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) £40,000 Incremental cost: Cost of the high-speed wheel grinder £30,000 Less salvage from the standard wheel grinder 9,000 21,000 Net advantage of purchasing the high-speed wheel Grinder £19,000 Question 2: (BASIC) 1. Contribution margin lost if the flight is discontinued £(12,950) Less flight costs that can be avoided if the flight is discontinued: Flight promotion £ 750 Fuel for aircraft 6,800 Liability insurance (1/3 x £4,200) 1,400 Salaries, flight assistants 500 Overnight costs for flight crew and assistants 300 9,750 Net decrease in profits if the flight is discontinued £ (3,200) The following costs are not relevant to the decision:Cost Reason Salaries, flight crew Fixed annual salaries, which will not change. Depreciation of aircraft Sunk cost. Liability insurance (two thirds) Two thirds of the liability insurance is unaffected by this decision. Baggage loading and flight Preparation This is an allocated cost, which will continue even if the flight is discontinued. Alternate Solution: Keep the Flight Drop the Flight Difference: Net Profit Increase or (Decrease) Ticket revenue £14,000 £ -0- £(14,000) Less variable expenses 1,050 -0- 1,050 Contribution margin 12,950 -0- (12,950) Less flight expenses: Salaries, flight crew 1,800 1,800 -0- Flight promotion 750 -0- 750 Depreciation of aircraft 1,550 1,550 -0- Fuel for aircraft 6,800 -0- 6,800 Liability insurance 4,200 2,800 1,400 Salaries, flight assistants 500 -0- 500 Baggage loading and flight preparation 1,700 1,700 -0- Overnight costs for flight crew and assistants at destination 300 -0- 300 Total flight expenses 17,600 7,850 9,750 Operating loss £ (4,650) £ (7,850) £ (3,200)2. The flights that are eliminated might have an average seat occupancy of 40% or less. Thus, by eliminating these flights and keeping the 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) Case 1 Case 2 Item Relevant Not Relevant Relevant Not Relevant a. Sales revenue X X b. Direct materials X X c. Direct labour X X d. Variable manufacturing Overhead X X e. Depreciation— Model B100 machine X X f. Book value— Model B100 machine X X g. Disposal value— Model B100 machine X X h. Market value—Model B300 machine (cost) X X i. Depreciation— Model B300 machine X X j. Fixed manufacturing Overhead X X k. Variable selling expense X X l. Fixed selling expense X X m. General administrative Overhead X XQuestion 4: (Intermediate) 1. Per Unit Differential Costs 15,000 units Make Buy Make Buy Cost of purchasing £35 £525,000 Direct materials £14 £210,000 Direct labour 10 150,000 Variable manufacturing overhead 3 45,000 Fixed manufacturing overhead, traceable1 2 30,000 Fixed manufacturing overhead, Common — — Total costs £29 £35 £435,000 £525,000 Difference in favour of continuing to make the parts £6 £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. Make Buy Cost of purchasing (part 1) £525,000 Cost of making (part 1) £435,000 Opportunity cost—segment margin foregone on a potential new product line 150,000 Total cost £585,000 £525,000 Difference in favour of purchasing from the outside supplier £60,000 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: Leather Library Chair Selling price per unit .............................................................................. £1,800 Variable cost per unit ............................................................................ 1,200 Contribution margin per unit (a) ............................................................. $ 600 Upholstery shop time required to produce one unit (b) .......................... 12 hours Contribution margin per unit of the constrained resource (a) ÷ (b) ......... £50 per hour 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 constrained resource for all three products: Gains-borough Armchair Leather Library Chair Chippen-dale Fabric Armchair Selling price per unit ................................. £1,300 £1,800 £1,400 Variable cost per unit ............................... 800 1,200 1,000 Contribution margin per unit (a) ................ £ 500 £ 600 £ 400 Upholstery shop time required to