are available:
Unit Variable Units
Product Unit Price Cost Per Hour
L $400 $200 8
M 300 150 22
N 600 250 8
O 200 100 20
- Which product should be emphasized first?
- L
- M
- N
- O
- Which product should be emphasized last?
- L
- M
- N
- O
Use the following data for next 2 questions:
Tieton Co. has two departments, Fabrication and Assembly. They produce 2 products. Product T needs 6 hours in fabrication and 6 hours in assembly. Product S needs 2 hours in fabrication and 4 hours in assembly. Fabrication has 24 hours available and Assembly 18. Total variable costs are $ 20 and $15 for T and S respectively. T sells for $22 and S for $16.
- The objective function to maximize Tieton’s profits is
- MAX$22T+ $16S
- MAX$20T+ $15S
- MAX$1T + $2S
- MAX$2T + $1S
- The constraints for Tieton’s 2 departments are
- 6T + 2S <= 24 AND 6T + 4S <= 18
- 6T + 2S <= 18 AND 6T + 4S <= 24
- 6T + 6S <= 24 AND 2T + 4S <= 18
- 6T + 6S <= 18 AND 2T + 4S <= 24
- Flox Hill Consulting has its own printing department with the following annual costs:
Supplies $400,000
Labor 300,000
Overhead 200,000
Total $900,000
The managers would like to outsource the printing function because it is not considered a core competency. The overhead is 60% fixed. Of the fixed overhead, $60,000 is the salary of the printing department director. The remaining overhead is an allocation of overhead costs for the entire consulting firm. The department director would still oversee the printing activities and coordinate all of the printing activities for the organization with the outside printing vendor. The maximum amount that Flox Hill is willing to pay an outside firm to replace the printing services is
a $820,000
b $900,000
- $700,000
- $840,000
- A company should always promote the product
- With the highest per unit contribution margin
- That results in the highest total contribution margin
- With the lowest variable cost per unit
- With the least waste
- The shadow price of a slack variable in a linear programming solution that maximizes the total contribution margin reflects
- The amount of excess capacity available for the associated constraint
- The decrease in contribution margin that occurs if a unit of the associated product is produced
- The contribution margin returned by the firm’s profitable product
- The increase in contribution margin that would occur if another unit of the constrained resource were available
- When resources are constrained, managers should emphasize the product with the
- Highest contribution margin per unit
- Highest contribution margin per unit of constrained resource
- Lowest average cost
- Largest market share
- When resources are constrained, managers are most likely to use the following method to develop decision making information
- Simple or multiple regression
- Analysis at the account level
- Linear programming
- High-low method
- In a linear programming problem, slack resources are the same as
- Idle capacity
- Constraints
- Limits on production
- Mixed costs
- Managers relax constraints by
- Using constrained resources more effectively
- Increasing available resources
III. Emphasizing the product with the highest contribution margin per unit
- I only
- II only
- I and II only
- I, II, and III
- If an organization cannot deliver goods or services quickly because of a constraint, managers might relax that constraint to
- Protect customer loyalty
- Ensure optimal profitability
- Increase the selling price of the product
- Find the next bottleneck
- In a special order decision, which of the following is most likely a qualitative factor that managers should consider?
- Can we deliver without disrupting current schedules?
- Will layoffs affect worker morale?
- Does this order reflect our core competencies?
- Will the decision affect future supply costs?
- Effect on brand name recognition is a qualitative factor that managers should consider in
- Product line keep and drop decisions
- Special order decisions
- Cost prediction decisions
- Make or buy decisions
- To ensure high quality in outsourcing decisions, organizations typically negotiate contracts with
- A high margin for error
- No uncertainties
- Specific performance criteria
- The lowest overall cost
- Why are qualitative factors often difficult to identify?
- They are unimportant in decision making
- No set formula provides assurance that managers have considered the correct issues
- They are only important when a company operates internationally
- Qualitative factors are not difficult to identify
- Which of the following is a relevant qualitative factor in a special order decision?
- The cost of constrained resources
- The effect of production processes on the political environment
- The effect of production processes on the legal environment
- How easily customers might share price information
- “Whether delivery timeliness is an important factor” is an example of a
- Quantitative factor
- Qualitative factor
- Constrained resource
- Cost driver
- Accuracy of cost estimates is one of the uncertainties in this type of decision.
- Special order
- Make or buy
III. Product emphasis
- I and II only
- I and III only
- II and III only
- I, II, and III
- Factors that affect information quality in operating decisions include:
- Uncertainties
- Timeliness
III. Analysis technique assumptions
- Overall cost structure
- I, III, and IV only
- II, III, and IV only
- I, II, and III only
- I and IV only
- For which of the following decisions is vendor reliability a major uncertainty?
- Constrained capacity
- Special order
- Outsourcing
- International
- Future revenues and costs are often a source of uncertainty for management decisions. Future revenues and costs can be affected by
- Economic environment changes
- Customer demand
III. Government regulation
- Forecasting techniques
- I and IV only
- I and II only
- I, II, and III only
- I, II, III, and IV
- General decision rules associated with outsourcing decisions assume the organization’s goal is to
- Minimize constraints
- Maximize short-term profits
- Capture market share
- Report financial information reliably
- The assumption that organizations seek to maximize short-term profits ignores
- Qualitative factors
- Fixed costs
- Constrained resources
- Managers’ desire for bonuses
- Uncertainties affect
- Special order decisions and outsourcing decisions, but not product emphasis decisions
- Special order and product emphasis decisions, but not outsourcing decisions
- Product emphasis and outsourcing decisions, but not special order decisions
- Special order decisions, outsourcing decisions and product emphasis decisions
- Depreciation is irrelevant in decision making
- Under any circumstances
- If it relates to equipment not yet purchased
- If it relates to equipment already on hand
- If it is different for each alternative
- A cost that has been incurred in the past and cannot be changed is a (an)
- Short-term cost
- Opportunity cost
- Sunk cost
- Variable cost
- Mr. Bigletter is employed at an annual salary of $25,000. He plans to start his own business and estimates that he can gross $30,000 annually. If he chooses to open the new business, his foregone salary is a (an)
- Irrelevant cost
- Sunk cost
- Opportunity cost
- Incremental cost
Use the following information for the next 3 questions.
Horton and Associates produces two products named BigBlast and LittleBlast. Last month 4,000 units of BigBlast and 1,000 units of the LittleBlast were produced and sold. Following are average prices and costs for last month:
BigBlast LittleBlast
Selling price $100 $200
Direct materials (25) (75)
Direct labor (15) (35)
Variable overhead (5) (30)
Product line fixed costs (10) (40)
Corporate fixed costs (25) (25)
Average margin per unit $ 20 $( 5)
The production lines for both products are highly automated, so large changes in production cause very little change in total direct labor costs. Workers who are classified as direct labor monitor the production line and are permanent employees who regularly work 40 hours per week. All costs other than “corporate fixed costs” listed under each product line could be avoided if the product line were dropped.
- Using only the information provided above, Horton could make several types of decisions. Possible decisions include
- Keep or drop
- Product emphasis
III. Special order
- Constrained resources
a I and II only
b I and III only
- I, II, and IV only
- III and IV only
- What is the breakeven sales volume (in units) for BigBlast? (In other words, what is the sales volume at which Horton should be financially indifferent between dropping and keeping BigBlast?)
a 728 units
b 2,545 units
- 1,084 units
- 790 units
- The following qualitative factors are relevant to Horton’s decision.
- Would dropping one product affect the sales of the other product?
- Are all product line fixed costs completely avoidable?
III. Would layoffs affect other workers’ morale?
a I only
b I and III only
- I, II, and III
- II and III only
Use the following data for the next 2 questions:
A manufacturer operating with excess capacity has been asked to fill a special order at $7.25 per unit. The regular price is $10 per unit. No other use of the currently idle capacity can be found. The manufacturer’s usual variable costs per unit are $3.50 for direct materials, $2.00 for direct labor, $1.00 for variable overhead, and $0.50 for sales commission. No sales commission would be paid on this special order. The average fixed overhead cost per unit is $0.25.
- Under the general decision rule, the minimum price per unit for this special order is
- $7.25
- $6.50
- $7.00
- $7.50
- Assume there is no excess capacity (i.e., the company can sell every unit that it produces to regular customers). Under the general decision rule, the minimum price per unit for this special order would be
a $10.00
b $7.25
- $5.75
- $6.50
More Difficult Multiple Choice
These multiple choice questions require more complex computations or present information differently than in the textbook.
Use the following data for the next 2 questions:
Growe Company manufactures sewing machines and requires 30,000 units of a component that is used in the manufacturing process. If Growe buys the part from Zigler Brothers, the plant will be idle. Of the fixed, 55% overhead will continue regardless of the decision. The cost to buy the part from Zigler is $46. The unit cost to make the part is:
Direct materials $12
Direct labor 20
Variable overhead 12
Average fixed overhead 10
Total $54
- Relevant costs to make the part are
- $1,320,000
- $1,380,000
- $1,620,000
- $1,455,000
- Which alternative is more profitable and by what amount?
- Buy, $150,000
- Make,$150,000
- Buy, $75,000
- Make, $75,000
- Tyke, Inc. produces 2 products A and B, each requiring direct material and labor. Total labor available is 200 hours, and 300 pounds of material. Each unit of A sells for $10, and B sells for $15. Given the following linear programming information:
Maximize: $4A + $5Y
Subject to: 3A + 1B ≤ 200
2A + 2B ≤ 300
What are the variable costs per unit for A and B?
- $4 and $15
- $14 and $19
- $6 and $10
- $7 and $14
- The Wasson Widget Co. has 1,000 obsolete widgets on hand. These units were produced a year ago at a cost of $10,000. The units could be scrapped for $1,000 or reworked for $2,000 and sold for $5,000. Which alternative is desirable and why?
- Scrap, income of $1,000 is higher than the other option
- Rework, incremental loss $7,000
- Rework, income of $3,000 is higher than the other option
- Scrap, incremental loss $9,000
Use the following data for the next 2 questions:
Vicade has 1,000 commercial video game machines in inventory produced at a cost of $400 each (60% variable and 40% fixed). The machines were to have been sold for $1,000 each. However, the machines currently contain a minor malfunction, reducing their selling price to $150 each. The company could correct the malfunction at a variable cost of $250 each, and then sell the machines for $550 each.
- For purposes of determining whether the machines should be reworked, what is the opportunity cost per unit?
- $150
- $200
- $240
- $400
- If the games are reworked, what will be the contribution per unit from doing so?
- $350
- $300
- $150
- $100
Multiple Choice from Study Guide
^{s}84. Each year Wright’s Widgets buys 10,000 subcomponents that it needs in the production of its widgets from an outside supplier for $15 each. If Wright instead used its existing idle capacity to produce it in-house, the variable production costs would be $8 per unit and $3 of fixed production overhead would be allocated to each unit. Additionally, Wright would need to hire one quality control technician for $28,000 per year. The excess capacity that would be required is currently leased to another company for $25,000 per year. What is the advantage or disadvantage if Wright continues to buy the subcomponent from the outside supplier?
- $13,000 advantage
- $17,000 disadvantage
- $37,000 advantage
- $3,000 disadvantage
Use the following information for the next 3 questions.
Taylor Enterprises sells its product for $40 per unit. Taylor recently received a special order from a customer for 20,000 units. Production costs per unit for regular sales are:
Direct materials $ 6
Direct labor 14
Manufacturing overhead (2/3 variable) 12
^{s}85. Suppose the special order price is $600,000 for all 20,000 units, and assume that Taylor has sufficient capacity to fill the special order. Should it be accepted?
- Yes, because profits will increase by $120,000
- No, because profits will decrease by $200,000
- No, because profits will decrease by $40,000
- Yes, because profits will increase by $40,000
^{s}86. Suppose that Taylor would like to earn $50,000 on this order and assume that there is sufficient capacity to fill the special order. What price per unit should Taylor charge for the special order?
- $34.50
- $42.50
- $30.50
- $26.50
^{s}87. Suppose that the special order price is $600,000 for all 20,000 units, but there is not sufficient capacity to fill the order; 8,000 units of regular business will be replaced by the special order if it is accepted. Should Taylor accept the special order and why?
- No, because profits will decrease by $56,000
- Yes, because profits will increase by $40,000
- No, because profits will decrease by $24,000
- No, because profits will decrease by $280,000
^{s}88. Moore Manufacturing has two major product lines, Gidgets and Gadgets. Income statements for the two product lines follow:
Gidgets Gadgets
Revenues $400,000 $400,000
Variable costs 225,000 150,000
Product line fixed costs 130,000 100,000
Allocated corporate fixed costs 120,000 90,000
Operating income (loss) $(75,000) $60,000
If the Gidget product line were dropped, all of its product line fixed costs could be avoided. Should the Gidget product line be dropped, and why?
- Yes, profits increase $75,000
- No, profits decrease $45,000
- No, profits decrease $55,000
- No, profits decrease $175,000
Use the following information for the next 4 questions.
Solo Co. made and sold 100,000 of its only product in 2004. Solo’s income statement for 2004 follows:
Sales $1,000,000
Direct materials 300,000
Direct labor 150,000
Variable manufacturing overhead 50,000
Fixed manufacturing overhead 100,000
Gross margin 400,000
Variable selling & administrative costs 75,000
Fixed selling & administrative costs 60,000
Operating income $265,000
In 2005, Solo expects to produce and sell 80,000 units, and the selling price and variable costs per unit will remain unchanged. One third of the direct materials costs are for a subcomponent that Solo purchases from an outside supplier. In 2005, Solo will be producing the component internally for $0.75 per unit.
^{s}89. What is the contribution margin per unit in 2005?
- $5.25
- $4.50
- $2.81
- $0.81
^{s}90. What is the expected operating income in 2005?
- $232,000
- $90,000
- $200,000
- $105,000
^{s}91. What is the effect on 2005 profits of Solo’s decision to produce the component internally?
- Increase by $25,000
- Increase by $20,000
- Decrease by $65,000
- Decrease by $33,000
^{s}92. Relevant costs in a special order decision include all of the following except
- Direct materials costs of $3 per unit
- Fixed cost of $1500 for rental of a machine needed to produce the order
- Contribution margin per unit of regular sales when there is sufficient capacity to produce the order
- Unusual shipping charges paid by Solo of $4 per unit for the special order
Use the following information for the next 3 questions.
Loso Co. made and sold 100,000 of its only product in 2004 for $15 each. Loso’s costs per unit for 2004 follow:
Direct materials $ 5.00
Direct labor 2.00
Variable manufacturing overhead 1.00
Fixed manufacturing overhead 1.50
Variable selling & administrative costs 0.80
Fixed selling & administrative costs 0.50
Total $10.80
In 2005, Loso expects to produce and sell 80,000 units. The selling price and variable costs per unit will remain unchanged, as will total fixed costs. Early in 2005, a new customer approaches Loso and requests a one-time special order for 30,000 units.
^{s}93. What are total budgeted fixed costs for 2005?
- $160,000
- $150,000
- $120,000
- $200,000
^{s}94. Suppose the special order will incur only half the regular variable selling & administrative costs and will require the rental of a special grinding machine for $15,000. Assume the capacity of Loso is 120,000 units per year. What is the minimum price per unit for the special order that Loso should accept?
- $9.00
- $8.90
- $11.00
- $10.90
^{s}95. Suppose the special order will incur only half the regular variable selling & administrative costs and will require the rental of a special grinding machine for $15,000. Assume the capacity of Loso is 100,000 units per year. What is the minimum price per unit for the special order that Loso should accept?
- $10.97
- $15.10
- $11.10
- $15.50
Use the following information for the next 3 questions.
Ricardo Company has three products, A, B, and C. The following information is available:
Product A Product B Product C
Sales $30,000 $70,000 $34,000
Variable costs 18,000 27,000 18,000
Contribution margin 12,000 43,000 16,000
Fixed costs:
Avoidable 4,500 12,000 12,000
Unavoidable 3,000 10,000 6,200
Operating income $ 4,500 $21,000 $ (2,200)
^{s}96. If Ricardo drops Product C, then operating income will
- Increase by $2,200
- Decrease by $16,000
- Decrease by $4,000
- Decrease by $9,800
^{s}97. Suppose that eliminating Product C will free up warehouse space for Product A’s use, and will reduce the avoidable fixed costs of Product A by $1,500. If Ricardo drops Product C, then operating income will
- Increase by $3,700
- Decrease by $14,500
- Decrease by $8,300
- Decrease by $2,500
^{s}98. Suppose that eliminating Product C will reduce sales of Product B by 10%. If Ricardo drops Product C, then operating income will
- Decrease by $11,000
- Decrease by $6,100
- Decrease by $4,300
- Decrease by $8,300
Use the following information for the next 3 questions.
Clark, Inc. makes 3 products, B, C, and D. Clark only has 110 machine hours available each week. Contribution margin, machine hour requirements, and weekly customer demand information is as follows:
B C D
Contribution margin per unit $8 $4 $7
Machine hours required per unit 0.6 0.4 0.2
Weekly customer demand 200 600 100
^{s}99. In what order should the products be produced?
- B, C, D
- C, D, B
- D, B, C
- B, D, C
^{s}100. How many units of each product should be produced?
- 200 Bs, 0 Cs, and 100 Ds
- 150 Bs, 0 Cs, and 100 Ds
- 0 Bs, 600 Cs, and 0 Ds
- 200 Bs, 100 Cs, and 100 Ds
^{s}101. What is the maximum amount that Clark would be willing to pay, above the normal cost, for one more machine hour per week?
- $10.00
- $13.33
- $35.00
- $0.00
^{s}102. Quantitative factors in a nonroutine operating decision
- Include nonfinancial information
- Could never include product quality considerations
- Are always relevant to a nonroutine operating decision
- Are of a higher quality than qualitative factors
^{s}103. Qualitative information used in a make or buy decision is least likely to include
- Reliability of the supplier
- Quality of the supplier’s product
- Effect of purchasing a component on the company’s long-term strategic plan
- None of the above (all are good examples of qualitative information)
Use the following information for the next 3 questions.
Karl, Inc. makes 2 products, W and X. Karl only has 100 machine hours and 400 labor hours available each week. Customer demand for both products is unlimited. Contribution margin and machine and direct labor hour requirements are as follows:
W X
Contribution margin per unit $12 $28
Machine hours required per unit 1.2 2.2
Labor hours required per unit 2.4 4.4
^{s}104. Which of the following statements is true?
- The machine hour constraint is slack
- The labor hour constraint is binding
- Karl should only produce one product
- This problem cannot be solved without using software or tedious mathematical computations not covered in this chapter
^{s}105. What is the optimal production plan?
- Produce 83 Ws and no units of X
- Produce 45 Xs and no units of W
- Produce 83 Ws and 45 Xs
- This problem cannot be solved without using software or tedious mathematical computations not covered in this chapter
^{s}106. How much would Karl be willing to pay, above the normal cost, to obtain one more machine hour and one more labor hour, respectively?
- $12.73 and $6.36
- $12.73 and $0
- $10.00 and $0
- This problem cannot be solved without using software or tedious mathematical computations not covered in this chapter.
^{s}107. Which of the following is considered a bottleneck in a product emphasis/constrained resource decision?
- Employees need to be paid extra when they work overtime
- The company’s 12 machines can only operate 18 hours per day
- Customer demand for product A is limited to 1,200 units per month
- All of the above are considered bottlenecks
^{s}108. Which of the following is true?
- In a product emphasis/constrained resource decision with 2 products and 2 constraints, it will always be optimal to make both products
- In a product emphasis/constrained resource decision with 2 products and 1 constraint, it will always be optimal to make only one product
- Product emphasis/constrained resource decisions with more than 2 products and more than 2 constraints cannot be solved without software
- All of the above are true
Multiple Choice from Web Quizzes (Available on Student Web Site)
^{w}109. The following information is always relevant for short-term decisions:
- Fixed costs
- Unavoidable costs
- Sunk costs
- Incremental costs
^{w}110. Variable costs are important for which type of relevant cost decisions?
I Special order
II Outsourcing
III Keep or drop a product
- I and II only
- II and III only
- I and III only
- I, II, and III
^{w}111. Under the general decision rule for relaxing a constraint, managers are willing to pay
- Only what they pay now
- Up to the entire contribution margin per unit of constrained resource
- What they pay now plus some or all of the contribution margin per constrained resource
- Less than what they pay now
^{w}112. A bottleneck
- Is not a capacity constraint
- Has an opportunity cost of lost revenue from unmet demand
- Is unrelated to capacity
- Cannot be used efficiently
Use the following information for the next 2 questions.
A manufacturer operating with excess capacity has been asked to fill a special order at $7.25 per unit. No other use of the currently idle capacity can be found. The manufacturer’s usual variable costs per unit are $3.50 for direct materials, $1.50 for direct labor, $1.50 for variable overhead, and $0.50 for sales commission. No sales commission would be paid on this special order. The average overhead per unit is $0.25.
^{w}113. The expected contribution margin per unit for the special order is
- $0.00
- $0.25
- $0.75
- $1.00
^{w}114. Under the general decision rule, the minimum price per unit for this special order is
- $7.25
- $6.50
- $7.00
- $7.50
^{w}115. A constraint is
- A limited resource that is not binding in that it does not slow down the manufacturing or service delivery process
- A limited resource that restricts an organization’s ability to provide enough products or services to satisfy demand
- A service that an organization has decided to discontinue
- A product that an organization has decided to discontinue
^{w}116. When an organization faces multiple constraints for multiple products, what kind of quantitative analysis needs to be performed?
- Use the same technique as for a special order
- No quantitative analysis, because there is no way to use constrained resources optimally
- A linear programming analysis that optimizes the contribution margin per constrained resource
- Rank products on contribution margin and pick the product with the highest one
^{w}117. How are constrained resources and relevant ranges related?
- Resources are usually constrained within their relevant ranges
- If production is beyond the capacity limit, resources are probably constrained, and production is outside of the relevant range
- When constrained resources are relaxed or elevated, the relevant range does not change
- There is no relation between constrained resources and relevant ranges.
^{w}118. Suppose a manager decides to sell a special order at the breakeven price. However, he is concerned that the organization could lose money if there are any errors in the analysis. About which factor should the manager be concerned?
- The accuracy of the cost function
- Current demand
- Opportunity costs
- Sunk costs
^{w}119. The general decision rule for choosing products to emphasize, assuming no constraints and no relevant qualitative factors, is to emphasize products
- That people like
- With the highest contribution margin per unit
- With lowest average costs
- That are easy to manufacture
^{w}120. If a firm has no extra capacity and a customer asks for a special order, what price is acceptable (assuming there are no relevant qualitative factors)?
- The regular price because this order replaces regular business
- Only variable cost
- Variable cost plus average fixed cost
- Only the average fixed cost
^{w}121. The general rule is to keep any product or service in the short term
- That can be sold
- That covers variable costs
- That covers variable costs plus any fixed costs that can be avoided if the product or service is dropped
- If it covers part of the avoidable costs
^{w}122. When deciding whether to outsource or insource a product or service, managers consider
- The reliability of the product or service supplier
- All of the fixed costs
- Only the variable costs
- No qualitative factors
^{w}123. A not-for-profit organization provides meals and medicine for homeless people. Because of funding cutbacks, one of the two services must be curtailed. To make this choice, managers are likely to consider all of the following except
- The volume of each service that can be provided with existing funding
- The number of other organizations providing each service
- Future funding possibilities
- The cost of the building housing the program
^{w}124. (CMA) What is the opportunity cost of making a component part in a factory given no alternative use of the capacity?
- The variable manufacturing cost of the component.
- The total manufacturing cost of the component.
- The total variable cost of the component.
- Zero
^{w}125. (CMA) Hillary Corporation has its own cafeteria with the following annual costs:
Food $200,000
Labor 150,000
Overhead 220,000
Total $575,000
The overhead is 40% fixed. Of the fixed overhead, $50,000 is the salary of the cafeteria supervisor. The remainder of the fixed overhead has been allocated from total company overhead. Assuming the cafeteria supervisor will remain and that Hillary will continue to pay her salary, the maximum cost Hillary is willing to pay an outside firm to replace the cafeteria services is
- $575,000
- $350,000
- $438,000
- $482,000
^{w}126. (CMA) Callow Company has considerable excess manufacturing capacity. A special job order’s cost sheet includes the following allocated manufacturing overhead costs:
Fixed costs $42,000
Variable costs 66,000
The fixed costs include a normal $7,400 allocation for in-house design costs, although no in-house design will be done. Instead, the job will require the use of external designers costing $15,500. What is the total amount to be included in the calculation to determine the minimum acceptable price for the job?
- $73,000
- $81,500
- $108,000
- $116,100
Matching
- Various general decision rules are used for different kinds of operating decisions. The types of operating decisions are listed below on the right; decision rules are listed on the left. Match each decision rule with the appropriate decision type. Each numbered item has only one correct answer. Each lettered item may be used once, more than once, or not at all.
____ 1. Accept if price is greater than or equal to the sum of variable costs, relevant fixed costs and opportunity costs
____ 2. Drop if the contribution margin is less than the sum of relevant fixed costs and opportunity costs ____ 3. Emphasize the product with the highest contribution margin per unit if resources are not constrained ____ 4. If resources are constrained, emphasize the product with the highest contribution margin per unit of the constrained resource ____ 5. If the price is greater than or equal to the sum of variable costs and opportunity costs, accept the order ____ 6. Keep work inside if the cost to buy is less than or equal to the sum of variable costs and relevant fixed costs ____ 7. Make the product if the cost to buy is greater than or equal to the difference between variable costs and opportunity costs ____ 8. Outsource if the cost to buy is greater than or equal to the sum of variable costs and relevant fixed costs, less opportunity costs ____ 9. When operating with resource constraints, emphasize the product with the highest overall profit margin ____ 10. When resources are constrained, sell as much as possible of the product with the highest price |
A. Special order
B. Product emphasis C. Keep or drop business segment D. Insource or outsource E. None of the above |
Exercises
- Jones Corporation prepared the following budgeted income statement at the beginning of the current year:
Expected sales (80,000 units) $400,000
Operating costs:
Variable costs $220,000
Fixed costs 100,000 320,000
Operating income $ 80,000
During the middle of the year, the managers estimated that regular sales would amount to only 70,000 units. Recently, a foreign company requested a special order for 10,000 units at a price of $4. If the order is accepted, each unit must be stamped with the customer’s name. This would require the purchase of a stamping machine for $10,000 that could only be used for this order.
- Determine the relevant costs for the special order decision.
- What will be the effect on overall company profits if the order is accepted?
- National Motors manufactures cars and currently uses only 50% of its manufacturing facility (20,000 cars). The company could utilize more of its facility by producing its own tires. It currently purchases tires at $30 per set of four. National would incur $12 per set for direct materials, $10 for direct labor, and $24 for overhead (which is 30% variable) if it produces the tires.
- Should National Motors make or buy the tires? Provide calculations that support your answer.
- Suppose National Motors could rent the unused portion of its plant and receive $1,500 a month. Should the company make or buy the tires? Provide calculations that support your answer
- List two qualitative factors that could affect this decision.
- Speedy Sports manufactures three kinds of tennis rackets. However, Speedy has a limited number of machine hours available to make these items. The following data pertain to each racket:
Wood Steel Graphite
Machine time per unit 48 min. 50 min. 75 min.
Unit sales price $25 $30 $50
Unit variable cost 15 19 34
Unit contribution margin $10 $11 $16
- In what order should the rackets be produced?
- Assume there are 1,200 machine hours available and that demand is 200, 600, and 500 units, respectively, for wood, steel, and graphite. Determine how many units of each should be produced.
- What is the maximum amount that Speedy would be willing to pay per machine hour to relax the constraint?
- Skiing Accessories has 3,000 machine hours of plant capacity available for manufacturing sun goggles. Following is information about these products.
Premium Regular
Selling price per unit $50 $30
Variable cost per unit $35 $10
Units that can be manufactured per machine
hour on the same production line 8 5
Estimated demand 12,000 goggles 21,000 goggles
- How many machine hours should be devoted to the manufacture of each product?
- What is the maximum amount that Skiing Accessories would be willing to spend to increase capacity?
- Kleindale Company currently manufactures a subassembly for its main product. The costs per unit are as follows:
Direct materials $ 1.50
Direct labor 15.00
Variable overhead 8.00
Average fixed overhead 32.00
Total $56.50
Merriman Corp has contacted Kleindale with an offer to outsource 5,000 subassemblies for $40.00 each. Kleindale would eliminate $100,000 of fixed overhead if it accepts the proposal.
- Should Kleindale make or buy the subassemblies? Provide calculations to support your answer.
- At what volume of subassembly production would Kleindale generally be indifferent to making or buying the subassembly?
- List two qualitative factors that might influence this make or buy decision.
- Fast Bikes manufactures bicycles for mountain and road use. At its plant in Yuma, it assembles two bikes: premier and regular mountain bikes. Here is information for these bikes.
Premier Regular
Selling price $1,600 $1,000
Variable costs per unit 1,200 500
Contribution margin per unit $400 $ 500
Contribution margin ratio 25% 50%
Variable costs include only direct materials and direct labor. There are only 600 machine hours available each day for manufacturing the bikes. Additional capacity cannot be obtained in the short run. Fast Bikes can sell as many of these mountain bikes as it produces. Premier bikes require 2 machine-hours each, and regular bikes require 5 machine-hours each.
- Which product should Fast Bikes emphasize?
- Currently there are no variable costs associated with machine operations; all costs are fixed. Up to what maximum amount per machine-hour would Fast Bike be willing to pay to increase the number of machine hours available?
- Weisbach Wallets (WW) produces nylon waterproof wallets. WW’s plant capacity is 50,000 per month. Unit costs for the current production volume of 48,000 wallets are:
Direct materials $6.00
Direct labor 4.00
Variable overhead 1.50
Fixed overhead 3.00
Marketing – fixed 1.00
Marketing – variable 2.80
Current monthly sales are 48,000 wallets at $18 each. Suppose REI Phoenix has contacted the manufacturing plant at WW about purchasing 2,000 units at $13 each. Current sales would not be affected by this order.
- Should WW accept this special order? Provide computations to support your answer.
- What is the minimum price that WW would generally accept for this order?
- List two qualitative factors that should be considered for this decision.
- Cowboy Boots Company produces two products: Fun and Fancy Boots. Last month 2,000 units of Fun Boots and 4,000 units of Fancy Boots were produced and sold. Average prices and costs for the two products in that month are displayed below.
Fun Fancy
Selling price $95 $225
Direct materials 40 95
Direct labor 7 25
Variable overhead 3 15
Product line fixed costs 15 45
Headquarters fixed costs 20 20
Average margin per unit $10 $ 25
The production lines for both products are highly automated, so large changes in production entail very little change in total direct labor costs. Workers who are classified as direct labor monitor the production line and are permanent employees who regularly work 40 hours per week.
All product-line costs, other than “corporate fixed costs,” could be avoided if the product line were dropped. Headquarters fixed costs totaled $120,000 and the total sales amounted to 6,000 units, so the average corporate fixed cost per unit was $20. About $18,000 of the corporate fixed costs could be avoided if Fun Boots were dropped, and about $12,000 of the corporate fixed costs could be avoided if Fancy Boots were dropped. The remaining $90,000 could be avoided only by going out of business entirely.
- What is the overall corporate breakeven in total sales revenue, assuming the sales mix is the same as last month’s?
- What is the breakeven sales volume (in units produced and sold) for Fun Boots? (In other words, what is the sales volume at which Cowboy should be financially indifferent between dropping and retaining Fun Boots?)
- Yogurt Supreme sells yogurt cones in a variety of natural flavors. Data for a recent month appear below:
Revenue (10,000 cones @ $0.93 each) $9,300
Cost of ingredients $3,500
Rent 2,500
Store attendant 1,800 7,800
Income $1,500
- The manager has received a call from a club requesting a bid on 100 cones to be picked up in 3 days. The cones could be made up well in advance by the store attendant during slack periods. Each cone would require, however, a special plastic cover that costs $0.05. What is the minimum acceptable price per cone for this special order?
- If the club is able to pay no more than the minimum price, what other considerations may affect the decision? List two.
- Quick Clean sends workers to homes and offices to perform cleaning services for special occasions. There are 4 different outlets and one headquarters for the company. Headquarters’ costs are allocated to outlets using a rate of 30% of revenue. The income statement for one of the outlets for last year was as follows:
Revenue (500 visits) $200,000
Costs:
Direct labor wages ($160 per visit) $80,000
Rent and insurance 20,000
Variable selling and administrative 10,000
Fixed selling and administrative 35,000
Allocated headquarters costs 60,000 205,000
Income $( 5,000)
- Quick Clean wants to know whether this outlet should be dropped. Identify the relevant cash flows and make a recommendation to management about this decision.
- List one qualitative factor that might affect this type of decision.
Short Answer
- List two different types of nonroutine operating decisions, and give an example of each one for a retail hardware store.
- When an organization faces constrained resources, there are several ways to either relax the constraint or maximize the use of it. List two actions an organization could take to minimize the effects of a constraint or to relax it.
- Describe quantitative and qualitative information, and explain why both are important in managementdecision making.
- List two qualitative factors that need to be considered when making a decision about whether to accept a special order.
- Donald is the sales manager of DVL Corporation. He is considering accepting a special order with a positive contribution margin. The order would require the company to purchase special equipment. Nevertheless, Donald estimates that the special order would contribute $10,000 to DVL’s profits during the current quarter. Discuss the factors that Donald should consider in deciding whether to accept the special order.
- Nancy is the sales manager of VLP Corporation, which manufactures and sells slipcovers for household furniture. The current selling price of a slipcover is $150. Nancy has the opportunity to fill a special order for slipcovers at a price of $140 each. Describe three uncertainties that Nancy faces in making the special order decision.
- NSL Corporation produces and sells bookcases and magazine racks. Its production operation is organized into three parts: fabrication (where the wood and other raw materials are cut), assembly (where the cut materials are assembled into finished products), and painting (where the final products are painted and prepared for customers). NSL is considering outsourcing one of the three functions, each of which would have an equal financial effect on the corporation overall. Discuss why each of the following qualitative factors might be so important that it could override quantitative considerations for this decision.
- Ability to ensure high quality
- Timeliness of delivery
- Whether NSL’s managers consider the function to be a core competency
- Describe the costs that are usually relevant to a make or buy decision.
- Describe two assumptions that need to be met when considering whether to keep or drop a product.
- What types of opportunity costs are considered in both keep or drop and make or buy decisions?
- Financial statement information uses average costs (variable plus average fixed overhead) to calculate cost of goods sold and to value inventory. Are these average costs useful in making operating decisions? Explain.
Problems
- State University is organized into four colleges with the following characteristics:
Business Engineering Science Humanities
Number of majors 5,000 4,500 4,800 1,200
Number of non-majors taking classes 1,000 500 2,400 3,600
Revenue from student fees $600,000 $500,000 $720,000 $480,000
Revenue from external grants $200,000 $1,500,000 $800,000 $120,000
Variable cost per student $35.00 $65.00 $80.00 $25.00
Fixed cost per student (based on total students) $35.00 $55.00 $25.00 $10.00
- List three items that would likely be included in the category of variable costs per student from the perspective of each college.
- List two items that would likely be included as fixed costs per student from the perspective of each college.
- Calculate the contribution margin per student from the perspective of each college and then from the perspective of the university as a whole.
- Calculate the total profit from the perspective of each college and then for the university as a whole.
- Based on financial considerations alone, identify the college that would be most likely to be dropped from the university during a budget crisis. Then identify the candidate that would least likely be dropped.
- List three uncertainties about the quantitative analyses you performed in part (e).
- List three qualitative issues that should be considered in making a decision to drop one of the colleges.
- Spinning Wool currently produces and sells three different types of yarn. Total demand for the yarn exceeds the firm’s capacity. The constraint on production is the time available on a special machine that cleans the wool used for the yarn. Data on the products and time required on the special machine are summarized in the following chart.
Type of Yarn
Fine Medium Coarse
Selling price $24 $30 $36
Variable manufacturing cost $12 $18 $11
Variable marketing cost $2 $2 $6
Fixed cost per lot $5 $8 $10
Machine hours needed per lot 0.2 0.25 0.5
Maximum demand (in lots) per period 4,000 3,750 5,000
The firm has only 2,500 hours of time available on the special machine per period. Fixed costs are $100,000 per period, which will not change if the product mix changes or if any products are dropped.
- Which product should Spinning Wool emphasize? Show your calculations.
- Up to how much per hour should Spinning Wool be willing to pay to increase capacity on the special machine?
- Describe two reasons why the managers cannot be certain that they have accurately estimated the product selling prices.
(continued on next page)
- Describe two reasons why the managers cannot be certain that they have accurately estimated the product variable costs.
- Discuss how the uncertainties in parts (c) and (d) are likely to affect the managers’ product emphasis decisions at Spinning Wool.
- Franklin Manufacturing has just received an offer from a supplier to buy 12,000 units of a computerized component used in its main product. The component is currently produced internally. The supplier has offered to sell the component for $75 per unit. The estimated costs of producing it are given below.
Direct materials $30
Direct labor $15
Variable overhead $25
Fixed overhead $28
Prior to making a decision, the company’s CEO commissioned a special study to see whether there would be any decrease in fixed overhead costs. The company would avoid two setups and that would reduce total spending by $10,000 per setup. One inspector would be laid off at a savings of $20,000. Janitorial services would be reduced by 200 hours at $15/hour. Although the work decreases by 200 hours, the janitor assigned to the computerized component line also spends time cleaning for other product lines and is guaranteed a 40 hour work week. Further, another department could use the area where this component is produced. That department is currently paying $90,000 to rent the same amount of space.
- Ignore the special study, and determine whether the gear should be produced internally or purchased from the supplier.
- Now repeat the analysis, using the special study data.
- Briefly identify qualitative factors that might affect the decision, including strategic implications.
- McVictor Industries solved the following linear programming problem as the basis for its budget for the next operating period. Fixed costs are budgeted as $80 per unit.
Objective Function: Maximize $250×Regular + $130×Premium
Subject to:
Assembly hours constraint:
10 hours × Regular + 25 hours × Premium ≤ 10,000 hours
Testing hours constraint:
10 hours × Regular + 5 hours × Premium ≤ 5,000 hours
Excel’s Solver function produced the results shown below.
Regular
375 |
Premium
250 |
Target function: | |
$126,250 | |
Constraints: | |
Assembly | 10,000 |
Testing | 5,000 |
Answer Report:
Target Cell (Max) | |||||||
Cell | Name | Original Value | Final Value | ||||
$A$7 | Target function | 0 | 126250 | ||||
Adjustable Cells | |||||||
Cell | Name | Original Value | Final Value | ||||
$A$5 | Regular | 0 | 375 | ||||
$B$5 | Premium | 0 | 250 | ||||
Constraints | |||||||
Cell | Name | Cell Value | Formula | Status | Slack | ||
$B$9 | Assembly | 10000 | $B$9<=10000 | Binding | 0 | ||
$B$10 | Testing | 5000 | $B$10<=5000 | Binding | 0 |
Sensitivity Report:
Adjustable Cells | ||||||||
Final | Reduced | Objective | Allowable | Allowable | ||||
Cell | Name | Value | Cost | Coefficient | Increase | Decrease | ||
$A$5 | Regular | 375 | 0 | 250 | 10 | 198 | ||
$B$5 | Premium | 250 | 0 | 130 | 495 | 5 | ||
Constraints | ||||||||
Final | Shadow | Constraint | Allowable | Allowable | ||||
Cell | Name | Value | Price | R.H. Side | Increase | Decrease | ||
$B$9 | Assembly | 10000 | 0.25 | 10000 | 15000 | 5000 | ||
$B$10 | Testing | 5000 | 24.75 | 5000 | 5000 | 3000 |
- What quantity of each product should McVictor produce?
- What is the contribution margin with this sales mix?
- Suppose McVictor wants to relax the constraint in Testing. Up to what maximum amount per hour would the company be willing to pay?
- If McVictor relaxes the constraint in Testing, will the contribution margin increase? Explain.
- What would happen if Assembly hours decrease by more than 5,000?
- By how much could the contribution margin of regular increase before the sales mix would change?
- Identify reasons why the managers cannot be certain that they have accurately estimated the resource constraints.
- Water Away produces and sells types of plastic boats. All three boats are manufactured using a single computer-controlled plastic injection molding machine.
Boat A Boat B Boat C
Selling price $79.00 $99.00 $149.00
Direct materials 34.00 34.00 43.00
Direct labor 0.40 0.60 1.00
Variable overhead 1.00 2.00 1.00
General overhead 24.00 36.00 60.00
Product Margin $19.60 $36.00 $44.00
Computer controlled injection molder:
Machine time required per unit 0.02 hr 0.03 hr 0.05 hr
Daily demand 200 units 120 units 60 units
Daily machine time requirements 4 hrs 3.6 hrs 3 hrs
To meet daily demand for all three products, 10.6 hours would be required on the injection molder. However, the machine must be attended at all times by a skilled operator who works only a standard 8-hour workday. Therefore, insufficient capacity exists to meet demand for all three products.
The labor cost per unit is determined by multiplying the operator’s wage of $20 per hour by the fraction of an hour required to produce a single boat. Direct labor employees are guaranteed a 40-hour work week. General overhead is almost entirely fixed.
- The production bottleneck is the machine, and this bottleneck can be relaxed by inducing the skilled operator to work overtime. Up to how much should the firm be willing to pay per hour in total for the first hour of overtime?
- The supervisor at the boat company believes that the bottleneck should be relaxed, even if the company only breaks even on the units sold after the capacity limit has been reached. Explain this reasoning.
- Midtown Clinic provides its own housekeeping services. The clinic director would like to outsource this service, and has found a company that will provide the service for $24 per hour. The following information has been collected about the cost per hour to the clinic for performing its own housekeeping services:
Cost per hour of service:
Cleaning supplies $ 2
Direct labor $17
Variable overhead $1
Total hours of housekeeping services per year 2,600
Total fixed overhead $36,000
- Should Midtown Clinic outsource housekeeping, assuming that $26,000 of fixed costs can be eliminated if the service is outsourced? Provide calculations to support your answer.
- At what level of service (in hours) would Midtown generally be indifferent between providing housekeeping services or outsourcing them, assuming that $26,000 of fixed costs can be eliminated?
- Identify one potential opportunity cost that the clinic director might have overlooked.
- Describe two qualitative factors that might affect this outsourcing decision.
Answers
True / False
- F
- F
- F
- T
- T
- F
- F
- T
- T
- F
- T
- F
- F
- F
- T
- F
- T
- T
- F
- T
- T
- T
- T
- F
- T
- T
- T
Multiple Choice
- C
- A
- C
- B
- D
- C
- B
- C
- C
- C
- B $8 + $10 + 0.75 ($12) + $3
- C ($33 – $30) * 40,000
- D 100,000 * $15 + ($10,000 * 0.35 * $25)
- D {100,000 * ($16.25 – $15) – (10,000 * $8.75)
- C $300 = 100 (n – $16.25) – $300
- D {7,000 * ($20 – $18)} – ($5 * 2,000)
- C
- A
- C
- D
- A
- D
- D
- B decrease = (-$80,000 + $40,000)
- A profit after discontinuance =-$20,000 +$4,000 +$4,000 = $(12,000)
- C
- D
- A
- A
- C
- A
- A
- A cost to make = $60 * 0.75; cost to buy = $50
- C cost to make = (9,000 * $6) + $15,000; cost to buy = (9,000 * $10) – $20,000;
- D
- A
- A
- A
- D
- B
- D
- D
- B
- B
- B (22 x $150 = $3,300)
- A (8 x $200 = $1,600)
- D
- A
- D (.4 *$200,000 + $700,000) + $60,000)
- B
- D
- B
- C
- A
- C
- A
- A
- B
- C
- B
- D
- B
- D
- C
- C
- C
- B
- A
- D
- D
- C
- C
- A
- A (4,000 x $10)/$55
- C
- B
- B
- D {30,000 * ($12 + $20 + $12)} + {$10 * 30,000 * 0.45}
- C Buy = $1,455,000; Make = 30,000 * $46
- C
- C
- A ($550 – $250) – $150
- B ($550 – $250)
^{s}84. B Make = $80,000 + $28,000 + $25,000 = $133,000; Buy = $15 x 10,000 = $150,000
^{s}85. D VC = $6+$14+$8 = $28; Price = $30
^{s}86. C $50,000/20,000 units = $2.50/unit; Price = $28+$2.50
^{s}87. A ($40 – $28) x 8,000 = $96,000; $40,000 – $96,000 = $(56,000)
^{s}88. B CM = $400,000 – $225,000 = $175,000; $175,000 – $130,000 = $45,000
^{s}89. B $10 – ($2.75 + $1.50 + $0.50 + $0.75) = $4.50
^{s}90. C $4.50 x 80,000 units = $360,000; $360,000 – ($100,000+$60,000) = $200,000
^{s}91. B ($1 – $0.75) x 80,000 units = $20,000
^{s}92. C
^{s}93. D ($2 x 100,000)
^{s}94. B $8.40 + ($15,000/30,000 units) = $8.90
^{s}95. A $15.00 – $8.80 = $6.20; $6.20 x 10,000 = $62,000; $8.90 + $62,000/30,000 units = $10.97
^{s}96. C $16,000 – $12,000 = $4,000
^{s}97. D $4,000 lost profit – $1,500 savings
^{s}98. D $4,000 + ($43,000 x 10%) = $8,300
^{s}99. C B: $8.00/0.6 hrs = $13.33/hr; C: $4.00/0.4 hrs = $10.00/hr; D: $7.00/0.2 hrs = $35.00/hr
^{s}100. B 110-(100 of Dx0.2) = 90 hrs; 90/0.6=150 of B
^{s}101. B
^{s}102. A
^{s}103. D
^{s}104. C mach hr: 1.2W + 2.2X ≤ 100; labor hr: 2.4W + 4.4X ≤ 400
^{s}105. B W CM/hr = $12/1.2 hrs = $10/hr; CM/hr for X is $28/2.2 hrs = $12.73/hr; Produce all Xs, or = 45.5 Xs
^{s}106. B
^{s}107. B
^{s}108. B
^{w}109. D
^{w}110. D
^{w}111. C
^{w}112. B
^{w}113. C
^{w}114. B
^{w}115. B
^{w}116. C
^{w}117. B
^{w}118. A
^{w}119. B
^{w}120. A
^{w}121. C
^{w}122. A
^{w}123. D
^{w}124. D
^{w}125. D $200,000 + $150,000 + 60%*220,000
^{w}126. B $66,000 + $15,500
Matching
- General Decision Rules
- A
- C
- B
- B
- E
- E
- E
- E
- E
- E
Exercises
- a. ($220,000 / 80,000)*10,000 units + $10,000 = $37,500
- (10,000 * $4) – $37,500 = $2,500 profit increase
- a. Cost to buy = $30 per set.
Cost to make = $12 + $10 + $24 (0.3) = $29.20 per set
Conclusion: Make the tires
- Extra revenue from buying = $1,500 * 12 = $18,000
Cost savings from making = 20,000 * ($30.00 – $29.20) = $16,000
Conclusion: Buy the tires
- Will the supplier’s quality be as high as National Motor’s quality? Will deliveries be timely? Students may have other correct responses.
- a. Contribution margin per minute of machine time:
Wood = $10 / 48 = $0.208
Steel = $11 / 50 = $0.22
Graphite: $16 / 75 = $0.213
Therefore, Speedy should produce steel rackets first, followed by graphite and wood.
- Speedy should use 500 machine hours to produce 600 steel rackets (600 * 50 / 60).
Next, Speedy should use 625 machine hours to produce 500 graphite rackets (500 * 75 / 60).
Finally, Speedy should use the remaining 75 machine hours to produce 93 wood rackets (93 * 48 / 60).
- The contribution margin on wood rackets, or $0.208×60 = $12.48/hour.
- a. 8 x $15 = $120 per hour versus 5 x $20 = $100 per hour. Use up 12,000/8 = 1,500 hours on Premium first. Then the remaining 1,500 on regular.
- Demand for regular is 21,000/5 = 4,200 hours so we can still sell it, can pay up to $100/hour to relax constraint.
- a. Make = $24.50 + $100,000/5,000 = $44.50, so they should buy at $40.
- $40 – $24.50 = $15.50. $100,000/$15.50 = 6,452 units.
- Possible qualitative factors include quality of the subassembly and timeliness of delivery. Students may think of others.
- a. Emphasize bike with highest contribution margin per hour.
$400/2 versus $500/5, so premier should be emphasized.
- $500/5 or $100 per hour.
- a. Yes, the CM/unit at $13 is $13 – $11.50 = $1.50.
- The minimum price = VC = $11.50
- Here are two qualitative factors; students may have other correct responses. Will other customers learn about the price and demand a decrease? Will costs change as the volume gets close to capacity?
- a. $330,000/($45 + 2*$90) = 1,467 pairs of fun boots and 2,934 pairs of fancy
- $30,000/$45 = 667 pairs of fun boots
- a. Price = $3,500/10,000 = $0.35 plus the special cover at $.05 = $0.40.
- Other considerations include the following; students may have other correct responses. Effect of special order on brand name recognition; Ability to keep ingredients fresh; Opportunity to keep employees busy during slow time
- a. Relevant cash flows are DL, rent, variable and fixed S & A which total $145,000. Therefore Quick Clean contribution margin is $200,000 – $145,000 = $55,000 which would be foregone if the outlet is closed. They should keep the outlet open because they will still incur the headquarters costs, but lose $55,000 to cover them.
- Following are several qualitative factors; students may have other correct answers. Managers do not know whether sales from this outlet would move to other outlets of Quick Clean or to competitors. If all sales moved to another Quick Clean outlet, the company would be better off to close this outlet. But if most of the sales went to competitors, they would not be better off. Will the company have any loss of reputation among customers at other outlets? Customers may worry that their outlet will close and choose to do business elsewhere.
Short Answer
- Below are examples of nonroutine operating decisions; students will think of other correct responses:
Special order – A customer wants to buy 10 snow shovels at a discounted price for a not-for-profit organization fund raising event.
Constrained resource – An item on sale has been sold out and there is still a high demand for it.
Keep or drop – A particular product, such as a specialized tool, has not been selling well and has a low contribution margin.
- Below are actions an organization can take; students may think of other correct responses:
* Buy more of the resource through other channels or increase capacity.
* Substitute another process for a capacity constraint.
* Emphasize the product with the highest contribution margin per constrained resource.
- Quantitative information is numerical and calculations can be performed with it. Qualitative information consists of factors that are not valued numerically. Quantitative information is important to nonroutine operating decisions because managers need to assess whether the company is likely to be better off financially with one decision alternative. Qualitative information is important because not all factors that are relevant to a decision can be quantified. For example, managers may be unable to reliably measure the reputation effects of closing a production facility. In addition, qualitative factors might override the quantitative analysis. For example, managers might choose to outsource an activity even if quantitative analyses favor insourcing, if the activity is not viewed as a core competency.
- The following are examples of qualitative factors for a special order; students may think of others. Will regular customers want a special price if they hear about the terms of this order? Does the company have excess capacity? Will the order replace regular business? Will the order improve brand name recognition?
- Below are possible factors that Donald should consider; students may think of others:
* General quantitative rule: Be as well off after the special order as before it
* Possibility of future business from this customer
* Existence of any specialized expertise to produce
* Alternative uses of any special-purpose equipment after order is filled
- Below are examples of uncertainties; students will think of others:
Will this customer place additional orders in the future?
Would other customers learn about the lower price?
Will the cost of material for the special order be significantly different from regular materials costs?
Will VLP’s employees have the expertise to make the new slipcovers?
- Ability to ensure high quality. If low quality products are delivered, NSL will have problems with quality and could lose customers or incur additional costs to improve the quality.
Timeliness of delivery. If the products are not processed in a timely manner and production does not meet demand, customers may purchase from another company.
Core competency issues. Most organizations want to outsource only those functions that are not core competencies. When organizations emphasize core competencies, they should have relative advantages over competitors, and so activities that include core competencies should not be outsourced. At the same time, managers may choose to outsource an activity that is not a core competency because they want to avoid allocating resources (including management time and effort) on activities for which they do not have a competitive advantage.
- Variable costs and any avoidable fixed costs are relevant to a make or buy decision.
- Following are two assumptions for keep or drop decisions; students may think of others. Other product sales will not be affected if this product is dropped. Unavoidable fixed costs will remain constant whether or not this product is dropped.
- The use of released capacity for other purposes must be considered for both types of decisions.
- Average costs are not particularly useful in short-term decision making because they include fixed costs. Fixed costs generally do not change as a result of short-term decisions, making them unavoidable and irrelevant for the decision.
Problems
- a. Following are examples of variable costs per student from a college perspective; students are likely to think of others: Duplication, laboratory supplies
- Following are examples of fixed costs per student from a college perspective; students are likely to think of others: Faculty salaries, utilities, depreciation
- Contribution margin per student
Business = ($600,000 + $200,000) / 6,000 – $35 = $98.33
Engineering = ($1,500,000 + $500,000) / 5,000 – $65 = $335
Science = ($720,000 + $800,000) / 7,200 – $80 = $131.11
Humanities = ($480,000 + $120,000) / 4,800 – $25 = $100
University = $3,689,000 / 23,000 = $160.39
- Profit
Business = 6,000 * ($98.33 – $35.00) = $379, 980
Engineering = 5,000 * ($335 – $55) = $1,400,000
Science = 7,200 * ($131.11 – $25.00) = $763,992
Humanities = 4,800 * ($100 – $10) = $432,000
University = $2,975,972
- Most likely to be dropped is Business, as it has the lowest contribution margin per student. Conversely, Engineering is the least likely to be dropped.
- Following are uncertainties about the quantitative analyses; students may think of others:
* Whether closure of one college will affect enrollments in other colleges
* Whether each of the following estimates is accurate:
* Number of majors
* Number of non-majors taking classes
* Revenue from student fees
* Revenue from external grants
* Variable cost per student
* Whether closure would affect other funding sources, such as donations from alumni
- Following are qualitative issues; students may think of others:
* Need to provide students with a well-rounded education
* Employee morale issues if one college is dropped
* University’s overall reputation
* Where faculty would be placed
* Whether the college is viewed as a core competency for the university as a whole
- a. Time needed per lot – Fine = 12 minutes, Medium = 15 minutes, and Coarse = 30 minutes, or production per hour of special machine time – Fine = 5 lots, Medium = 4 lots, or Coarse = 2 lots.
CM/lot – Fine = $10, Medium = $10, and Coarse = $19.
CM per machine hour – Fine = $10 x 5 = $50, Medium = $10 x 4 = $40, or Coarse = $19 x 2 = $38.
First produce Fine, then produce Medium, and lastly Coarse
- 4,000/5 = 800 hours for Fine, then 3,750/4 = 937.5 hours for Medium, leaving 762.5 hours for Coarse which needs 5,000/2 = 2,500 hours. So we get $38/hour for Coarse and are willing to give that up to buy more hours.
- Following are possible uncertainties about product selling prices; students may think of others. Prices are subject to pressure from competitors, changes in consumer preferences, and economic times. If any of these changes, expected prices could increase or decrease, depending on the nature of the change.
- Following are possible uncertainties about product variable costs; students may think of others. Direct labor may be more or less efficient than expected. Prices could change on direct material inputs, and variable overhead charges, such as supplies, could change because of prices changes or efficiency of use.
- The uncertainties discussed in parts (c) and (d) are likely to have 2 major effects on product emphasis decisions. First, these uncertainties can cause the managers to emphasize products that ultimately do not turn out to be the best choices. A product may be overemphasized if it turns out that its selling price is lower than expected or its variable costs are higher than expected. A product may be underemphasized if the converse occurs. Second, these uncertainties can cause managers to “hedge” their product emphasis decisions; they may not make decisions based strictly on the quantitative analysis.
- a. Make = $30 + $15 + 25 = $70. Buy = $75, so make.
- Make = $70 + (($10,000 + $20,000 + $90,000)/12,000) = $80 so buy.
- Following are possible qualitative factors; students may think of others. Need to consider quality of the computerized component and delivery timeliness.
- a. 375 regular and 250 premium
- $12,620
- $24.75/hour
- No, the contribution margin would not increase because there is a binding constraint in Assembly.
- The optimal sales mix will change
- $10 per unit
- The resource constraints assume that each unit of product can be produced for the number of estimated hours and that there will be no deviations from the expected quantity of each constrained resource. The actual use of resources and resource availability are likely to vary both due to random changes in productivity and due to unanticipated problems such as materials defects, machinery breakdowns, variations in the pace of manual work, and other factors.
- a. $20 per hour plus contribution margins as follows:
Boat A = $44 x 50/hr = $2,200,
Boat B = $63 x 33.3/hr = $2,098,
Boat C = 105 x 20 = $2,100.
First produce Boat A for 4 hours, then Boat C for 3 hours, and then boat B. Because more time could be spent on B, $2,098 is available plus $20 = $2,118.
- Brand name recognition and customer loyalty increase as more units are made and sold. If the expansion is permanent, next year the company could be better off.
- a. Cost per hour of service if provided in-house = ($2 + $17 + $1 + $26,000/2,600) = $30. Outsource.
- $24X = $20X + $26,000, so X = 6,500 hours.
- Opportunity costs could include the use of space that is now occupied by the housekeeping services.
- The problem asks students to describe 2 qualitative factors. The textbook cites the following types of qualitative factors for outsourcing decisions: Quality, Delivery timeliness, Ability of supplier to meet obligations, Whether activity is a core competency. Students might describe two of these factors, or they might think of others that are relevant to the information in the problem.
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