Accounting

Chapter 3
Making and Managing

Accounting Information
Learning Objectives―Coverage by question type
LO1 – Provide examples of direct and indirect costs, materials and labor costs, and overhead
costs.
True / False Multiple Choice Exercises, Problems & Short Answer
1 None 1-3
LO2 – Provide examples of incremental costs, sunk costs, relevant costs, avoidable costs, and
opportunity costs.
2-11 1-17 None
LO3 – Use the concepts of incremental costs, sunk costs, relevant costs, avoidable costs, and
opportunity costs in four basic decision-making settings: the make or buy decision, the
decision whether to drop a product, the special order decision, and deciding how to best
use a scarce resource in the short run.
12-23 18-50 4-16
© Cambridge Business Publishers, 2021

3-1 Management Accounting, 7th Edition
Chapter 3: Making and Managing Accounting Information
True / False
LO1
Terms: Direct cost
Difficulty: 2
1. A direct cost is a cost that would disappear if the cost object to which it relates is
removed.
Answer: True.
Explanation: A direct cost is a cost that can unambiguously be associated with a cost
object. Materials and direct labor are examples of direct costs. The cost of a piece of
production equipment that was acquired and used only to produce one product is an
example of a direct cost.
LO2
Terms: Opportunity cost
Difficulty: 2
2. Opportunity costs are implicit costs.
Answer: TRUE
LO2
Difficulty: 2
3. When a firm maximizes profits it will simultaneously minimize opportunity costs.
Answer: TRUE
LO2
Terms: Sunk cost
Difficulty: 1
4. Sunk costs are always irrelevant costs for decision making.
Answer: TRUE
LO2
Terms: Sunk cost
Difficulty: 1
5. An example of a sunk cost is the historical cost paid for equipment.
Answer: TRUE

Test Bank, Chapter 3 3-2
LO2
Terms: Differential cost
Difficulty: 1
6. For decision-making, incremental costs assist in choosing between alternatives.
Answer: TRUE
LO2
Terms: Incremental cost, incremental revenues
Difficulty: 1
7. For a particular decision, incremental revenues and costs are always relevant.
Answer: TRUE
LO2
Terms: Relevant cost
Difficulty: 2
8. A cost may be relevant for one decision, but not relevant for a different decision.
Answer: TRUE
LO2
Difficulty: 1
9. When opportunity costs exist, they are always relevant.
Answer: TRUE
LO2
Difficulty: 2
10. Depreciation expense allocated to a product line is a relevant cost when deciding to
discontinue that product.
Answer: FALSE
Explanation: Depreciation expense allocated to a product line is NOT a relevant cost
when deciding to discontinue that product.

LO2
Terms: Sunk cost
Difficulty: 1
11. When replacing an old machine with a new machine, the book value of the old machine
is a relevant cost.
Answer: FALSE
Explanation: When replacing an old machine with a new machine, the book value of the
old machine is a sunk cost.
LO3
Terms: Make-or-buy decision
Difficulty: 1
12. In make-or-buy decisions, the suppliers' reputation for quality and service is a relevant
quantitative factor.
Answer: FALSE
Explanation: In make-or-buy decisions, the suppliers' reputation for quality and service
is not a relevant quantitative factor.
LO3
Terms: Outsourcing
Difficulty: 2
13. If a company is deciding whether to outsource a part, general administration costs are
always unavoidable.
Answer: FALSE
Explanation: If a company is deciding whether to outsource a part, general
administration costs are not always unavoidable.
LO3
Terms: Avoidable cost
Difficulty: 1
14. Avoidable costs are eliminated when a product is outsourced.
Answer: TRUE
LO3
Difficulty: 2
15. Sometimes qualitative factors are the most important factors in make-or-buy decisions.
Answer: TRUE

LO3
Terms: Outsourcing
Difficulty: 1
16. If a company is deciding whether to outsource a part, the reliability of the supplier is an
important factor to consider.
Answer: TRUE
LO3
Terms: Outsourcing
Difficulty: 2
17. Outsourcing is risk-free to the purchaser of a part because the supplier now has the
responsibility of producing the part.
Answer: FALSE
Explanation: Outsourcing still has risk to the purchaser because the purchaser must
now depend on the reliability of the supplier.
LO3
Difficulty: 2
18. In determining whether to keep or drop a product line, avoidable fixed costs are relevant
to the decision.
Answer: TRUE
LO3
Terms: Contribution margin
Difficulty: 2
19. In determining whether to keep or drop a product line, product contribution is calculated
as sales minus variable costs, minus avoidable fixed costs.
Answer: TRUE
LO3
Difficulty: 2
20. For one-time-only special orders, variable costs may be relevant but not fixed costs.
Answer: FALSE
Explanation: For one-time-only special orders, variable costs and avoidable fixed costs
are relevant.

LO3
Terms: One-time-only special order
Difficulty: 2
21. Bid prices and costs that are relevant for regular orders are the same costs that are
relevant for one-time-only special orders.
Answer: FALSE
Explanation: Bid prices and costs that are relevant for regular orders may be different
than costs that are relevant for one-time-only special orders.
LO3
Terms: Linear programming
Difficulty: 2
22. Problems involving two or more constraints are often solved using linear programming.
Answer: TRUE
LO3
Terms: Linear programming
Difficulty: 2
23. In linear programming, total fixed costs will remain unchanged regardless of the
production plan.
Answer: TRUE

Multiple Choice
LO2
Terms: Sunk cost
Difficulty: 1
1. Sunk costs:
A) are relevant.
B) are incremental.
C) have future implications.
D) are ignored when evaluating alternatives.
Answer: D
LO2
Terms: Sunk cost
Difficulty: 1
2. The cost of a computer system installed last year is an example of:
A) a sunk cost.
B) a relevant cost.
C) an incremental cost.
D) an avoidable cost.
Answer: A
LO2
Terms: Sunk cost
Difficulty: 1
3. Costs that cannot be changed by any decision made now or in the future are:
A) fixed costs.
B) indirect costs.
C) avoidable costs.
D) sunk costs.
Answer: D
LO2
Difficulty: 1
4. For decision making, a listing of the relevant costs:
A) will help the decision maker concentrate on the pertinent data.
B) will only include future costs.
C) will only include costs that differ among the decision alternatives.
D) should include all of the above.
Answer: D

LO2
Terms: Sunk cost
Difficulty: 1
5. Which of the following costs are NEVER relevant in the decision-making process?
A) fixed costs
B) historical costs
C) relevant costs
D) variable costs
Answer: B
LO2
Difficulty: 1
6. When deciding to purchase a new cutting machine or continue using the old machine, the
following costs are all relevant except the:
A) $100,000 cost of the old machine.
B) $40,000 cost of the new machine.
C) $20,000 disposal value of the old machine.
D) $6,000 annual savings in operating costs if the new machine is purchased.
Answer: A
LO2
Difficulty: 1
7. In evaluating different alternatives, it is useful to concentrate on:
A) variable costs.
B) fixed costs.
C) total costs.
D) relevant costs.
Answer: D
LO2
Difficulty: 1
8. Costs are relevant to a particular decision if they:
A) are variable costs.
B) are fixed costs.
C) differ across, the decision alternatives being considered.
D) remain unchanged across the alternatives being considered.
Answer: C

Use the following information to answer Questions 9-12.
Down East Chemicals is considering replacing its existing computer system with a new
computer system. The new system can offer considerable savings in computer processing and
inventory management costs. Information about the existing system and the new system follow:
Existing Computer New Computer

Original cost $10,000 $15,000
Annual operating cost $ 3,500 $ 2,000
Accumulated depreciation $ 6,000 ―
Current salvage value of the existing system $ 4,000 ―
Remaining life in 5 years 5 years
Salvage value in 5 years $ 0 $ 0
Annual depreciation $ 2,000 $ 3,000
LO2
Terms: Sunk cost
Difficulty: 1
9. Sunk costs include:
A) the original cost of the existing system.
B) the original cost of the new system.
C) the current salvage value of the existing system.
D) the annual operating cost of the new system.
Answer: A
LO2
Difficulty: 1
10. Relevant costs for this decision include:
A) the original cost of the existing system.
B) accumulated depreciation.
C) the current salvage value of the existing system.
D) the remaining life of 5 years.
Answer: C

LO2
Difficulty: 2
11. Which of the following is an avoidable cost if a company gives up making a product?
A) All the variable costs associated with making that product
B) The cost of the supervisor who will be laid off as a result of discontinuing the product.
C) The costs of the machinery that can be sold when the product is discontinued.
D) All of the above
Answer: D
LO2
Difficulty: 3
12. If Down East Chemicals replaces the existing computer system with the new one, over the next 5
years operating income will:
A) increase by $2,500.
B) increase by $17,500.
C) decrease by $10,000.
D) increase by $5,000.
Answer: A
Explanation: A) Operating costs of new computer system ($2,000 × 5 years) – operating
costs of existing system ($3,500 × 5 years) = $7,500 less in operating costs. However,
the new machine will have $1,000 more in depreciation expense each year for 5 years,
which results in a $2,500 increase in operating income.
LO2
Difficulty: 3
13. Should Down East Chemicals replace the existing computer system with the new
system? What are the cash flow savings or additional cost over the 5 years? Ignore
income taxes.
A) Yes, replace; net savings of $5,000.
B) Yes, replace; net savings of $15,000.
C) No, do not replace; additional costs of $5,000.
D) No, do not replace; additional costs of $3,500.
Answer: D
Explanation: D) New system ($15,000) cost of new + $7,500 savings in operating costs
+ $4,000 salvage value of old machine = additional cost of $3,500

Use the following information to answer Questions 14 & 15.
Susan's 5-year-old Hyundai Santa Fe requires repairs estimated at $3,000 to make it

roadworthy again. Her friend, Julie, suggested that she should buy a 5-year-old used Toyota
Rav4 instead for $3,000 cash. Susan estimated the following costs for the two cars:
Hyundai Santa Fe Toyota Rav4

Acquisition cost $15,000 $3,000
Repairs $3,000 ---
Annual operating costs
(Gas, maintenance, insurance) $2,280 $2,100
LO2
Difficulty: 3
14. The cost(s) not relevant for this decision is(are):
A) the acquisition cost of the Hyundai Santa Fe.
B) the acquisition cost of the Toyota Rav4.
C) the repairs to the Hyundai Santa Fe.
D) the annual operating costs of the Toyota Rav4.
Answer: A
LO2
Difficulty: 3
15. What should Susan do? What are her savings in the first year?
A) Buy the Toyota Rav4; $9,780.
B) Fix the Hyundai Santa Fe; $5,518.
C) Buy the Toyota Rav4; $180.
D) Fix the Hyundai Santa Fe; $5,280.
Answer: C
Explanation: Hyundai ($3,000 + $2,280) – Toyota ($3,000 + $2,100) = $180 cost
savings with the Toyota option
LO2
Terms: Quantitative factor, qualitative factor
Difficulty: 2
16. When making decisions:
A) quantitative factors are the most important.
B) qualitative factors are the most important.
C) appropriate weight must be given to both quantitative and qualitative factors.
D) both quantitative and qualitative factors are unimportant.
Answer: C

LO2
Terms: Qualitative factor
Difficulty: 2
17. Employee morale at Dos Santos, Inc., is very high. This type of information is known as:
A) a qualitative factor.
B) a quantitative factor.
C) an incremental factor.
D) an opportunity cost.
Answer: A
LO3
Terms: Relevant cost analysis
Difficulty: 1
18. Which of the following is not an example of relevant cost example given in the course
text?
A) The make or buy decision.
B) The decision to drop a product.
C) The decision to buy a new piece of production decision.
D) Costing orders.
Answer: D
LO3
Difficulty: 1
19. As described in your text, which of the following costs is irrelevant in a decision?
A) Variable cost
B) Mixed cost
C) Opportunity cost
D) Sunk cost
Answer: D
LO3
Difficulty: 1
20. Which of the following is likely to be an incremental cost when developing and launching
a new product?
A) The cost of designing the product.
B) The cost of producing the product.
C) The cost of advertising the product.
D) All the above.
Answer: D

LO3
Difficulty: 2
21. Why is a sunk cost important?
A) Because it provides a way of making sure that a cost was properly incurred.
B) Because it reminds people about the bad decisions they made.
C) Because it should be ignored when making decisions.
D) Because it can be used by auditors when verifying financial records.
Answer: C
LO3
Difficulty: 2
22. What is meant by the sunk cost effect?
A) The process of training people to always recognize sunk costs.
B) The shame brought on people who make, what prove to be, bad decisions.
C) The use of sunk costs in making a decision.
D) None of the above.
Answer: C
LO3
Difficulty: 1
23. Which of the following is a correct definition of the term relevant cost?
A) A cost that is accurately measured
B) A cost that increases at a steady rate as production volume changes
C) A cost that changes as the result of taking a course of action
D) Any cost that is used by a decision maker
Answer: C
LO3
Difficulty: 2
24. Paris Company has the capacity to produce one product. Product A has a contribution
margin of $10. Product B has a contribution margin of $8. Product C has a contribution
margin of $6.
If Paris Company decides to produce Product B what is the opportunity cost?

A) $6
B) $8
C) $10
D) None of the above.
Answer: C

LO3
Difficulty: 2
25. Which of the following are relevant items to consider when an organization is thinking
about buying a needed part or product instead of making it?
A) All variable costs
B) Any avoidable costs
C) Any transportation costs
D) All the above.
Answer: D
LO3
Terms: Relevant cost—the special order problem
Difficulty: 2
26. Fox Company has just received an unexpected order from a customer for 1,000 units of a
new product. The product will have total variable costs of $15.00 per unit. Fox Company
will have to rent a machine for $10,000, pay overtime amounting to $5,000 to a supervisor
to handle this order, and fixed packaging and shipping costs of $2,000 for this order.
The minimum (floor) price per unit that Fox Company should charge for this order is:
A) $15
B) $25
C) $30
D) $32
Answer: D
Explanation: 15 + (10000+5000+2000)/1000
LO3
Terms: Relevant cost—the special order problem
Difficulty: 2
27. Fox Company has just received an unexpected order from a customer for 1,000 units of a
new product. The product will have total variable costs of $15.00 per unit. Fox Company
will have to rent a machine for $10,000, pay overtime amounting to $5,000 to a supervisor
to handle this order, and fixed packaging and shipping costs of $2,000 for this order.
The production supervisor has just advised that to complete this special order, production
and sales of 500 units of an existing product, which is sold for $35.00 per unit and has a
variable cost of $23 per unit, will have to be sacrificed.
The minimum (floor) total price that Fox Company should charge for this order is:
A) $15,000
B) $30,000
C) $38,000
D) $44,000
Answer: C
Explanation: 15*1,000 + (10000+5000+2000) + ((35-23)*500)

LO3
Terms: Relevant cost—the production mix problem
Difficulty: 2
28. Scotty Company produces three products with the following characteristics:
A B C
Maximum Unit Sales 10,000 8,000 6,000
Price per Unit $10.00 $15.00 $22.00
Variable Cost per Unit 4 7 12
Machine time (minutes) per unit 2 2 5
Production is constrained by machine time and there are 1,000 hours (60,000 minutes)
of machine time available.
The most profitable production plan is:

A) 10,000 A, 8,000 B, 4,800 C
B) 10,000 A, 8,000 B, 6,000 C
C) 7,000 A, 8,000 B, 6,000 C
D) 6,000 A, 4,000 B, 3,000 C
Answer: A
Explanation: cm/mh: A $3, B $4, C $2 B first to maximum sales then A then C
LO3
Difficulty: 3
29. Relevant costs of a make-or-buy decision for a part include all the following except:
A) fixed salaries that will not be incurred if the part is outsourced.
B) current direct material costs of the part.
C) special machinery for the part that has no resale value.
D) material-handling costs that can be eliminated if the part is outsourced.
Answer: C
LO3
Difficulty: 2
30. Which of the following would NOT be considered in a make-or-buy decision?
A) fixed costs that will no longer be incurred
B) variable costs of production
C) potential rental income from space occupied by the production area
D) unchanged supervisory costs
Answer: C

LO3
Difficulty: 2
31. Relevant costs in a make-or-buy decision of a part include:
A) setup overhead costs for the manufacture of the product using the outsourced part.
B) currently used manufacturing capacity that has alternative uses when part is
outsourced.
C) annual plant insurance costs that will remain the same.
D) corporate office costs that will be allocated differently.
Answer: B
Minden Company manufactures part QE767 used in several of its engine models. Monthly
production costs for 10,000 units are as follows:
Direct materials $ 80,000

Direct labor 20,000
Variable support costs 50,000
Fixed support costs 40,000
Total costs $190,000
It is estimated that 20% of the fixed support costs assigned to part QE767 will no longer be
incurred if the company purchases the part from the outside supplier. Minden Company has the
option of purchasing the part from an outside supplier at $16 per unit.
LO3
Terms: Outsourcing
Difficulty: 3
32. If Minden Company accepts the offer from the outside supplier, the monthly avoidable
costs (costs that will no longer be incurred) total:
A) $ 32,000.
B) $ 82,000.
C) $158,000.
D) $190,000.
Answer: C
Explanation: $80,000 + $20,000 + $50,000 + ($40,000 × 20%) = $158,000

LO3
Terms: Outsourcing, avoidable costs
Difficulty: 3
33. If Minden Company purchases 10,000 QE767 parts from the outside supplier per month,
then its monthly operating income will:
A) decrease by $2,000.
D) decrease by $58,000.
Answer: A
Explanation: Avoidable costs $158,000 – ($16 × 10,000 units) = decrease of $2,000
LO3
Difficulty: 3
34. The maximum price that Minden Company should be willing to pay the outside supplier
for each unit of part QE767 is:
A) $10.00
B) $15.00
C) $15.80.
D) $16.00
Answer: C
Explanation: Avoidable costs $158,000 / 10,000 units = $15.80 per part
Arya Jams currently makes jams and jellies and a variety of decorative jars used for packaging.
An outside supplier has offered to supply all the needed decorative jars. For this make-or-buy
decision, a cost analysis revealed the following avoidable unit costs for the decorative jars:
Direct materials $0.25

Direct labor 0.03
Unit-related support costs 0.10
Batch-related support costs 0.12
Product-sustaining support costs 0.22
Business-sustaining support costs 0.28
Total cost per jar $1.00

LO3
Difficulty: 3
35. The relevant cost per jar is:
A) $0.28 per jar.
B) $0.38 per jar.
C) $0.72 per jar.
D) $1.00 per jar.
Answer: D
Explanation: All avoidable costs are relevant for this decision.
LO3
Difficulty: 3
36. The maximum price that Arya Jams should be willing to pay for the decorative jars is:
A) $0.28 per jar.
B) $0.38 per jar.
C) $0.72 per jar.
D) $1.00 per jar.
Answer: D
Explanation: Considering only quantitative factors, the company should not pay more
than the avoidable costs of $1.00 per jar. There may be qualitative factors that are also
important.
LO3
Difficulty: 1
37. Which of the following does not need to be considered when evaluating a make-or-buy
decision?
A) savings from an alternative use of the production equipment
B) the original cost of the production equipment
C) the quality of the supplier's product
D) the reliability of the supplier's delivery schedule
Answer: B
LO3
Terms: Outsourcing
Difficulty: 2
38. Which of following are risks of outsourcing the production of a part?
A) poor quality
B) late delivery
C) unscheduled price increases
D) All of the above are risks of outsourcing.
Answer: C

LO3
Terms: Outsourcing
Difficulty: 2
39. Which of the following minimize the risks of outsourcing the production of a part?
A) the use of short-term contracts that specify price
B) the responsibility for on-time delivery is now the responsibility of the supplier
C) building close relationships with the supplier
D) All of the above minimize the risks of outsourcing.
Answer: C
LO3
Difficulty: 2
40. When evaluating a make-or-buy decision, which of the following does not need to be
considered?
A) alternative uses of the production capacity used to make the product or part
B) the original cost of the production equipment
C) the quality of the supplier's product
D) the reliability of the supplier's delivery schedule
Answer: B
LO3
Difficulty: 2
41. When deciding whether to discontinue a segment of a business, managers should focus
on:
A) unavoidable fixed costs.
B) reallocation of corporate costs.
C) contribution margin and avoidable fixed costs of the segment.
D) operating income per unit of the discontinued segment.
Answer: C

Junniper Company has three products, R2, R4, and R2D2. The following information is
available:
Product
R2 R4 R2D2
Sales $30,000 $45,000 $12,000
Variable costs 18,000 24,000 7,500
Contribution margin 12,000 21,000 4,500
Fixed costs:
Avoidable 4,500 9,000 3,000
Unavoidable 3,000 4,500 2,700
Operating income $4,500 $7,500 $ (1,200)
LO3
Terms: Relevant cost, avoidable cost
Difficulty: 3
42. Junniper Company is thinking of dropping Product R2D2 because it is reporting a loss.
Assuming Junniper drops Product R2D2 and does not replace it, operating income will:
D) decrease by $2,700.
Answer: C
Explanation: $12,000 – $7,500 – $3,000 = $1,500. The product contributes $1,500
toward corporate profits. Without the product, operating income would be $1,500 less
than currently reported.
LO3
Terms: Relevant cost, avoidable cost
Difficulty: 3
43. Assuming Product R2D2 is discontinued and the space formerly used to produce the
product is rented for $6,000 per year, operating income will:
C) increase by $6,000.
D) increase by $7,200.
Answer: B
Explanation: $(1,500) + $6,000 = $4,500

LO3
Terms: Costing orders
Difficulty: 2
44. When deciding to accept a one-time-only special order from a wholesaler, management
should do all of the following except:
A) analyze product costs.
B) consider the impact of the special order on future prices of their products.
C) determine whether excess capacity is available.
D) verify past design costs for the product.
Answer: D
LO3
Terms: Capacity
Difficulty: 2
45. When there is excess capacity, it makes sense to accept a one-time-only special order
for less than the current selling price when:
A) incremental revenues exceed incremental costs.
B) additional fixed costs must be incurred to accommodate the order.
C) the company placing the order is in the same market segment as your current
customers.
D) None of the above is correct.
Answer: A
Glass Company manufactures three different product lines, Model TS, Model AY, and Model
GG. Considerable market demand exists for all models. The following per unit data apply:
Model
TS AY GG
Selling price $100 $120 $140
Direct materials 12 12 12
Direct labor ($12 per hour) 24 24 48
Variable support costs ($4 per machine-hour) 8 16 16
Fixed support costs 20 20 20

LO3
Difficulty: 2
46. Which model has the greatest contribution margin per unit?
A) Model TS
B) Model AY
C) Model GG
D) Bboth Models TS and AY
Answer: B
Explanation: Model TS: 100 - 12 - 24 - 8 = 56
Model AY: 120 - 12 - 24 - 16 = 68*
Model GG: 140 - 12 - 48 - 16 = 64
LO3
Difficulty: 3
47. Which model has the greatest contribution margin per machine-hour?
A) Model TS
B) Model AY
C) Model GG
D) Both Models YA and GG
Answer: A
Explanation: Model TS 56/2=28**
Model AY 68/4=17
Model GG 64/4=16
LO3
Difficulty: 3
48. If there is excess capacity, which model is the most profitable to produce?
A) Model TS
B) Model AY
C) Model GG
D) Both Models TS and AY
Answer: B
Explanation: Model Y since it has the greatest contribution margin per unit.

LO3
Terms: Capacity, contribution margin
Difficulty: 3
49. If there is a machine breakdown, which model is the most profitable to produce?
A) Model TS
B) Model AY
C) Model GG
D) Both Models AY and GG
Answer: A
Explanation: Model TS since it has the greatest contribution margin per machine-hour.
LO3
Terms: Capacity, contribution margin
Difficulty: 3
50. How can the Vice-president of sales at Glass Company encourage her salespeople to
promote the more profitable model?
A) Put all sales persons on salary.
B) Provide higher sales commissions for higher priced items.
C) Provide higher sales commissions for items with the greatest contribution margin per
constrained resource.
D) Provide higher sales commissions for higher priced items and items with the greatest
contribution margin per constrained resource.
Answer: C

Exercises, Problems & Short Answer
LO1
Terms: Indirect cost, fixed manufacturing overhead
Difficulty: 2
1. Is depreciation on a factory a direct or indirect cost?
Answer: Indirect cost

Explanation: Depreciation on general factory assets, often called fixed manufacturing
overhead, is an indirect cost since the asset provides benefits to multiple cost objects.
LO1
Terms: Direct cost, indirect cost
Difficulty: 2
2. Can labor cost be a direct cost or indirect cost?
Answer: Yes
Explanation: Indirect labor cost is the cost of any worker that supports the
manufacturing process. Examples of indirect labor include supervisory costs and
workers who move materials around the factory. Direct labor costs relate to workers
who work directly on making products.
LO1
Terms: Direct, indirect cost
Difficulty: 3
3. Is the cost of glue used to make furniture a direct or indirect cost?
Answer: Indirect
Explanation: Since the glue is consumed by the piece of furniture it is properly classified
as a direct cost. However, it would be prohibitively expensive to measure and record the
quantity of glue used to make each piece of furniture. So, in this case, glue would be
treated as an indirect cost and labelled indirect variable manufacturing cost.

LO3
Terms: Relevant cost, avoidable cost, outsourcing
Difficulty: 3
4. Giant Auto manufactures part WB23 used in several of its truck models. 10,000 units are
produced each year with production costs as follows:
Direct materials $ 45,000

Direct labor 15,000
Variable support costs 35,000
Fixed support costs 25,000
Total costs $120,000
Giant Auto has the option of purchasing part WB23 from an outside supplier at $11.20
per unit. If part WB23 is outsourced, 40% of the fixed costs cannot be immediately
converted to other uses.
Required:
a. Describe avoidable costs. What amount of the part WB23's production costs is
avoidable?
b. Should Giant Auto outsource part WB23? Why or why not?
c. What other items should Giant Auto consider before outsourcing any of the parts it
currently manufactures?
Answer:
a. Avoidable costs are those costs eliminated when a part, product, product line, or
business segmented is discontinued. Avoidable production costs for part WB23 total
$110,000, which include all of the part's costs except the $10,000 ($25,000 × 40%)
of fixed costs that cannot be immediately converted to other uses.
b. Based on the financial considerations given, Giant Auto should not outsource part
WB23 because the $112,000 (10,000 units × $11.20 per part) outsourced cost is
greater than the $110,000 reduction in annual production costs. In other words, the
outsourcing would cost Giant Auto an additional $2,000 annually.
c. Other factors to consider include the supplier's ability to meet expected quality and
delivery standards, and the likelihood of suppliers increasing prices of parts in the
future.

LO3
Difficulty: 3
5. Joan’s Delicacies currently makes fudge for retail and mail order customers. It also
offers a variety of roasted nuts. Fudge sales have increased over the past year, so Joan
is considering outsourcing the roasted nuts and using the roasting space to make
additional fudge. A reliable supplier has quoted a price of $0.85 per pound for the
roasted nuts. The following amounts reflect the in-house manufacturing costs per pound
for the roasted nuts:

Direct labor 0.06
Unit-related support costs 0.10
Batch-related support costs 0.04
Product-sustaining support costs 0.05
Business-sustaining support costs 0.15
Total cost per pound $0.90
Required:
a. Should Joan’s Delicacies outsource the roasted nuts? Why or why not? Discuss all
items that should be considered.
b. What incentives can Joan offer the supplier of the roasted nuts to encourage
continued reliability?
Answer:
a. Because Joan’s Delicacies can make use of the roasting space, it can be assumed
the business-sustaining support costs are avoidable. Assuming the unit-related,
batch-related, and product-sustaining support costs are also all avoidable costs,
YES, Joan’s Delicacies should outsource the nuts because the $0.85 per pound of
the supplier is less than the current $0.90 per pound cost to Joan.
b. Joan can offer the supplier prompt payment and a guaranteed total purchase volume
annually to encourage continued reliability.

LO3
Difficulty: 3
6. Cirrus Company manufactures a part for use in one of its products. When 10,000 units
are produced, the costs per unit are:

Direct manufacturing labor 3.00
Variable manufacturing support 1.20
Fixed manufacturing support 1.60
Total $6.40
Stephen Company has offered to sell to Cirrus Company 10,000 units of the part for
$6.00 per unit. The plant facilities could be used to manufacture another item at a
savings of $9,000 if Cirrus Company accepts the offer. In addition, $1.00 per unit of fixed
manufacturing support on the original item would be eliminated.
Required:
a. What is the relevant cost per unit for the original part?
b. Which alternative is best for Cirrus Company? By how much?
Answer:
a.
Cost savings from use of facilities 0.90
Direct manufacturing labor 3.00
Variable manufacturing support 1.20
Avoidable fixed manufacturing support 1.00
Total relevant per unit costs $6.70
b.
Make Buy Effect of Buying
Purchase price $60,000 $(60,000)
Cost savings in space $ 9,000 9,000
Direct materials $ 6,000 6,000
Direct mfg. labor 30,000 30,000
Flexible manufacturing support 12,000 12,000
Fixed support saved 10,000 10,000
Totals $67,000 $60,000 ($7,000)
The best alternative is to buy the part.

LO3
Difficulty: 3
7. Clark Auto Company manufactures a part for use in its production of automobiles. When
10,000 items are produced, the costs per unit are:
Direct materials $ 12
Direct manufacturing labor 6 0
Variable manufacturing support 24
Fixed manufacturing support 32
Total $128
Python Company has offered to sell Clark Auto Company 10,000 units of the part for
$120 per unit. The plant facilities could be used to manufacture another part at a savings
of $180,000 if Clark Auto accepts the supplier's offer. In addition, $20 per unit of fixed
manufacturing support on the original part would be eliminated.
Required:
a. What is the relevant cost per unit for the original part?
b. Which alternative is best for Clark Auto Company? By how much?
Answer:
a.
Cost savings from use of facilities $18
Direct materials $12
Direct manufacturing labor 60
Variable manufacturing support 24
Avoidable fixed manufacturing support 20
Total relevant per unit costs $34
b.
Make Buy Effect of Buying
Purchase price $1,200,000
Cost savings in space $ 180,000 180,000
Direct materials $ 120,000 120,000
Direct manufacturing labor 600,000 600,000
Variable manufacturing support 240,000 240,000
Fixed manufacturing support saved 200,000 200,000
Totals $1,340,000 $1,200,000 $140,000
The best alternative is to buy the part.

LO3
Terms: Relevant cost, sunk cost
Difficulty: 3
8. Assume you are a sophomore in college and are committed to earning an
undergraduate degree. Your current decision is whether to finish college in four
consecutive years or take a year off and work for some extra cash.
Required
a. Identify at least two revenues or costs that are relevant to making this decision.
Explain why each is relevant.
b. Identify at least two costs that would be considered sunk costs for this decision.
c. Comment on at least one qualitative consideration for this decision.
Answer:
a. Relevant revenues/costs are those that differ between the alternatives of continuing
with college or taking a year off from college and working. Relevant costs for
continuing your college education without a break include:
1. Earnings lost next year due to the hours you are not able to work because of
classes and homework.
2. As a result of graduating a year earlier, higher wages will be earned a year
earlier as well.
b. Sunk costs for this decision include:

1. Amounts paid for college tuition and books during the past two years.
2. Amounts committed for college tuition and books for the remaining two years.
c. Qualitative considerations would include having different activities and priorities

than your friends who are students, graduating later than students who started
college the same time you did, and difficulty of retaining information over the year
off from school.

LO3
Terms: Relevant cost,
Difficulty: 2
9. A restaurant is deciding whether it wants to update its image or not. It currently has a
cozy appeal with an outdated décor that is still in good condition, menus and carpet that
need to be replaced anyway, and loyal customers.
Required
Identify the following for the restaurant management:
a. Those costs that are relevant to this decision

b. Those costs that are not relevant
c. Qualitative considerations
Answer:
For the decision of whether to update the restaurant's image:
a. Relevant costs include a one-time cost of the renovation for the updated image, a
change in future sales which includes an increase in sales due to the updated image,
decrease in sales due to loss of that cozy appeal, and loss of sales due to being
closed or having a limited serving area during renovation.
b. Costs that are not relevant include the costs of replacing the menus and the carpet
since they need to be replaced whether the image is updated or not.
c. Qualitative considerations include whether the restaurant will lose that cozy appeal it
currently has, if the restaurant needs to be closed for renovations it may result in a
loss of customers, and new customers may not be the type of customer the
restaurant wants to attract.
LO3
Terms: Relevant revenues, relevant costs
Difficulty: 2
10. Are relevant revenues and costs the only information needed by managers to select
among alternatives? Explain using examples.
Answer:
No. Relevant revenues and costs provide a financial analysis but they do not take into
consideration qualitative implications. In a make-or-buy decision, examples of qualitative
issues include the supplier's ability to meet expected quality and delivery standards and
the likelihood that suppliers will increase prices of the components or parts in the future.

LO3
Difficulty: 3
11. Menno Sausage Company is considering replacing its giant sausage mixer with a new
one. The following data have been compiled to evaluate the decision.
Existing New
Original cost $16,000 $20,000
Annual operating cost $8,000 $4,400
Remaining life 10 years 10 years
Disposal value now $6,000 ―
Salvage value in 10 years 0
Required:
a. What costs are relevant?
b. What costs are sunk?
c. What are the net cash flows over the next 10 years assuming Menno Sausage
Company purchases the new sausage mixer?
Answer:
a. Relevant costs include the acquisition cost of the new sausage mixer, annual
operating costs for both the old and the new sausage mixers, and the current
disposal value of the old mixer.
b. Sunk costs include the original cost of the existing sausage mixer.
c. Net cash flows over 10 years with the new sausage mixer:
Cash inflow:
Decrease in annual operating expenses ($3,600 × 5) $36,000
Sale of the existing sausage mixer 6,000
Cash outflow:
Acquisition of the new sausage mixer 20,000
Net cash inflow $ 22,000

LO3
Difficulty: 3
12. Mary McTavish, the owner and manager of Mary's Roasted Beef Company, replaced the
company's convection ovens just six months ago. Today, Pennsylvania Oven
Manufacturing announced the availability of a new convection oven that cooks much
more quickly with lower operating expenses. Mary is considering the purchase of this
faster, lower-operating cost, convection oven to replace the existing one they recently
purchased. Selected information about the two ovens is given below:
Existing New Oven

Original cost $120,000 $100,000
Accumulated depreciation $ 10,000 ---
Current salvage value $ 80,000 ---
Remaining life 10 years 10 years
Annual operating expenses $ 20,000 $ 15,000
Disposal value in 10 years $ 0 $ 0
Required:
a. What costs are sunk?
b. What costs are relevant?
c. What are the net cash flows over the next 10 years assuming that Mary purchases
the new convection oven?
d. What other factors should Mary consider when making this decision?
Answer:
a. Sunk costs include the original cost of the existing convection oven and the
accompanying accumulated depreciation.
b. Relevant costs include:

• Acquisition cost of the new oven
• Current disposal value of the existing convection oven
• Annual operating expenses for the existing and the new oven
c. Net cash flows over 10 years with the new oven:
Cash inflow:
Decrease in annual operating expenses ($5,000 × 10) $ 50,000
Sale of the existing oven 80,000
Cash outflow:
Acquisition of the new Turbo oven (100,000)
Net cash inflow $ 30,000
d. Other items the manager should consider when making this decision include:
• The new oven's reliability and efficiency is still unknown since it is a brand
new product.
• If the New oven bakes faster than it claims, the company may be able to
increase sales due to the quicker baking time.

LO3
Difficulty: 2
13. Which costs are relevant for making decisions that affect the short-term? The long-term?
Why?
Answer:
Relevant costs for making decisions that affect the short term include variable costs,
since these are the only costs that can be adjusted in the short term. All costs are
relevant for making decisions that affect the long term, because in the long term all costs
can be adjusted.
LO3
Difficulty: 2
14. Are sunk costs considered relevant when choosing among alternatives? Explain.
Answer:
No. Amounts that remain the same among alternatives do not add useful information for
selecting an alternative, and therefore, are not considered relevant for decision making.
Sunk costs by definition are those costs that have already been committed, cannot be
changed, and will never differ among alternatives.
LO3
Difficulty: 2
15. Explain what revenues and costs are relevant when choosing among alternatives.
Answer:
Amounts that differ among alternatives are considered relevant. Amounts that remain
the same among alternatives do not add useful information for selecting an alternative,
and therefore, are not considered relevant for decision making.

LO3
Terms: Relevant cost, contribution margin, scarce resource
Difficulty: 3
16. Southampton Chairs manufactures two models, Standard and Premium. Weekly
demand is estimated to be 120 units of the Standard Model and 70 units of the Premium
Model. Only 420 machine hours are available per week. The following per unit data
apply:
Standard Premium
Contribution margin per unit $12 $15
Number of machine hours required 2 2
Required:
a. For each model, compute the contribution margin per machine hour.
b. To maximize weekly production profits, how many machine hours would you
recommend of each model? How many units of each model?
c. If there are 500 machine hours available per week (instead of only 420 machine
hours per week), how many chairs of each model should Southampton produce to
maximize profits?
Answer:
a. Contribution margin per machine hour is $6 for the Standard chair, and $5 for the
Premium chair.
b. To maximize profits, 240 machine hours should be used to manufacture 120 units of
the Standard chair, and 180 machine hours should be used to manufacture 60 units
of the Premium chair. (240 mh + 180 mh = 420 mh available per week.)
c. If there are 500 machine hours available per week, there is excess capacity.
Demand for both types of chairs can be met and Southampton Chairs should
manufacture 120 Standard chairs and 70 Premium chairs per week.


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What are direct costs, indirect costs, materials costs and labor costs?

What are direct costs, indirect costs, materials costs and labor costs?

What are some examples of incremental costs, sunk costs, relevant costs, avoidable costs, and opportunity costs mentioned in the text?

What are some examples of incremental costs, sunk costs, relevant costs, avoidable costs, and opportunity costs mentioned in the text?

Chapter 3

Making and Managing

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© Cambridge Business Publishers, 2021

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Existing Computer New Computer

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Susan's 5-year-old Hyundai Santa Fe requires repairs estimated at $3,000 to make it

Hyundai Santa Fe Toyota Rav4

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If Paris Company decides to produce Product B what is the opportunity cost?

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The most profitable production plan is:

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Use the following information to answer Questions 32-34.

Direct materials $ 80,000

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Use the following information to answer Questions 35 & 36.

Direct materials $0.25

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Use the following information to answer Questions 46-50.

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Answer: Indirect cost

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Direct materials $ 45,000

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Direct materials $0.50

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Direct materials $0.60

The best alternative is to buy the part.

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The best alternative is to buy the part.

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b. Sunk costs for this decision include:

c. Qualitative considerations would include having different activities and priorities

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a. Those costs that are relevant to this decision

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© Cambridge Business Publishers, 2021

Existing New Oven

b. Relevant costs include:

c. Net cash flows over 10 years with the new oven: