COST AND MANAGEMENT ACCOUNTING 3A BSR3A01 FMN03A3 CMA03A3 Relevant Costs for Decision Making Solutions Question 1 BASIC Cost savings if the high speed wheel grinder is purchased 15 000 7 000 8 000 8 000 x 5 years 40 000 Incremental cost Cost of the high speed wheel grinder Less salvage from the standard wheel grinder Net advantage of purchasing the high speed wheel Grinder Question 2 BASIC 1 Contribution margin lost if the flight is discontinued Less flight costs that can be avoided if the flight is discontinued Flight promotion Fuel for aircraft Liability insurance 1 3 x 4 200 Salaries flight assistants Overnight costs for flight crew and assistants Net decrease in profits if the flight is discontinued The following costs are not relevant to the decision 30 000 9 000 40 000 21 000 19 000 750 6 800 1 400 500 300 12 950 9 750 3 200 Cost Salaries flight crew Depreciation of aircraft Liability insurance two thirds Baggage loading and flight Preparation Alternate Solution Ticket revenue Less variable expenses Contribution margin Less flight expenses Salaries flight crew Flight promotion Depreciation of aircraft Fuel for aircraft Liability insurance Salaries flight assistants Baggage loading and flight preparation Overnight costs for flight crew and assistants at destination Total flight expenses Operating loss Reason Fixed annual salaries which will not change Sunk cost Two thirds of the liability insurance is unaffected by this decision This is an allocated cost which will continue even if the flight is discontinued Keep the Flight 14 000 1 050 12 950 1 800 750 1 550 6 800 4 200 500 1 700 300 17 600 4 650 Drop the Flight Difference Net Profit Increase or Decrease 0 0 0 1 800 0 1 550 0 2 800 0 1 700 0 7 850 7 850 12 950 0 14 000 1 050 750 0 6 800 1 400 500 0 300 9 750 3 200 The flights that are eliminated might have an average seat occupancy of 40 or less Thus by eliminating these flights and keeping the 2 flights with a higher average seat occupancy the overall average seat occupancy for the company as a whole would be improved This could reduce profits however in at least two ways First the flights that are eliminated could have a contribution margin that is greater than their avoidable costs such as in the case of flight 482 in part 1 If so then eliminating these flights would reduce the company s total contribution margin more than it would reduce total costs and profits would decline Second these flights might be acting as feeder flights bringing passengers to cities where connections to more profitable flights are made Thus eliminating flights that act as feeders could cause a loss of passenger revenue in other flights of the company Question 3 Intermediate Item a Sales revenue b Direct materials c Direct labour d Variable manufacturing Overhead e Depreciation Model B100 machine f Book value Model B100 machine g Disposal value Model B100 machine h Market value Model B300 machine cost i Depreciation Model B300 machine j Fixed manufacturing Overhead k Variable selling expense l Fixed selling expense m General administrative Overhead X X X X X Not Relevant Case 2 Relevant X Not Relevant Case 1 Relevant X X X X X X X X X X X X X X X X X X X X Question 4 Intermediate 1 Cost of purchasing Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead traceable1 Fixed manufacturing overhead Common Total costs Difference in favour of continuing to make the parts Buy 35 Per Unit Differential Costs Make 14 10 3 2 29 6 35 15 000 units Make 210 000 150 000 45 000 30 000 435 000 Buy 525 000 525 000 90 000 1 Only the supervisory salaries can be avoided if the parts are purchased The remaining book value of the special equipment is a sunk cost hence the 4 per unit depreciation expense is not relevant to this decision Based on these data the company should reject the offer and should continue to produce the parts internally 2 Opportunity cost segment margin foregone Cost of purchasing part 1 Cost of making part 1 on a potential new product line Total cost Difference in favour of purchasing from the outside supplier Make Buy 435 000 150 000 585 000 60 000 525 000 525 000 Thus the company should accept the offer and purchase the parts from the outside supplier Question 5 Advanced 1 The value of relaxing the constraint can be determined by computing the contribution margin per unit of the constrained resource Selling price per unit Variable cost per unit Contribution margin per unit a Upholstery shop time required to produce one unit b Contribution margin per unit of the constrained resource a b The company should be willing to pay up to 50 per hour to keep the upholstery shop open after normal working hours 2 To answer this question it is desirable to compute the contribution margin per unit of the Leather Library Chair 1 800 1 200 600 12 hours 50 per hour constrained resource for all three products Selling price per unit Variable cost per unit Contribution margin per unit a Upholstery shop time required to produce one unit b Contribution margin per unit of the Gains borough Armchair 1 300 800 500 Leather Library Chair 1 800 1 200 600 Chippen dale Fabric Armchair 1 400 1 000 400 8 hours 12 hours 5 hours constrained resource a b 62 50 per hour 50 00 per hour 80 00 per hour The offer to upholster chairs for 45 per hour should be accepted The time would be used to upholster Chippendale Fabric Armchairs If this increases the total production and sales of those chairs the time would be worth 80 per hour a net gain of 35 per hour If Chippendale Fabric Armchairs are already being produced up to demand then having these chairs upholstered in the other company would free up capacity to produce more of the other two chairs In both cases the additional time is worth more than 45 per hour