The ABC Company manufactures components for use in producing one of its finished products. When 12,000 units are produced, the full cost per unit is $35, separated as follows:Direct materials $ 5Direct labor 15Variable overhead 10Fixed overhead 5The XYZ Company has offered to sell 12,000 components to ABC for $37 each. If ABC accepts the offer, some of the facilities currently being used to manufacture the components can be rented as warehouse space for $40,000. However, $3 of the fixed overhead currently applied to each component would have to be covered by ABC's other products. What is the differential cost to the ABC Company of purchasing the components from the XYZ Company?
Answer(s): B
Differential (incremental) cost is the difference in total cost between two decisions. The relevant costs do not include unavoidable costs, such as the $3 of fixed overhead. It would cost ABC an additional $20,000 to purchase, rather than manufacture, the components.
A company needs special gears. The machinery to make the gears can be rented for $100000 for 1 year, but the company can buy the gears and avoid the rental cost. Because the demand for the gears may be high (0.6 probability) or low (0.4 probability) and contribution margins vary, the company prepared the following decision tree:Which of the following statements is true?
The expected value of buying the gears is
Production of a special order will increase gross profit when the additional revenue from the special order is greater than
Answer(s): D
Gross profit will increase if the incremental or marginal cost of producing the order is less than the marginal revenue. Marginal cost equals the relevant variable costs assuming fixed costs are not affected by the special order.
When considering a special order that will enable a company to make use of currently idle capacity. which of the following costs is irrelevant?
Because depreciation will be expensed whether or not the company accepts the special order, it is irrelevant to the decision. Only the variable costs are relevant.
Which of the following cost allocation methods is used to determine the lowest price that can be quoted for a special order that will use idle capacity within a production area?
Answer(s): C
If idle capacity exists, the lowest feasible price for a special order is one covering the variable cost. Variable costing considers fixed cost to be a period cost, not a product cost. Fixed costs are not relevant to short term inventory costing with idle capacity because the fixed costs will be incurred whether or not any production occurs. Any additional revenue in excess of the variable costs will decrease losses or increase profits.
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