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Relevant Costing

Type of costs used in Decision Making


Relevant costs expected future costs and are different between decision alternatives
Out-of-pocket costs require current or near future cash outlays or incurring of a liability for a
decision at hand
Postponable costs may be deferred or shifted to a future date or period of time without adversely
affecting current operations. Not avoidable costs
Opportunity costs income or benefit sacrificed
Imputed costs assumed or hypothetical costs representing the cost or value of a resource that is
utilized for a specific purpose
Sunk costs non-recoverable costs incurred in the past (historical) usually irrelevant should not be
totally ignored
Joint costs in process further or sell-as-is, usually irrelevant, total will not change no matter how
the same is allocated to individual products

MAKE OR BUY
X Company, a manufacturer of furniture sets, is considering to purchase the seat cushions needed for
its chair. The expected purchase price of these seat cushions is P50 per unit.
If it would continue to produce these cushions, the company expects to incur the following costs:
Raw Materials P13 Direct Materials P13
Direct Labor 15 Direct Labor 15
Variable Overhead 5 Variable Overhead 5
Fixed Overhead (based on the Total variable manufacturing cost per unit 33
average production x No. of units 10,000 units
requirement of 10,000 units) 20 Total variable manufacturing cost per unit P330,000
Total production cost per unit P53
MAKE BUY
Direct Materials (P13x10,000) P130000 Purchase Price P50
Direct Labor (P15x10,000) 150000 x No. of units 10,000
RELEVANT
Variable Overhead (P5x10,000) 50000
Total variable manufacturing cost P330000 Total Purchase Costs P500,000
Fixed FOH (P20x10,000) 200000 Fixed FOH 200,000 IRRELEVANT
Total Cost P530000 Total Cost P700,000

NET ADVANTAGE OF MAKING THE SEAT CUSHIONS (P530,000-P700,000) = P170,000


Purchase price per unit P50
Less relevant Manufacturing
cost per unit:
Materials P13
Labor 15
Variable Overhead 5 33
Difference P17
x No. of units 10000
Net advantage of making the seat cushions P170000
*Assume that 40% of the fixed factory overhead could be eliminated if the company would
discontinue the manufacture of seat cushions.
Purchase price per unit P50
Less relevant Manufacturing
cost per unit:
Materials P13
Labor 15
Variable Overhead 5
Fixed Overhead (40% of P20) 8 41
Difference P9
x No. of units 10000
Net advantage of making the seat cushions P90,000

*Assume that materials and labor costs are expected to increase by 20% next period. Factory
overhead will be eliminated in case the company decides to buy the seat cushions from other
suppliers. Moreover, the facilities presently being used in the manufacture of seat cushions can be
utilized to manufacture another part of the main product in case such facilities become vacant when
the company decides to stop producing the seat cushions. This alternative use of resources would
result into cost savings of P100,000 for X Company. Assume further that the companys requirement
for seat cushions is expected to increase by 4,000 units next period.
Forecast data:
No. of units 10,000 + 4,000 14,000 units
materials P13 x 120% P15.60
Labor P15 x 120% P18.00
Relevant Manufacturing costs:
Materials (P15.30x14000) P218400
Labor (P18.00x14000) 252000
Variable Overhead (P5.00x14000) 70000
Fixed overhead (P200000x40%) 80000 P620400
Less net purchase costs:
purchase cost (P50x14000) P700000
Less savings from alternative use of facilities 100000 600000
Net advantage of buying the seat cushions P20400

ACCEPT OR REJECT A SPECIAL ORDER


X Company presently produces and sells 20000 units of product G which represents only 80% of its
normal capacity of 25000 units. Its regular selling price is P50 per unit and its manufacturing, selling
and administrative costs are as follows:

Materials P10
Labor 12
Variable Overhead 8
Fixed Overhead (P60000/20000) 3
Variable selling and admin costs 7
Fixed selling and admin costs (P40000/20000) 2
Total unit costs P42
Special Selling price (P50x70%) P35
Less relevant costs:
Materials P10
Labor 12
Variable overhead 8 30
Marginal profit P5
x No. of units ordered 3000
Incremental profit from accepting the special order P15000

*X Companys normal capacity is 60000 units. Since the past few months, it has utilized only one half
of this capacity. For Last month, the result of its operations is summarized:

Sales (30000 units) P1500000


Less variable costs 600000
Contribution Margin 900000
Less Fixed costs 500000
Profit P400000

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