Question

11-30. Relevant Cost Exercises. Each of the following situations is independent:

Make or Buy. Terry Inc manufactures machine parts for aircraft engines. CEO Bucky Walters is considering an offer from a subcontractor to provide 2,000 units of product OP89 for $120,000. If Terry does not purchase these parts from the subcontractor, it must continue to produce them in-house with these costs:

	Cost per unit
Direct materials	28
Direct labor	18
Variable overhead	16
Allocated fixed overhead	4

Required. Should Terry Inc accept the offer from the subcontractor? Why or why not? Include a consideration of both financial and nonfinancial factors.

Disposal of Assets. A company has an inventory of 2,000 different parts for a line of cars that has been discontinued. The net book value (NBV) of this inventory is $50,000. The parts can be either re-machined at a total cost of $25,000 and the sold for $30,000 or sold as-is for $2,500.

Required. What should it do? Include a consideration of both financial and nonfinancial factors.

Replacement of an asset. An uninsured boat costing $90,000 was wrecked the first day it was used. It can be either sold as-is for $9,000 cash and replaced with a similar boat costing $92,000 or rebuilt for $75,000 and be brand new as far as operating characteristics and looks are concerned.

Required. What should be done? Include a consideration of both financial and nonfinancial factors.

Profit for Processing Further. Deaton Corporation manufactures products A, B and C from a joint process. Joint costs are allocated on the basis of relative sales value of the product at the split-off point. Additional information for Deaton Corporation follows:

	A	B	C	Total
Units produced	12,000	8,000	4,000	24,000
Joint costs	144,000	60,000	36,000	240,000
Sales value before additional processing	240,000	100,000	60,000	400,000
Additional costs for further processing	28,000	20,000	12,000	60,000
Sales value if processed further	280,000	120,000	70,000	470,000

Required.

Define the following terms: joint production process; join production costs; separable processing costs; and split-off point.

Which, if any, of products A, B, and C should be processed further and the sold? (Show calculations).

Why do accountants allocate to individual products joint/common costs in a joint manufacturing process?

Make or Buy. Eggers Company needs 20,000 units of a par to use in producing one of its products. If Eggers buys the part from McMillan Company for $90 instead of making it, Eggers will not use the released facilities in another manufacturing activity. Forty percent of the fixed overhead will continue irrespective of CEO Donald Mickey’s decision. The cost data are:

Cost to make the part:
Direct materials	35
Direct labor	16
Variable overhead	24
Fixed overhead	20
	95

Required. Determine which alternative is more attractive to Eggers and by what amount. What nonfinancial factors might bear upon the ultimate decision?

Selection of the Most Profitable Product. DVD Production Company produces two basic types of video games, Flash and Clash. Pertinent data for DVD Production Company follow:

	Flash	Clash
Sales price	250	140
Costs
Direct materials	50	25
Direct labor (@ $25/hr.)	100	50
Variable overhead factory*	50	25
Fixed factory overhead*	20	10
Marketing costs (all fixed)	10	10
Total costs	230	120
Operating profit	20	20
*Based on labor hours: 2 direct labor hours (DLHs) per unit of Flash, and 1 DLH per unit of Clash

The DVD game craze is at its height so that either Flash or Clash alone can be sold to keep the plant operating at full capacity. However, labor capacity in the plant is insufficient to meet the combined demand for both games. Flash and Clash are processed through the same production departaments.

Required.

What is the meaning and importance of the statement that “Flash and Clash are processed through the same production departments”?

Which product should be produced? Briefly explain your answer.

Special-Order pricing. Barry’s Bar-B-Que is a popular lunch-time spot. Barry is conscientious able the quality of his meals, and he has a regular crowd of 600 patrons for his $5 lunch. His variable cost for each meal is about $2, and he figures his fixed costs, on a daily basis, at about $1,200. From time to time, bus tours groups with 50 patrons stop by. He was welcomed them since he has capacity to seat 700 diners in the average lunch period, and his cooking and wait staff can easily handle the additional load. The tour operator generally pays for the entire group on a single check to save the wait staff and cashier the additional time. Due to competitive conditions in the tour business, the operator is now asking Barry to lower the price to $3.50 per meal per each of the 50 tour bus members.

Required. Should Barry accept the $3.50 price? Why or why not? What if the tour company were willing to guarantee 200 patrons (or four bus loads) at least once a month for $3.50 per meal?

Answer 1

Answer:	Cost to produce goods in-house
	Direct material	$                            28.00
Add:	Direct labour	$                            18.00
Add:	Variable Overhead	$                            16.00
Add:	Allocated Fixed Cost	$                                   -	(It will not be cossidered as it is sunk cost)
	Total relevant cost per unit	$                            62.00
	Number of units	$                      2,000.00
	Total relevant cost for 2,000 unit	$                 124,000.00	(2,000*$62)
Less:	Price offered by sub-contractor for 2,000 units	$                 120,000.00
	Saving in cost	$                      4,000.00
	As there is saving in cost by $4,000 the offer should be accepted. The acceptance of offer may lead to leakage of design, may create unemployment.
	Alternative use of the spare capacity realized can also be evaluated.
	Other non financial factors to be considered are quality of parts offered, delivery of parts on time.