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Answers to Questions
1. Information that is relevant for decision making differs between the alternatives
and is future oriented.
2. A variable cost may or may not be relevant. The fact that a cost is variable has
no bearing on its relevance. For instance, the cost of direct labor is usually
3. Costs can be classified into the following levels:
(1) Unit-level costs - Costs that are incurred each time a company makes a product
or performs a service. These costs can be avoided by eliminating the
production of a single unit of product or service.
(3) Product-level costs - Costs that are incurred to support specific kinds of
products or services. Product-level costs are eliminated when the product
line is discontinued.
4. Information does not have to be entirely accurate to be relevant for decision
making. Knowing that a future cost can be avoided makes the cost relevant even
5. The conclusion is invalid because it fails to consider the importance of qualitative
6. The president appears to be overlooking the concept of a sunk cost. His company
has already incurred a $50,000 loss. The fact that it has not recognized the loss
borrowing the funds.
7. An opportunity cost is the sacrifice of some benefit (revenues, cost savings) that is
given up by not choosing an alternative. Opportunity costs are relevant in
8. The checking account is not truly free. There is an opportunity cost associated
9. The original costs of the two machines represent sunk costs and should not be
10. Some fixed costs are avoidable. For example advertising costs may be fixed
to the decision under consideration.
11. Numerous qualitative characteristics could apply to special order decisions. Two
specific considerations are: (1) the effects on regular customers who may learn
12. The allocated depreciation, warehousing costs, and property taxes will be the
13. The two factors that should be considered in allocating shelf space are per unit
contribution margin and turnover.
14. The relevant costs are the additional costs that will be incurred as a result of
necessary to fill the special order batch.
15. It may be possible for a company to purchase a product or service at a price below
16. If the fixed costs that Ms. Meyers is referring to are avoidable fixed costs,
17. Qualitative factors that should be considered include: (1) the availability of
reliable suppliers that can comply with quality standards and delivery schedules,
(2) the possibility of low-ball pricing where the supplier accepts a low price for the
18. While it may appear from the segment’s reports that it is operating at a loss, this
is not necessarily the case. When a segment is eliminated, some of the costs
assigned to that segment may still continue. Some of the facility-level costs that
19. Replacing the old machine could result in lower operating income in the first year
of the replacement if the old machine is sold at a loss. The loss would affect
Exercise 13-1
Cost Item
Relevance
Behavior
Cost per box
Relevant
Variable
Sales commissions per box
Irrelevant
Variable
Rent of display space
Irrelevant
Fixed
Advertising
Relevant
Fixed
Since sales commissions per box and the rental cost do not differ between the
alternatives, they cannot be avoided regardless of which alternative is chosen.
Accordingly, these costs are not relevant.
Exercise 13-2
Cost Items
Relevance
Behavior
Materials cost ($9 per unit)
Relevant
Variable
Company president’s salary
Irrelevant
Fixed
Depreciation on manufacturing equipment
Irrelevant
Fixed
Customer billing costs (1% of sales)
Irrelevant
Variable
Rental cost of manufacturing facility
Relevant
Fixed
Advertising costs ($200,000 per year)
Irrelevant
Fixed
Labor cost ($8 per unit)
Relevant
Variable
Sales commissions (1.50% of sales)
Irrelevant
Variable
Salaries of administrative personnel
Irrelevant
Fixed
Shipping and handling ($0.50 per unit)
Irrelevant
Variable
Depreciation on office furniture
Irrelevant
Fixed
Manufacturing supplies ($0.25 per unit)
Relevant
Variable
Production supervisor’s salary
Relevant
Fixed
All unit-level manufacturing costs (materials, labor, manufacturing supplies) are relevant
because they could be avoided if the products were purchased instead of manufactured.
Similarly, it is highly probable that the product-sustaining and facility-sustaining costs that
are associated with making the products (production supervisor’s salary and rental of
Exercise 13-3
a.
Fixed Costs
Bracelet A
Bracelet B
Advertising cost
$ 7,500
$5,000
Depreciation on existing equipment
5,000
4,000
Total fixed costs
$12,500
$9,000
b.
Variable Costs
Bracelet A
Bracelet B
Cost of materials per unit
$16
$ 30
Cost of labor per unit
32
32
Total variable costs
$48
$62
c.
Avoidable Costs
Bracelet A
Bracelet B
Cost of materials per unit
$ 16
$ 30
Advertising cost
7,500
5,000
Exercise 13-4
Cost Description
Cost Classification
Salary of company president
Facility-level cost
Research and development cost
Product-level cost
Factory lawn care cost
Facility-level cost
Cost of patent
Product level cost
Startup cost to change color of a product
Batch-level cost
Cost of resetting sewing machines to change shirt size
Batch-level cost
Real estate tax for the factory
Facility-level cost
Direct labor
Unit-level cost
Exercise 13-5
a. By holding on to his business, Mr. Brimer is losing the opportunity to sell it.
b. Mr. Brimer can continue to operate his independent taxi company. Alternatively, he
Decision
Independent
Business
Work As
Dispatcher
Opportunity cost
$(73,000)
Cost of investment
$(73,000)
Business income
60,000
Investment income ($73,000 x .10)
7,300
Salary
55,000
The opportunity cost and the cost of the investment are not relevant because they do
c. From a qualitative perspective, Mr. Brimer may prefer to keep his business. His
Exercise 13-6
The facility-sustaining overhead is not relevant because it will be incurred regardless of
whether the special order is accepted or rejected. The differential revenue and avoidable
costs are shown below:
Relevant Revenue and Costs
Sales revenue ($2,750 x 40 slabs)
$110,000
Cost of raw materials ($1,200 x 40 slabs)
(48,000)
Cost of direct labor ($600 x 40 slabs)
(24,000)
Contribution to profit
$ 38,000
Exercise 13-7
Since the product- and facility-sustaining costs do not differ between the alternatives, they
are not avoidable. The differential revenue and relevant (avoidable) costs are shown below:
Relevant Revenue and Costs
Additional revenue (6,000 x $450)
$2,700,000
Unit-level materials (6,000 x $200)
(1,200,000)
Unit-level labor (6,000 x $180)
(1,080,000)
Unit-level overhead (6,000 x $50)
(300,000)
Contribution to profit
$ 120,000
Exercise 13-8
Miko must consider the impact on the company’s existing customers. The special order
customer should be outside Miko’s normal selling territory so as to avoid demands by
existing customers for lower prices. Also, if the special order customer serves the same
Exercise 13-9
a. The unit-level costs increase and decrease in direct proportion with changes in the
number of units sold and produced. Accordingly, these costs are variable costs. The
variable cost per unit is computed by dividing the total unit-level costs by the number
b.
Incremental revenue ($10 x 8,000 units)
$80,000
Variable costs ($7.60 x 8,000 units)
60,800
Contribution to profit
$19,200
Exercise 13-10
The allocated facility-sustaining costs are not avoidable because they will be incurred
regardless of whether the handlebars are made or outsourced. The relevant (avoidable) costs
are shown below:
Item
Per Unit
Total
Cost of materials
$15
$150,000
Cost of labor
10
100,000
Overhead
2
20,000
Total cost
$27
$270,000
Exercise 13-11
a. The maximum amount that Rimes would be willing to pay is the amount of
production costs that could be avoided if production were stopped. In other words,
the cost of buying the engines must be equal to or less than the avoidable cost of
making them. Accordingly, the question can be answered by calculating the per unit
avoidable cost of production. The cost of the depreciation on equipment cannot be
avoided because it is a sunk cost that has already been incurred. Corporate-level
facility-sustaining cost will be incurred regardless of whether engines are purchased
or manufactured. Accordingly, the allocated portion of corporate-level facility-
sustaining costs does not differ between the alternatives and is not avoidable. The
relevant (avoidable) costs are as follows:
Avoidable Costs for Lawn Mower Engines
Cost of materials (20,000 units x $24)
$ 480,000
Labor (20,000 units x $26)
520,000
Production supervisor’s salary
85,000
Rental cost of equipment used to make engines
23,000
Total cost to make 15,000 engines
$1,108,000
Cost per unit ($1,108,000 ÷ 20,000 units)
$55.40
Exercise 13-11 (continued)
The maximum amount that Rimes would be willing to pay to purchase engines would
be $55.40 per unit.
b. The avoidable cost per unit would decrease because the fixed costs (supervisor’s salary
Exercise 13-12
a. The facility-sustaining costs are not avoidable because they will be incurred
regardless of whether the speakers are produced internally or are outsourced. The
relevant (avoidable) costs are shown below:
Decision
Make
Unit-level cost of materials and labor
$382,500*
Other avoidable manufacturing costs
89,000
Total avoidable costs
$471,500
If Daisuke decides to make the speakers, its cost will be higher and net income will be
b. Daisuke should consider the following qualitative factors. If Daisuke makes the
speakers, the company will gain control of the production process. Quality control
Exercise 13-13
a. Two-thirds of the product-level and all of the facility-sustaining costs are not
avoidable. These costs are not relevant to the decision because they will be incurred
Avoidable Costs
Unit-level materials
$ 6,000
Unit-level labor
6,600
Unit-level overhead costs
4,200
Product-level costs
3,600
Total costs
$20,400
Because the cost of buying containers is $25,000 (i.e., $2.50 x 10,000), Freeman would
be better off continuing to make them.
b. Freeman is giving up the opportunity to obtain $8,000 of lease income by continuing
to make the containers. This is an opportunity cost that could be avoided by
purchasing the containers. When this cost is included in the decision, total avoidable
Exercise 13-14
a. First, identify all of the revenues and costs associated with the operation of Segment
A. These items are listed in the problem under the column labeled Segment A.
Remember the two alternatives are to either keep Segment A or to eliminate the
segment. Eliminate the items that do not differ between these alternatives and the
sunk costs. The $44,000 of general fixed costs will continue regardless of whether the
segment is eliminated. Consequently, this cost is not avoidable. Similarly, the
depreciation charge should be removed because it is a sunk cost. The relevant cost
and revenue items are shown below:
Relevant Rev. and Cost items for Segment A
Sales
$165,000
Cost of goods sold
(121,000)
Sales commissions
(15,000)
Advertising expense
(3,000)
Effect on income
$26,000
The above analysis suggests the segment is contributing $26,000 to the profitability of
the company as a whole. This analysis can be verified by creating comparative
company income statements under the two alternatives. The appropriate
computations are shown below:
b.
Decision
Keep Seg. A
Eliminate Seg. A
Sales
$655,000
$490,000
Cost of goods sold
(308,000)
(187,000)
Sales commissions
(59,000)
(44,000)
Contribution margin
288,000
259,000
Gen. fixed operating expenses
(140,000)
(140,000)
Advertising expense
(13,000)
(10,000)
Net Income
$ 135,000
$109,000
Since Segment A contributes $26,000 to profitability it should not be eliminated.
Exercise 13-15
a. The companywide facility-sustaining costs are not avoidable and therefore not
relevant to the elimination decision. The relevant revenue and cost data are
summarized below:
Income Statement
Revenue
$250,000
Salaries for drivers
(175,000)
Fuel expenses
(25,000)
Insurance
(35,000)
Division level facility-sustaining costs
(20,000)
Contribution to profit
$ (5,000)
Since incremental revenue is less than avoidable costs, the segment should be
eliminated, thereby increasing companywide income by $5,000.
b. Since total avoidable costs amount to $255,000, increasing segment revenue to
c. To justify its existence, segment revenue must be at least equal to avoidable costs.
