GNBCY Practice Exam Solutions – Chapter 14
Part (a) Solution (Learning Objective 1):
The common fixed costs of $10,000 (or $130,000 - $120,000) are irrelevant to this decision.
Part (a) Solution (Learning Objective 2):
CM that would be lost if department is discontinued
$(150,000) Less fixed costs that can be avoided if department is discontinued
120,000 Increase (decrease) in net operating income
Based on this information alone, because the company’s net operating income would decrease by $30,000 per year, management should not eliminate this department.
Solution (Learning Objective 3):
A relevant cost is a cost that differs between alternatives in a decision-making situation. Since the variable selling and administrative expenses of $3.00 per unit would need to be incurred to sell the defective units, they are relevant to the decision and should be used as a guide for setting the minimum price on these defective units.
Note that none of the other per unit costs would be relevant as a guide for setting the minimum price on the defective units. The four types manufacturing costs listed above are sunk costs (i.e., a cost that has already been incurred and that cannot be changed by any decision made now or in the future) and, as such, are not relevant to this decision. The fixed selling and administrative expenses is a common fixed cost (i.e., a cost that supports the operations of more than one segment of an organization and is not avoidable in whole or in part by eliminating any one segment) and, as such, are not relevant to this decision.)
Part (a) Solution (Learning Objective 3):
The product costs related to making the parts that can be eliminated are the variable manufacturing costs ($64 per unit) and two-thirds of the fixed manufacturing costs (2/3 x $36 = $24) for a total of $88 (or $64 + $24) per unit. Those are the costs that are relevant to the “make” decision. The cost that is relevant to the “buy”...
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