Cost Analysis and Contribution Margin Quiz
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What is the contribution margin with the new machine?

  • $100,000
  • $70,000
  • $80,000
  • $95,000 (correct)

    • The net advantage to renting the new machine is $30,000.

    True

    What is the total fixed expense when renting the new machine?

    $65,000

    The decrease in direct labour cost is $_____ annually.

    <p>15,000</p> Signup and view all the answers

    Match the following costs with their corresponding values:

    <p>Direct materials = $70,000 Direct labour (current) = $40,000 Variable overhead = $10,000 Fixed expense = $62,000</p> Signup and view all the answers

    What is the total variable expenses with the current situation?

    <p>$120,000</p> Signup and view all the answers

    What is the contribution margin lost if digital watches are dropped?

    <p>$300,000</p> Signup and view all the answers

    Blending irrelevant costs with relevant costs can lead to confusion.

    <p>True</p> Signup and view all the answers

    What is the net annual cost saving from renting the new machine?

    <p>$12,000</p> Signup and view all the answers

    Dropping the digital watches leads to a net advantage of $40,000.

    <p>False</p> Signup and view all the answers

    What is the total amount of fixed expenses listed if digital watches are kept?

    <p>$400,000</p> Signup and view all the answers

    The salary of the line manager is __________.

    <p>$90,000</p> Signup and view all the answers

    Match the following components to their respective types (Variable/Fixed):

    <p>Salary of line manager = Fixed Manufacturing expenses = Variable Advertising – direct = Fixed Shipping = Variable</p> Signup and view all the answers

    What is the total variable expenses if digital watches are kept?

    <p>$200,000</p> Signup and view all the answers

    What are the consequences of dropping the digital watch line in terms of contribution margin?

    <p>The company gives up its contribution margin.</p> Signup and view all the answers

    If the digital watches are dropped, the company will incur a net operating loss of $100,000.

    <p>True</p> Signup and view all the answers

    Which of the following is a relevant cost for Cynthia's decision to drive or take the train?

    <p>Cost of gasoline</p> Signup and view all the answers

    The kennel cost for Cynthia's dog is a relevant cost in her decision to take the train.

    <p>False</p> Signup and view all the answers

    What non-financial factor might influence Cynthia's final decision?

    <p>Relaxation during the train ride</p> Signup and view all the answers

    What is the total time required to make Product 22?

    <p>1,100 min</p> Signup and view all the answers

    The time available to produce Product 22 is greater than the time required to produce it.

    <p>True</p> Signup and view all the answers

    The cost of __________ is considered a sunk cost and not relevant to Cynthia's current decision.

    <p>the car</p> Signup and view all the answers

    Match the following costs to their relevance in Cynthia's decision:

    <p>Cost of gasoline = Relevant Monthly school parking fee = Not relevant Train fare = Relevant Car maintenance costs = Relevant</p> Signup and view all the answers

    How many units of Product 22 can be produced, given a weekly demand of 2,200 units?

    <p>4,400</p> Signup and view all the answers

    Which benefit of taking the train is difficult to quantify in dollar terms?

    <p>Relaxing on the train</p> Signup and view all the answers

    The total time available for production of Product 11 is _____ min.

    <p>1,300</p> Signup and view all the answers

    What is the total variable expenses for the digital watches?

    <p>$200,000</p> Signup and view all the answers

    The benefits of having a car in Moncton are considered relevant despite being hard to assign a dollar value.

    <p>True</p> Signup and view all the answers

    Match the following products with their total time requirements:

    <p>Product 22 = 1,100 min Product 11 = 1,300 min</p> Signup and view all the answers

    From a financial standpoint, which option is better for Cynthia?

    <p>Taking the train</p> Signup and view all the answers

    What is the weekly demand for Product 22?

    <p>2,200 units</p> Signup and view all the answers

    The digital watches have a higher contribution margin than the fixed expenses allocated to them.

    <p>False</p> Signup and view all the answers

    The time required per unit for Product 22 is 0.5 minutes.

    <p>True</p> Signup and view all the answers

    What is the net operating loss when digital watches are kept?

    <p>$100,000</p> Signup and view all the answers

    What is the total time available for production?

    <p>2,400</p> Signup and view all the answers

    When a company is involved in more than one activity in the entire value chain, it is considered to be __________.

    <p>vertically integrated</p> Signup and view all the answers

    Why should the digital watch segment be kept despite showing a loss?

    <p>Fixed costs allocated make it appear less profitable.</p> Signup and view all the answers

    Match the following financial terms to their definitions:

    <p>Contribution Margin = Sales minus total variable expenses Net Operating Loss = When expenses exceed revenues Fixed Expenses = Costs that do not change with production volume Variable Expenses = Costs that vary directly with production volume</p> Signup and view all the answers

    Dropping the digital watch segment would eliminate all fixed costs associated with it.

    <p>False</p> Signup and view all the answers

    What is the total fixed expenses when digital watches are dropped?

    <p>$260,000</p> Signup and view all the answers

    What is the target selling price per unit set by Ritter?

    <p>$30</p> Signup and view all the answers

    Ritter's total unit product cost is $20.

    <p>True</p> Signup and view all the answers

    What is the required ROI on investments for Ritter?

    <p>20%</p> Signup and view all the answers

    The unit product cost is the sum of direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead, totaling ___.

    <p>$20</p> Signup and view all the answers

    How is the markup percentage on absorption costing calculated?

    <p>(20% × $100,000) + (($2 × 10,000) + $60,000)) / (10,000 × $20)</p> Signup and view all the answers

    If Ritter only sells 7,000 units at $30 each, what revenue would be generated?

    <p>$210,000</p> Signup and view all the answers

    The absorption costing approach is always accurate in forecasting unit sales.

    <p>False</p> Signup and view all the answers

    Match the following components of Ritter's costs with their amounts:

    <p>Direct materials = $6 Direct labor = $4 Variable manufacturing overhead = $3 Fixed manufacturing overhead = $7</p> Signup and view all the answers

    Study Notes

    Chapter 12: Relevant Costs for Decision Making

    • Relevant cost is a cost that differs between alternatives.
    • Avoidable cost can be eliminated, wholly or partly, when choosing one alternative over another.
    • Avoidable costs are relevant; Unavoidable costs are irrelevant.
    • Sunk costs and future costs that don't vary between alternatives are never relevant.
    • Relevant cost analysis is a two-step process.
      • Eliminate costs and benefits that don't differ between alternatives.
      • Use the remaining costs and benefits to make the decision.

    Learning Objectives

    • Distinguish between relevant and irrelevant costs in decision making.
    • Prepare analyses for various decision situations.
    • Determine the most profitable use of a constrained resource and the value of obtaining more of the constrained resource.
    • Compute selling prices based on costs using absorption and variable costing approaches.
    • Understand how customer sensitivity to pricing changes should influence pricing decisions.
    • Analyze pricing decisions using value-based pricing.
    • Compute target costs based on selling prices.

    Identifying Relevant Costs and Benefits

    • A relevant cost differs between alternatives.
    • An avoidable cost can be eliminated by choosing one alternative over another.
    • Avoidable costs are relevant; unavoidable costs are irrelevant.
    • Two types of costs never relevant:
      • Sunk costs
      • Future costs that do not vary between alternatives.

    Relevant Cost Analysis: A Two-Step Process

    • Identify costs and benefits relevant to each decision situation.
    • Eliminate costs and benefits that do not vary between alternatives.
    • Use the remaining costs and benefits to make the decision; these are the avoidable (differential) costs.

    Different Costs for Different Purposes

    • Costs relevant in one decision may not be relevant for another.

    Identifying Relevant Costs

    • Cost of the car is a sunk cost (irrelevant to a current decision).
    • Annual insurance cost is irrelevant: it remains the same whether driving or taking the train.
    • Gasoline cost is relevant if driving, not incurred if taking the train.
    • Car maintenance is relevant, dependent on driven kilometers.
    • Monthly school parking is irrelevant, incurred in either case.
    • Round-trip train fare is relevant as it can be avoided if driving.
    • Benefits of relaxing on the train, hassles of parking, and cost of putting the dog in a kennel are relevant but cannot be assigned dollar values.

    Identifying Relevant Costs (Continued)

    • Costs of parking in Moncton are relevant since avoiding them leads to more money.

    Identifying Financial Costs of Driving vs. Taking the Train

    • Calculations are shown for the cost of driving; for train travel.

    Total and Differential Cost Approaches

    • Data is presented for a situation where managers are considering renting a new machine.
    • Calculations are shown for the cost savings of renting the machine compared to the current situation.
    • Differential approach is effective in situations with detailed income statements.

    Adding/Dropping Segments

    • Managers face crucial decisions about adding or dropping business segments (e.g., products or stores).
    • Differential revenues and costs are key to these decisions.

    Adding/Dropping Segments (Continued)

    • Specific example presented using Lovell Company's declining digital watch line.

    A Contribution Margin Approach

    • Decision rule: Drop the digital watch segment only if profit increases.
      • Profit only increases if fixed cost savings exceed lost contribution margins.

    Adding/Dropping Segments (Segment Income Statement example)

    • Show the segment income statement from the example for Digital Watches

    Adding/Dropping Segments (Continued)

    • Discussion of which costs/expenses will be carried forward if segment is dropped

    Adding/Dropping Segments (Continued)

    Specific examples show if the segment should be kept or dropped.

    A Comparative Format

    • Comparative income statement approach - showing results for the company with and without the segment.

    Beware of Allocated Fixed Costs

    • In decisions regarding segments, common fixed costs are often allocated to products, causing a segment to seem less profitable than it truly is.

    The Make or Buy Decision

    • When a company performs multiple value-chain activities, it is vertically integrated, including decisions about "make or buy."
    • Advantages and disadvantages of making parts internally are presented.
    • An Example of Part 4A, made internally, compares cost of making to cost of buying from an outside source.

    The Make or Buy Decision (example)

    • Calculations provided for the company to make Part 4A

    The Make or Buy Decision (example)

    • The cost to make Part 4A is compared to the cost of buying from an outside company.

    Opportunity Cost

    • Opportunity cost is the benefit forfeited as a consequence of choosing a particular course of action.
    • For example, if you choose one course, you lose the chance of another one.

    Special Orders

    • Special orders are one-time orders not included in a company's regular business.
    • Only incremental costs and benefits are relevant in evaluating special orders.

    Special Orders (Example)

    • A foreign distributor offers to purchase 3,000 units of a given product at a lower-than-normal price from an example company.

    Special Orders (Example)

    • An example calculation shows how to determine if the order should be accepted based on contribution margin and capacity.

    Quick Check

    • Various examples for situations requiring pricing decisions; and explanations.
    • Calculate the lowest price to accept to avoid losing money.
    • Examples regarding making or buying products and materials, and other situational examples are shown.

    Joint Product Costs

    • In many industries, several end products are created from a singular raw material input.
      • Two or more products produced from a singular input are called joint products
    • The split-off point in the production process means multiple goods can be created.

    Joint Products (diagrammatic representation)

    Diagrams to conceptualize the split-off process in the creation of multiple products from one starting material.

    Joint Products (Example)

    • An example calculation shows the manufacturing costs and sales associated with different products.

    The Pitfalls of Allocation

    • Joint costs should not be allocated to individual products for making decisions.

    Sell or Process Further

    • Joint costs are irrelevant to decisions made after split-off
    • Processing further is profitable if incremental revenue exceeds increased costs.

    Data about Sawmill’s Joint Products

    • Data about the sales value at the split-off point, sales value after further processing, and allocated joint costs for products lumber and sawdust are shown

    Analysis of Sell or Process Further

    • Incremental revenue and Cost of further processing.
    • Calculations are provided to evaluate whether to sell products as is or to process them further

    Utilization of a Constrained Resource

    • A limited resource restricts the company's ability to meet demand.
    • A key theory of constraints (TOC) effectively manages constraints.
    • The challenge is to best utilize a constrained resource to enhance profits.

    Contribution Margin in Relation to a Constrained Resource

    • Product mix optimization maximizes total contribution margin while remaining fixed.
    • Products yielding the highest contribution margin per unit of constrained resource should be prioritized.
    • Example calculation of contribution margin and time required per unit given for two products.

    Example: Contribution Margin in Relation to a Constrained Resource (Continued)

    • The concept, utilizing the constrained resource; and maximizing profit is demonstrated; as well as examples of product mixes.

    Quick Check

    • How many units of each product can be processed through the constrained resource (Machine A1) in one minute?
    • What generates greater profit to the business: Utilizing one minute of Machine A1 for Product 1, or utilizing one minute of Machine A1 for Product 2?

    CM in Relation to a Constrained Resource (Example)

    • Calculations are shown providing the best possible product mix to maximize profit when facing a constrained resource.

    Setting a Target Selling Price - Absorption Costing

    • Absorption costing approach sets the cost base based on the absorption costing unit product cost rather than the variable cost.
    • Relevant data (variable and fixed manufacturing costs and SG&A data) to determine the target selling price is presented.

    Setting a Target Selling Price - Absorption Costing (Example)

    • Example calculation to determine price, incorporating a specified markup percentage given a specified production volume.

    Determining the Markup Percentage

    • Markup percentage can be based on industry norms, company tradition or explicitly calculated.
    • Equation to explicitly calculate the markup percentage in absorption costing.

    Determining the Markup Percentage (Example)

    • An example to calculate the markup percentage given a required return on investment and sales volume.

    Problems with the Absorption Costing Approaches

    • Assumptions in absorption costing may differ greatly from reality.
    • Customers have choices to impact results.

    Problems with the Absorption Costing (Example)

    • Examples demonstrated where the absorption costing approach may lead to inappropriate decisions or incorrect conclusions.

    Setting a Target Selling Price - Variable Costing

    • Variable costing approach is consistent with CVP analysis and doesn't arbitrarily allocate common fixed costs to specific products.

    Setting a Target Selling Price for Service Companies Using Time and Materials Pricing

    • Service companies frequently use a time and materials pricing model, employing two pricing rates: one based on direct labor time, and the other on the direct material used in completing a project.

    Pricing and Customer Latitude

    • Customers appreciate choice in purchase decisions.
    • Customers can make alternate purchases from competitors, impacting pricing decisions.

    Value-Based Pricing

    • Value-based pricing uses the economic value of benefits delivered to customers as its basis for fixing prices.
    • Economic value to the customer (EVC) estimates customers' perceived value of a product or service.

    Economic Value to the Customer

    • A product's economic value to the customer equals the reference value plus the differentiation value.
    • Reference value is the price of the best alternative, whereas differentiation value is the value of how a product improves on the best alternative.

    Differentiation Value

    • Differentiation value is created either by facilitating greater customer sales with a product or by promoting greater cost savings.

    Economic Value to the Customer (EVC)

    • The EVC is the sum of the reference value and the differentiation value.
    • Pricing should fall within the range of the reference value and the EVC.

    Target Costing

    • Target costing determines the maximum allowable cost for a new product and then constructs a prototype to meet that cost limitation.
    • Target cost = anticipated selling price - desired profit.

    Reasons for Using Target Costing

    • Target costing incorporates market supply and demand into the design stage.
    • Target pricing reflects market values and sets cost targets to maximize profitability.

    Reasons for Using Target Costing (Continued)

    • Target costing departs significantly from traditional design-costing-pricing models by first establishing the target cost, then designing the product to conform to that cost.

    Target Costing (Example)

    • Example to calculate target cost given a desired profit, projected sales volume and investment figures.

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    Managerial Accounting Chapter 12: Relevant Costs for Decision Making PDF

    Description

    Test your understanding of contribution margins and cost analysis related to fixed and variable expenses, specifically in the context of renting equipment and dropping product lines. This quiz includes practical scenarios to assess your knowledge of financial decision-making.

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