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Exam 12: Decision Making: Relevant Costs and Benefits

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Question 31

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Flower Company, which is operating at capacity, desires to add a new service to its rapidly expanding business. The service should be added as long as service revenues exceed:

A) variable costs.
B) fixed costs.
C) the sum of variable costs and fixed costs.
D) the sum of variable costs and any related opportunity costs.
E) the sum of variable costs, fixed costs, and any related opportunity costs.

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Question 32

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An accounting information system should be designed to provide information that is useful. To be useful the information must be:

A) qualitative rather than quantitative.
B) unique and unavailable through other sources.
C) historical in nature and not purport to predict the future.
D) marginal between two alternatives.
E) relevant, accurate, and timely.

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Question 33

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The following costs are relevant to the decision situation cited except:

A company that is operating at full capacity should emphasize those products and services that have the:

Mystic Incorporated produces a variety of products that carry the logos of teams in the Canadian Football League (CFL). The company recently paid the league $85,000 for the rights to market a popular player jersey and immediately began production. The following information is available: Number of jerseys manufactured: 25,000 Cost of jerseys manufactured: $\$ 625,000$ Amount of manufacturing costs paid to-date: $\$ 410,000$ Number of jerseys sold to-date: 0 Estimated future marketing costs: $\$ 330,000$ Anticipated selling price per jersey: $42 The CFL is about to file a lawsuit to stop jersey sales and is demanding another $50,000 from Mystic for the manufacturing rights. Conversations with Mystic's attorneys indicate that the league has a strong case and is likely to win the suit. If this situation arises, Mystic will be unable to recover any amounts paid to the CFL. Required: Mystic's sales department anticipates very strong demand and a sellout of all jerseys manufactured. A. Determine the overall profitability of the jersey product line if Mystic settles the disagreement with the CFL and the anticipated sellout occurs. B. Should the company pay the additional $50,000 demanded by the league or should the jersey program be dropped? Show computations to support your answer.

Fifth Avenue designs is studying whether to outsource its Public Relations (P/R) activities. Salaried professionals who earn $200,000 would be terminated; in contrast, administrative assistants who earn $50,000 would be transferred elsewhere in the organization. Miscellaneous departmental overhead (e.g., supplies, copy charges, overnight delivery) is expected to decrease by $20,000, and $35,000 of corporate overhead, previously allocated to Public Relations, would be picked up by other departments. If Fifth Avenue can secure needed P/R services locally for $230,000, how much would the company benefit by outsourcing?

Outdoors Inc. manufactures two products: Canoes and Kayaks. The results of operations for 2012 follow. $\begin{array}{l}\begin{array}{lll}\\\text { Units}\\\text { Sales}\\\text { Less: Cost of Goods Sold}\\\text { Gross Margin}\\\text { Less: Selling Expenses}\\\text { Operating Income}\\\end{array}\begin{array}{lll}\text { Canoes }\\12.000 \\\$ 288,000 \\\underline{216,000}\\72,000 \\\underline{72000}\\\underline{\$ 0} \end{array}\begin{array}{lll}\text { Kayaks}\\4,000 \\\$ 800,000 \\\underline{516,000} \\ 284,000 \\\underline{159,000} \\\underline{\$ 125,000} \\\end{array}\begin{array}{lll}\text { Total }\\16,000\\\$ 1,080,000\\\underline{732,000}\\{348,000}\\\underline{231,000}\\\underline{\$ 125.000}\end{array}\end{array}$ Fixed manufacturing costs included in cost of goods sold amount to $2 per unit for Canoes and $19 per unit for Kayaks. Variable selling expenses are $5 per unit for Canoes and $21 per unit for Kayaks; remaining selling amounts are fixed. Outdoors Inc. wants to drop the Canoes product line. If the line is dropped, company-wide fixed manufacturing costs would fall by 10% because there is no alternative use of the facilities. What would be the impact on operating income if Canoes is discontinued?

The term "outsourcing" is most closely associated with:

"It's close to a $40,000 loser and we ought to devote our efforts elsewhere," noted Kara Whitmore, after reviewing financial reports of her company's attempt to offer a reduced-price daycare service to employees. The daycare's financial figures for the year just ended follow. $\begin{array} { | l | r | } \hline \text { Revenues } & \$ 120.000 \\\hline \text { Variable costs } & 45.000 \\\hline \text { Traceable fixed costs } & 89.000 \\\hline \text { Allocated corporate overhead } & 24.000 \\\hline\end{array}$ If the daycare service/centre is closed, 70% of the traceable fixed cost will be avoided. In addition, the company will incur one-time closure costs of $6,800. Required: A. Show calculations that support Kara Whitmore's belief that the daycare centre lost almost $40,000. B. Should the centre be closed? Show calculations to support your answer. C. What problem might the company experience if the centre is closed?

In early September, Merina Holden purchased an $800 ticket to the December 31 game of the Toronto Maple Leafs. Parking for the game was expected to cost approximately $30, and Holden would probably spend another $25 for a souvenir program and food. It is now December 14. The Maple Leafs were having a miserable season and the temperature was expected to peak at 5 degrees Celsius on game day. Merina therefore decided to skip the game and instead, took her sister to a Lady Gaga concert, with tickets and dinner costing $150. The sunk cost associated with this decision situation is:

A special order generally should be accepted if:

Millennium 21 sells clothing, shoes, and accessories at a downtown location in Montreal, Quebec. Information for the year ended December 31, 2012 follows: $\begin{array}{l}\begin{array}{lll}\\\text { Sales}\\\text { Variable costs}\\\text { Fixed costs}\\\text { Total costs}\\\text { Operating Income (Loss)}\\\end{array}\begin{array}{lll}\underline{\text { Clothing }}\\\$ 650,000\\390,000\\\underline{200,000}\\\underline{590,000}\\\underline{960,000}\end{array}\begin{array}{lll}\underline{\text { Shoes }} \\ \$ 220,000 \\150,000 \\\underline{100,000}\\\underline{250,000} \\\underline{(\$ 30,000)}\\\end{array}\begin{array}{lll}\underline{\text { Accessories }}\\{\$ 125,000}\\65,000 \\\underline{45,000} \\\underline{110,000}\\\underline{ \$ 15,000}\end{array}\end{array}$ Management is considering closing the shoe operation because of the loss and expanding the space that is currently devoted to accessories sales. A salaried salesperson in the shoe department who earns $40,000 will be terminated; however, all other departmental fixed costs will continue to be incurred. Millennium 21 will spend $20,000 on remodeling costs and anticipates that accessories sales will increase by $80,000. This additional sales revenue is expected to generate a 25% contribution margin for the firm. Finally, because clothing customers often purchased shoes and feel strongly about "one-stop shopping," clothing sales are expected to fall by 10% if the shoe department is closed. Required: Determine whether the shoe department should be closed. The company is currently earning $45,000 ($60,000 - $30,000 + $15,000). If the shoe department is closed, total income amounts to only $10,500 as shown below, meaning the department should remain in operation.

Clancy Van Lines is considering the acquisition of two new trucks. Because of improved mileage, these vehicles are expected to have a lower operating cost per mile than the trucks the company plans to replace. Management is studying whether the firm would be better-off keeping the older vehicles or going ahead with the replacement, and has identified the following decision factors to evaluate. 1. Cost and book value of the old trucks 2. Moving revenues, which are not expected to change with the acquisition 3. Operating costs of the new and old vehicles 4. New truck purchase price and related depreciation charges 5. Proceeds from sale of the old vehicles 6. The 8% return on alternative investments that Clancy will forego by tying up cash in the new trucks 7. Drivers' wages and fringe benefits Required: Classify the seven decision factors listed into the following categories (note: factors may be used more than once). A. Relevant costs. B. Opportunity costs. C. Sunk costs. D. Factors to be considered in the decision.

Smith Manufacturing has 27,000 labour hours available for producing X and Y. Consider the following information: $\begin{array} { | l | c | c | c | } \hline & \text { Product X } & & \text { Product Y } \\\hline \text { Required labour time per unit (hours) } & 2 && 3 \\\hline \text { Maximum demand (units) } & 6,000 && 8.000 \\\hline \text { Contribution margin per unit } & \$ 5.00& & \$ 6.00 \\\hline \text { Contribution margin per labour hour } & \$ 2.50 && \$ 2.00 \\\hline\end{array}$ If Smith follows proper managerial accounting practices, which of the following production schedules should the company set? $\begin{array} { | l | r | r | r | } \hline & \text { Product X } & & \text { Product Y } \\\hline 1 & 0 \text { units } && 8,000 \text { units } \\\hline 2 & 1,500 \text { units } & & 8,000 \text { units } \\\hline 3 & 6,000 \text { units } & &0 \text { units } \\\hline 4 & 6.000 \text { units } && 5.000 \text { units } \\\hline 5 & 6.000 \text { units } && 8.000 \text { units } \\\hline\end{array}$

Which of the following costs can be ignored when making a decision?

Mamma Lucy's Pizza is a franchise operation with 47 stores across Canada. Store No. 10 has fallen on hard times and is about to be closed. The following figures are available for the period just ended: $\begin{array} { l r } \text { Sales } & \$ 305,000 \\\text { Cost of sales } & 97,900 \\\text { Building occupancy costs: } & \\\quad \text { Rent } & 56,500\\\quad \text { Utilities } & 26,000 \\\text { Supplies used } & 16,600 \\\text { Wages } & 87,700\\\text { Miscellaneous } & 4,000 \\\hline \text { Allocated corporate overhead } & 19,200\\\hline\end{array}$ All employees except the store manager would be discharged. The manager, who earns $37,000 annually, would be transferred to Store No. 12 in a neighboring suburb. Also, no. 10's furnishings and equipment are fully depreciated and would be removed and transported to Mamma Lucy's warehouse at a cost of $3,200. Required: A. What is Store No. 10's reported loss for the period just ended? B. Should the store be closed? Briefly explain your response. C. Would Mamma Lucy's likely lose all $305,000 of sales revenue if Store No. 10 were closed? Briefly explain your response.

Worldwide Enterprises has been approached about providing a new service to its clients. The company will bill clients at the rate of $150 per hour; the related hourly variable and fixed operating costs will be $65 and $28, respectively. If all employees are currently working at full capacity on other client matters, the per-hour opportunity cost of being unable to provide this new service is:

Which of the following statements is true with respect to activity-based costing?

Sampsonnites, a manufacturer of travel accessories, has excess capacity. The company's Kingston, Ontario plant has the following per-unit cost structure for Note No.12: $\begin{array} { | l | l | } \hline \text { Variable manufacturing } & \$ 50 \\\hline \text { Fixed manufacturing } & 25 \\\hline \text { Variable selling } & 6 \\\hline \text { Fixed selling } & 10 \\\hline \text { Traceable fixed administrative } & 5 \\\hline \text { Allocated administrative } & 2 \\\hline\end{array}$ The traceable fixed administrative cost was incurred at the Kingston plant; in contrast, the allocated administrative cost represents a "fair share" of Sampsonnites' corporate overhead. The Kingston plant has been presented with a special order of 6,000 units of Note No.12 on which no selling cost will be incurred. The proper relevant cost in deciding whether to accept this special order would be:

Golden Company makes 3,000 units per year of a part called a "glup" for use in one of its products. Data concerning the unit production costs of glup follow: $\begin{array} { | l | c | } \hline \text { Direct Materials } & \$ 35 \\\hline \text { Direct Labour } & \$ 10 \\\hline \text { Variable Manulacturing Overhead } & \$ 8 \\\hline \text { Fixed Manufacturing Overhead } & \$ 20 \\\hline \text { Total Manufacturing Cost per Unit } & \$ 73 \\\hline\end{array}$ An outside supplier has offered to sell Golden Company all the glups it requires. If Golden decided to discontinue making the glups, 40% of the above fixed manufacturing overhead costs could be avoided. Assume that direct labour is a variable cost. Required: A. Assume Golden Company has no alternative use for the facilities presently devoted to production of the glups. If the outside supplier offers to sell glups for $65 each, should Golden Company accept the offer? Should the centre be closed? Show calculations to support your answer. B. Assume that Golden Company could use the facilities presently devoted to production of glups to expand production of another product that would yield an additional contribution margin of $80,000 annually. What is the maximum price Golden Company should be willing to pay the outside supplier for glups?