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Exam 13: Relevant Information for Special Decisions

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Question 1

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Lindsay purchased a raffle ticket for $27. Just before the grand prize drawing two people tried to buy her ticket. The first person offered $120, and another offered $155. What is Lindsay's opportunity cost of keeping the raffle ticket?

A) $54
B) $155
C) $147
D) $182

E) C) and D)
F) A) and B)

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Question 2

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A company that provides services (not goods) to its customers may incur costs that are appropriately classified as product-level costs.

A) True
B) False

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Question 3

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Monica paid $12 for a music CD for which she later was offered $15. After that someone offered her $18 for the CD. If Monica keeps the CD, the amount of her opportunity cost is $33.

All of the following are variables that could be considered in a decision to outsource a component that is currently being produced in-house. Which of the following is not likely to be relevant?

ServicePro provides two kinds of services. During the most recent accounting period, the two service lines produced the following operating results: $\begin{array}{lrl}&\text { Service } 1&\text { Service } 2\\\text { Service revenue } & \$ 80,000 & \$ 20,000 \\\text { Unit-level materials } & \$(20,000) & \$(2,000) \\\text { Unit-level labor } & \$(30,000) & \$(14,000) \\\text { Product-level selling \& administrative costs } & \$(10,000) & \$(2,500) \\\text { Company wide facility-level costs } & \underline{\$(5,000) }&\underline{\$(5,000) }\\\text { Net income (loss) } & \underline{\$ 15,000}&\underline{\$(3,500) }\end{array}$ If the company stops providing Service 2:

Bates Company plans to add a new item to its line of consumer product offerings. Two possible products are under consideration. Each unit of Product A costs $6 to produce and has a contribution margin of $3, while each unit of Product B costs $12 and has a contribution margin of $4. What is the differential revenue for this decision?

Ann is trying to decide which one of two job offers she will accept. Several items are presented below: $\begin{array}{lcc}&\text { Job offer A}&\text { Job offer B}\\\text { (1) Base salary } & \$ 50,000 & \$ 50,000 \\\text { (2) Overtime compensation } & \text { Comp. time } & \text { Hourly rate } \\\text { (3) Moving allowance } & \$ 3,000 & \$ 3,000\\\text {(4) Signing bonus}& \$ 2,000 &\$0\\\text { (5) Job search costs incurred } & \$ 300& \$500\end{array}$ Select the items that are irrelevant to Ann's decision.

Which of the following items is qualitative?

Anton Valve Company produces a mechanical valve used in water systems. Three years ago the company introduced an electronic version of the valve. Sales of the mechanical model have steadily declined, and the company will report a loss on the product this year as follows: $\begin{array}{lr}\text {sales revenue}&\$200,000\\\text {Less costs:}\\\\\text { Unit-level manufacturing costs } & 157,500 \\\text { Batch-level costs } & 2,500 \\\text { Product-level costs } & 5,000 \\\text { Facility-level costs } & 30,000 \\\text { Allocated corporate costs } & \underline{11,500}\\\text { Total costs } &\underline{ 206,500 }\\\text { Net loss } & \underline{\$(6,500)}\end{array}$ If production of the mechanical valve is discontinued, product-level costs will be eliminated but facility-level and corporate costs would not be affected. Required:Prepare a quantitative analysis that indicates whether the valve should be discontinued.What qualitative factors should be considered in this decision?

The decision to accept a lower than normal selling price may depend on the availability of excess capacity.

The Enhanced Products Division of Forrest Industries makes ceramic pots that are used to hold large decorative plants. During the current year, the division produced 10,000 pots and incurred the following costs: $\begin{array}{llr} \text {\text { Unit-level materials costs }(10,000 @ \$ 15) } &\$150,000\\ \text {Unit-level labor costs (10,000 @ \( \$ 20) \) } &200,000\\ \text {Unit-level overhead costs \( (\mathbf{1 0 , 0 0 0} \) @ \$16) } &160,000\\ \text { Depreciation expenses on equipment* } &30,000\\ \text { other manufacturing overhead** } &36,000\\\end{array}$ *The equipment was purchased for $150,000 and has a current book value of $120,000, remaining useful life of four years, and a zero salvage value. If the company does not use the equipment, it can be leased for $8,000 per year. **Includes supervisors' salaries and rent for manufacturing plant.Required:The division is considering replacing the equipment used to manufacture its ceramic pots. Replacement equipment can be purchased at a price of $200,000. The new equipment, which is expected to last four years and have a salvage value of $20,000, will reduce unit-level labor costs by 25%. Assuming the division desires to maintain its production and sales at 10,000 ceramic pots per year, prepare a schedule that shows the relevant cost of operating the existing equipment versus the cost of operating the new equipment. Should the existing equipment be replaced? Why or why not?

Variable costs are always relevant in decision making.

What is a segment elimination decision? Under what conditions should a company decide to eliminate a segment?

ServicePro provides two kinds of services. During the most recent accounting period, the two service lines produced the following operating results: $\begin{array}{lrl}&\text { Service } 1&\text { Service } 2\\\text { Service revenue } & \$ 120,000 & \$ 48,000 \\\text { Unit-level materials } & \$(28,000) & \$(10,000) \\\text { Unit-level labor } & \$(38,000) & \$(22,000) \\\text { Product-level selling \& administrative costs } & \$(18,000) & \$(11,500) \\\text { Company wide facility-level costs } & \underline{\$(6,000) }&\underline{\$(6,000) }\\\text { Net income (loss) } & \underline{\$ 30,000}&\underline{\$(1,500) }\end{array}$ If the company stops providing Service 2:

Talladega produces the clock used in the product. Talladega has received an offer from Daytona, Incorporated, to supply the clock. If Talladega discontinues production of the clock, the company will be able to eliminate its product-level costs because no other products along the same line are produced by the company. However, due to its concern for quality, the company will have to inspect each clock. Various costs and items are described below: Required:For each item in the table, place a check mark or X in the column that best describes the item in the context of the described outsourcing decision. A cost varies if the amount of the cost or the incurrence of the cost differs between the two alternatives: continuing to make the clocks or purchasing the clocks from Daytona.

Although opportunity costs are not recorded in the financial records, they nevertheless are useful for decision making.

Clean, Inc. cleans and waxes floors for commercial customers. The company is presently operating at less than capacity, with equipment and employees idle at times. The company recently received an order from a potential customer outside the company's normal geographic service region for a price of $25,000. The size of the proposed job is 38,000 square feet. The company's normal service costs are as follows: $\begin{array} { l l } \text { Unit-level materials } & \$ 0.34 \text { per squar foot } \\\text { Unit-level labor } & \$ 0.41 \text { per square foot } \\\text { Unit-level variable overhead } & \$ 0.24 \text { per square foot } \\\text { Facility-level overhead } & \text { Allocated at } \$ 0.26 \text { per square foot }\end{array}$ If the company accepts the special offer:

Differential revenues are expected future revenues that vary among the alternatives under consideration.

Costs that are not related to any specific product, batch, or unit of production are referred to as facility-level costs.

Only variable costs are relevant for decision making.