Chapter 14 – Decision Making: Relevant Costs and Benefits
14-1
CHAPTER 14
Decision Making: Relevant Costs and Benefits
ANSWERS TO REVIEW QUESTIONS
14-1 The seven steps in the decision-making process are as follows:
Clarify the decision
14-2 The managerial accountant’s role in the decision-making process is to participate as
14-3 A quantitative analysis is expressed in numerical terms. A qualitative analysis
14-4 A decision model is a simplified representation of the choice problem. Unnecessary
14-5 The result of a quantitative analysis is that one alternative is preferred over the next–
best alternative by some numerical amount, such as profit. The amount by which the
best alternative dominates the second-best alternative establishes a “price” on the
Chapter 14 – Decision Making: Relevant Costs and Benefits
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14-6 Relevant information is pertinent to a decision problem. Accurate information is
precise. Timely information is available to the decision maker in time to make the
14-7 Two important criteria that must be satisfied in order for information to be relevant
are as follows:
14-8 The book value of an asset is its acquisition cost less its accumulated depreciation.
14-9 The book value of inventory, like the book value of any asset, is not a relevant cost.
14–10 Managers sometimes exhibit a behavioral tendency to inappropriately consider a
sunk cost in making a decision, because they believe that their original decision to
14–11 An example of an irrelevant future cost is a cost that will occur in the future but does
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14–12 An opportunity cost is the potential benefit given up when the choice of one action
14–13 People often exhibit a behavioral tendency to ignore or downplay the importance of
14–14 If a firm has excess production capacity, there is no opportunity cost to the
acceptance of a special order. On the other hand, if the firm is already at capacity
14–15 In a differential-cost analysis, the decision maker determines the difference in each
14–16 In making a decision about adding or dropping a product line, the decision maker
14–17 A joint production process is one in which the processing of a common input results
in two or more distinct products known as joint products. A special decision that
14–18 The allocated joint processing costs are irrelevant when making a decision as to
14–19 The proper approach to making a production decision when limited resources are
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14–20 The contribution margin per unit of scarce resource is a product’s unit contribution
margin divided by the number of units of the scarce resource required to produce
14–21 Sensitivity analysis may be used to cope with uncertainty in decision making by
14–22 There is an important link between decision making and managerial performance
evaluation, because managers typically make decisions that maximize their
14–23 Four potential pitfalls in decision making that represent common errors are the
following:
14–24 Unitized fixed costs can cause errors in decision making because the fixed cost per
14–25 Sunk costs are irrelevant in decision making because they have already occurred in
Chapter 14 – Decision Making: Relevant Costs and Benefits
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14–26 This remark fails to recognize the fact that the identification of relevant information
14–27 The concepts underlying a relevant-cost analysis remain valid both in an advanced
manufacturing environment and in a situation where activity-based costing is used.
14–28 Five ways to relax a bottleneck constraint are as follows:
• Working overtime at the bottleneck operation.
Chapter 14 – Decision Making: Relevant Costs and Benefits
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SOLUTIONS TO EXERCISES
EXERCISE 14-29 (25 MINUTES)
Students’ answers to this exercise will vary widely. The following illustration is set in a
QUANTITATIVE ANALYSIS
1. Clarify the decision problem: The first step was to clarify the problem. Was the
perceived slow response time real or merely a perception by the residents of the
neighborhood? What was the average response time for emergency vehicles to the
area? Were proper procedures being followed? What was the condition of the roads,
bridges, and traffic lights on the route to the neighborhood in question?
2. Specify the criterion: The City Council decided that some type of action was
3. Identify the alternatives: The city engineer identified the following alternatives:
4. Develop a decision model: The decision model consisted of a computer program that
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EXERCISE 14-29 (CONTINUED)
5. Collect the data: The data needed for the decision model included employee
QUALITATIVE CONSIDERATIONS
The computer model indicated that either alternative would satisfy the criterion of
reducing emergency response times by five minutes, and that the positioning of emergency
6. Make a decision: The City Council decided to build a satellite fire and rescue station.
EXERCISE 14-30 (20 MINUTES)
FLIGHT ROUTE DECISION
Revenues and Costs
Under Two Alternatives
(a)
Nonstop
Route*
(b)
With Stop
In San
Francisco*
(c)
Differential
Amount†
Passenger revenue ……………………………………….
$240,000
$258,000
$(18,000
)
Landing fee in San Francisco ………………………..
-0-
(5,000
)
5,000
Use of airport gate facilities …………………………..
-0-
(3,000
)
3,000
Flight crew cost …………………………………………….
(2,000
)
(2,500
)
Fuel ……………………………………………………………..
)
)
3,000
Meals and services ……………………………………….
)
)
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EXERCISE 14-31 (15 MINUTES)
The owner’s analysis incorrectly includes the following allocated costs that will be incurred
regardless of whether the ice cream counter is operated:
Utilities ……………………………………………………………………………………………………….
$ 4,350
Depreciation of building ………………………………………………………………………………
4,500
Total …………………………………………………………………………………………………………..
$14,850
It is possible that closing the ice cream counter might save a portion of the utility
cost, but that is doubtful.
A better analysis follows:
Sales ………………………………………………………………………………………
$67,500
Less: Cost of food …………………………………………………………………..
Gross profit …………………………………………………………………………….
Less: Operating expenses
Wages of counter personnel ……………………………………….
$18,000
Paper products ……………………………………………………………
Depreciation of counter equipment and furnishings* …….
3,750
Total ……………………………………………………………………………
Profit on ice cream counter
$ 9,750
EXERCISE 14-32 (15 MINUTES)
1.
(a) $11,100 allocation of rent on factory building: Irrelevant, since Toon Town Toy
Chapter 14 – Decision Making: Relevant Costs and Benefits
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EXERCISE 14-33 (15 MINUTES)
(a) $51,000 salary of Packaging Department manager: Irrelevant, since this manager will
(b) $66,000 salary of Cutting Department manager if a new person must be hired:
The following comparison may help to clarify the analysis:
ANNUAL SALARY COST INCURRED BY TOON TOWN TOY COMPANY
If Packaging
Department
is Kept
If Packaging
Department
is Eliminated
Salary of newly hired person to manage the
Total ……………………………………………………………..
Salary of the person currently managing the
*Continues to manage Packaging Department.
†Moves to Cutting Department position.
Additional comment:
There are many possible reasons why it might cost Toon Town Toy Company more
to hire a new Cutting Department manager than to transfer a current employee to the
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EXERCISE 14-34 (15 MINUTES)
1.
The owner’s reasoning probably reflects the following calculation:
Savings in annual operating expenses if old pizza oven is replaced ………………
)
)
3.
Correct analysis:
Savings in annual operating expenses if old pizza oven is replaced ………………
Acquisition cost of new oven, which will be operable for one year ………………..
)
Net benefit from replacing old pizza oven …………………………………………………….
EXERCISE 14-35 (30 MINUTES)
Answers will vary depending on the company and activity chosen. There are many trade-
Chapter 14 – Decision Making: Relevant Costs and Benefits
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EXERCISE 14-36 (15 MINUTES)
1.
Relevant data:
Current sales value for unmodified parts ……………………………………………………..
$ 7,000
Sales value for modified parts ……………………………………………………………………..
Modification costs ……………………………………………………………………………………
Irrelevant data:
Current book value of inventory …………………………………………………………………..
This is a sunk cost. It will not affect any future course of action.
2.
There are two alternatives for disposing of the obsolete parts: (a) sell in
unmodified condition or (b) modify and then sell.
(a) Benefit if parts are sold without modification ………………………………………….
$ 7,000
(b) Sales value for modified parts ………………………………………………………………..
Less: Cost of modification …………………………………………………………………….
Net benefit if parts are sold after being modified ……………………………………..
Conclusion: Modify the parts and then sell them.
EXERCISE 14-37 (15 MINUTES)
Dear (president’s name):
We recommend against processing banolide into kitrocide. The incremental cost of
Chapter 14 – Decision Making: Relevant Costs and Benefits
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EXERCISE 14-38 (20 MINUTES)
Sales revenue for one jar of silver polish ………………………………….
$8.00
Less: Sales revenue for 1/4 pound of Grit 337 ………………………….
Incremental revenue from further processing …………………………...
$7.00
Incremental costs of further processing:
$1.40
EXERCISE 14-39 (15 MINUTES)
1.
The relevant cost of the theolite to be used in producing the special order is the
(a) 21,750p sales value: Discussed in requirement (1).
Chapter 14 – Decision Making: Relevant Costs and Benefits
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EXERCISE 14-40 (20 MINUTES)
1.
The relevant cost of genatope is calculated as follows:
*Additional cost incurred on the next order of genatope as a result of
Cost of replacing the 1,000 kilograms to be used in the special order
(b) 1,000 kilograms to be used in the special order: Relevant, as shown in
Chapter 14 – Decision Making: Relevant Costs and Benefits
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EXERCISE 14-41 (10 MINUTES)
The most profitable product is the one that yields the highest contribution margin per unit
of the scarce resource, which is direct labor. We do not know the amount of direct-labor
time required per unit of either product, but we do know that Beta requires six times as
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EXERCISE 14-42 (15 MINUTES)
1. Decision variables:
2. Objective function:
3. Constraints:
(a) Direct-labor time constraint: .25X + 1.5Y 11,000
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EXERCISE 14-43 (30 MINUTES)
1. (a) Notation: X denotes the quantity of zanide produced per day
Y denotes the quantity of kreolite produced per day
(b) Contribution margin:
Zanide
Kreolite
Price ……………………………………………………….
Unit variable cost ……………………………………………………….
Maximize
24X + 42Y
2. Graphical solution: See next page.
Corner points in feasible region:
Objective function value:
X = 0
Y = 0
$ 0
X = 0
Y = 8
X = 6
Y = 6
X = 12
Y = 0
Chapter 14 – Decision Making: Relevant Costs and Benefits
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EXERCISE 14-43 (CONTINUED)
Graphical solution:
Y
25
15
5
X
Machine I constraint
Optimal solution (X = 6, Y = 6)
Objective function
Machine II constraint
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Chapter 14 – Decision Making: Relevant Costs and Benefits
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SOLUTIONS TO PROBLEMS
PROBLEM 14-44 (25 MINUTES)
1. Contemporary Trends will be worse off by $6,400 if it discontinues wallpaper sales.
Paint and
Supplies
Carpeting
Wallpaper
Sales……………………..
$190,000
$230,000
$ 70,000
Less: Variable costs….
56,000
Contribution margin….
$ 76,000
$ 69,000
$ 14,000
If wallpaper is closed, then:
Loss of wallpaper contribution margin……
$(14,000)
Remodeling…………………………………….
(6,200)
Added profitability from carpet sales*……
32,500
Fixed cost savings ($22,500 x 40%)……….
9,000
Decreased contribution margin from paint
Increased advertising………………………..
Income (loss) from closure…………………
$ (6,400)
2. This cost should be ignored. The inventory cost is sunk (i.e., a past cost that is not
3. The Internet- and magazine-based firms likely have several advantages:
• These companies probably carry little or no inventory. When a customer places
Chapter 14 – Decision Making: Relevant Costs and Benefits
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PROBLEM 14-44 (CONTINUED)
PROBLEM 14-45 (50 MINUTES)
1. Sets result in a 20% increase, or 1,500 dresses (1,250 1.20 = 1,500).
Total Number of
Percent
of Total
Dresses
Accessory
Capes
Handbags
Total
Complete sets …………………………...
70%
1,050
1,050
1,050
Dress and accessory cape ………….
Dress and handbag …………………….
15%
Dress only …………………………………
9%
135
Total units if additional items are
1,500
1,140
1,275
Less: Unit sales if additional items
1,250
—
Incremental sales ……………………….
1,140
1,275
$48,000
$14,592
$6,120
$68,712
Additional costs:
Chapter 14 – Decision Making: Relevant Costs and Benefits
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2. Qualitative factors that could influence the company’s management team in its
decision to manufacture matching accessory capes and handbags include:
PROBLEM 14-45 (CONTINUED)
• company image of a dress manufacturer versus a more extensive supplier of
PROBLEM 14-46 (25 MINUTES)
1.
Blender
Food
Processor
Unit cost if purchased from an outside supplier …………………………..
$60
$114
Incremental unit cost if manufactured:
$18
$48
Unit cost savings if manufactured …………………………………………………….
$12
Machine hours required per unit ……………………………………………………….
Cost savings per machine hour if manufactured
$12