Topic 1: Decision Making and Control

1. Cynthia, a Boston student, is considering visiting her friend in New York. She has a car. She can drive
or take the train. By car it is 230 miles to her friends apartment.
She is trying to decide which alternative is less expensive and has gathered the following information:
Cost of car = RM18,000 bought 2 years ago.

1
2
3
4
5

Automobile Costs (based on 10,000 miles drive per year)

Annual Cost of
Fixed Items
RM
Annual straight line depreciation on car
2,800
Cost of gasoline
Annual cost of auto insurance and license
1,380
Maintenance and repairs
Parking fees at school
360
Total average cost

Cost per Mile

RM
0.280
0.050
0.138
0.065
0.036
0.569

Some Additional Information

7
8
9
10
11
12
13

Reduction in resale value of car per mile of wear

Round-trip train fare
Benefits of relaxing on train trip
Cost of putting dog in kennel while gone
Benefits of having car in New York
Hassle of parking car in New York
Per day cost of parking car in New York

RM
0.026
104
?
40
?
?
25

2. You are currently working as an accountant in an insurance company, but you are thinking of starting
up your own business. In considering whether or not to start your own business, your current salary would
be:
A
B
C
D

A sunk cost
An incremental cost
An irrelevant cost
An opportunity cost

3. What term is used to represent the benefit sacrificed when one course of action is chosen in preference
to an alternative?
A
B
C
D

Avoidable cost
Direct cost
Incremental cost
Opportunity cost

4. A firm has some material which originally cost RM45,000. It has a scrap value of RM12,500 but if
reworked at a cost of RM7,500, it could be sold for RM17,500.
What would be the incremental effect of reworking and selling the material?
A
B
C
D

A loss of RM27,500
A loss of RM2,500
A profit of RM5,000
A profit of RM10,000

5. In order to utilize some spare capacity, Zola is preparing a quotation for a special order which requires
1,000 kilograms of Material R.
Zola has 600 kilograms of Material R in inventory (original cost RM5 per kg). Material R is used in the
companys main product Q.
The resale value of Material R is RM4.00 per kg. The present replacement price of Material R is RM6.
Material R is readily available on the market.
The relevant cost of the 1,000 kilograms of Material R to be included in the quotation is:
A
B
C
D

RM4,000
RM5,000
RM5,400
RM6,000

6. A company is considering accepting a one-year contract that will require four skilled employees.
The four skilled employees could be recruited on a one-year contract at a cost of RM40,000 per employee.
The employees would be supervised by an existing manager who earns RM60,000 per annum. It is
expected that supervision of the contract would take 10% of the managers time.
Instead of recruiting new employees, the company could retrain some existing employees who currently
earn RM30,000 per year. The training would cost RM15,000 in total. If these employees were used they
would need to be replaced at a total cost of RM100,000.
The relevant labour cost of the contract is:
A
B
C
D

RM100,000
RM115,000
RM135,000
RM166,000

7. X Ltd makes two products, X and Y. One unit of Product X requires 5 kg of materials and 2 hours of
labour. One unit of Product Y requires 4 kg of the same material and 3 hours of the same labour. There
are only 2,000 hours labour available each week and the maximum amount of material available each
week is 3,000 kg. Potential sales demand each week is 300 units of Product X and 450 units of Product Y.
Required
Identify whether materials or labour is a limiting factor.
2

8. A company manufactures three products. Sales demand for the products in the next period is estimated
to be:
Product A
Product B
Product C

6,200 units
8,000 units
11,500 units

Selling prices and unit costs are

Selling price
Costs:
Direct materials
Direct labour (RM8 per hour)
Variable overhead
Fixed overhead

Product A
RM per unit
9.70

Product B
RM per unit
11.10

Product C
RM per unit
13.80

2.80
2.40
0.90
2.70

3.90
2.40
0.90
2.70

4.92
3.20
1.20
3.60

The company is experiencing a shortage of direct labour and estimates that a maximum of 8,500 hours
will be available in the next period.
Required
(a) Demonstrate that the availability of direct labour will be a limiting factor in the next period.
(b) Determine the production schedule for the next period that will maximize profit.
9. POV manufactures three products X,Y and Z that use the same machines. The budgeted income
statements for the three products are as follows:

Sales
Prime costs
Variable overheads
Fixed overheads
Profit/(loss)
Annual sales demand (units)
Machine hours per unit

X
RM000
1,000
(500)
(250)
(200)
50

Y
RM000
1,125
(562.5)
(187.5)
(315)
60

5,000
20

7,500
21

Z
RM000
625
(437.5)
(62.5)
(130)
(5)
2,500
26

Fixed overheads are absorbed on the basis of machine hours. The budgeted machine hours based on
normal capacity were 322,500 hours. However, after budget had been formulated, an unforeseen
condition has meant that during the next period the available machine capacity has been limited to
296,500 hours.
Required
(a) Determine the optimum production plan for the next period.
(b) Calculate the resulting profit that your production plan will yield.
3

10. Estimates for the following period, relating to a companys range of products, are as follows:
Sales:
Demand (units)
Revenue (total RM)
Costs (total RM):
Variable costs:
Direct materials
Direct labour
Variable overheads
Fixed overheads

Product W

Product X

Product Y

Product Z

2,000
20,000

500
10,000

900
13,500

1,600
19,200

6,000
6,600
1,000
3,000

3,700
2,910
500
2,000

5,580
3,915
810
2,500

5,920
7,200
1,120
3,100

Owing to capacity restrictions, total direct labour hours (all paid at RM15 per hour) will be limited to
1,255 in the following period. The company has decided to concentrate production on the most profitable
products.
Required
For the following period:
(a) Calculate the expected shortfall in direct labour hours
(b) Determine the order of profitability of the four products given that labour hour restriction exist
(c) Establish the production schedule to maximize profit and calculate the resulting profit
(d) Calculate the increase in profit if direct labour can be increased by 60 hours

11. Worth produces four products L, E, W and S which have the following costs per unit:

Direct materials (at RM10/kg)

Direct labour (at RM12/hour)
Overheads (at RM6/ labour hour)
Total cost
Contribution/unit
Maximum demand per month

L
RM
15
12
12
39

E
RM
10
12
6
28

W
RM
12.5
18
9
39.5

S
RM
20
18
9
47

10
3,000

15
2,000

12
1,500

20
2,500

Only 15,000 kg of materials and 10,250 labour hours are available.

What is the optimal production plan given that the company wishes to maximize contribution?

A
B
C
D

L
Units
3,000
2,250
3,000
3,000

E
Units
2,000
2,000
2,000
2,000

W
Units
1,500
1,500
1,500
1,000

S
Units
2,500
2,500
1,500
2,500
4

12. Securit Plc manufactures a variety of products for the security industry. Due to significantly increased
demand for its products, the company must make a decision about buying in some components from an
outside supplier.
The following information relates to three components:
Component
Budgeted production (units)
Machine hours (per unit)
Direct materials (per unit)
Direct labour hours (per unit)

P
2,000
1.0
RM2.00
1.0

Q
2,000
1.5
RM3.00
2.0

R
2,000
1.5
RM4.00
2.0

Direct labour is budgeted at RM2 per direct labour hour. Variable overheads are budgeted at RM2 per
direct labour hour.
Machine hours are limited to 4,000 hours during this budget period for these three components. AN
outside supplier has quoted RM24, RM38 and RM45 per unit respectively for components P, Q and R.
Required
(a) Advise the company on which components and how many they should buy in order to achieve the
budgeted output at minimum cost. Support your advice with calculations.
(b) Identify two factors (other than cost) a company will need to consider when deciding whether to buy
in components.
13. Fidgets Ltd manufactures three components used in its finished product. The component workshop is
currently unable to meet the demand for components and the possibility of subcontracting part of the
requirement is being investigated on the basis of the following data.
Component
Variable costs of production
Outside purchase price
Excess cost per unit
Machine hours per unit
Labour hours per unit

A
RM
3.00
2.50
(0.50)

B
RM
4.00
6.00
2.00

C
RM
7.00
13.00
6.00

1
2

0.5
2

2
4

Required
(a) Decide which component should be bought from external suppliers if the company has no limiting
factors.
(b) Decide which component should be bought from external suppliers if production is limited to 4,000
machine hours per week.
(c) Decide which component should be bought from external suppliers if production is limited to 4,000
labour hours per week.

14. Four components are manufactured by a company and used in the assembly of its final products. The
production capacity of 25,000 machine hours per period, for the manufacture of the components, is not
sufficient to meet demand. The capacity restriction is overcome by buying-in components from an outside
supplier.
Relevant data are as follows:
Component
Capacity utilization
(machine hours per unit)
Units required per period
Production costs (RM per unit):
Direct materials
Direct labour
Variable overhead
Fixed overhead
Cost of buying-in (RM per unit)

3
4,200

2
3,000

2
2,500

1
5,000

24
18
2
18
54

12.5
13
1.3
13
32

17
14
1.4
14
38

14
10
1
10
29

At the above bought-in prices it is worthwhile buying-in sufficient quantities of components to make up
the capacity shortfall.
Required
(a) Calculate the production capacity shortfall (machine hours and %)
(b) Determine the production schedule, and details of bought-in requirements, that would maximize profit.
(c) Calculate the total additional cost of buying-in components.

15. Further Processing of Joint Products

Appletime grow apples and then sorts them into one of three grades, A, B or C, based on their condition.
Appletime must decide whether to sell the Grade B apples at split-off or to process them into apple pie
filling. The company normally sells the Grade B apples in 120 five-pound bags at a per-unit price of
RM1.25. If the apples are processed into pie filling, the result will be 500 cans of filling with additional
costs of RM0.24 per can. The buyer will pay RM0.90 per can.
Required
(a) What is the contribution to income from selling the Grade B apples in five-pound bags?
(b) What is the contribution to income from processing the Grade B apples into pie filling?
(c) Should Appletime continue to sell the Grade B apples in bags or process them further into pie filling?

16. Special Order Decisions

Leibnitz Company has been approached by a new customer with an offer to purchase 20,000 units of
model TR8 at a price of RM9 each. The new customer is geographically separated from the companys
other customers, and existing sales would not be affected. Leibnitz normally produces 100,000 units of
TR8 per year but only plans to produce and sell 75,000 in the coming year. The normal sales price is
RM14 per unit. Unit cost information for the normal level of activity is as follows:
Direct materials
Direct labour
Variable overhead
Fixed overhead
Total

RM
3.00
2.80
1.50
2.00
9.30

Fixed overhead will not be affected by whether or not the special order is accepted.
Required
(a) What are the relevant costs and benefits of the two alternatives (accept or reject the special order)?
(b) By how much will operating income increase or decrease if the order is accepted?

17. Keep or Drop Decisions

Shown below is a segmented income statement for Norton Materials Incs three product lines:

Sales revenue
Less: Variable expenses
Contribution margin
Less: Direct fixed expenses
Advertising
Salaries
Depreciation
Segment margin

Blocks
RM
500,000
250,000
250,000

Bricks
RM
800,000
480,000
320,000

Tile
RM
150,000
140,000
10,000

Total
RM
1,450,000
570,000
580,000

(10,000)
(37,000)
(53,000)
150,000

(10,000)
(40,000)
(40,000)
230,000

(10,000)
(35,000)
(10,000)
(45,000)

(30,000)
(112,000)
(103,000)
335,000

The roofing tile lines has a contribution margin of RM10,000 (sales of RM150,000 minus total variable
costs of RM140,000). All variable costs are relevant. Relevant fixed costs associated with this line include
RM10,000 in advertising and RM35,000 in supervision salaries.
Required
(a) List the alternatives being considered with respect to the roofing tile line
(b) List the relevant benefits and costs for each alternative
(c) Which alternative is more cost effective and by how much

18. Keep or Drop with Complementary Effects

Shown below is a segmented income statement for Norton Materials Incs three product lines:

Sales revenue
Less: Variable expenses
Contribution margin
Less: Direct fixed expenses
Advertising
Salaries
Depreciation
Segment margin

Blocks
RM
500,000
250,000
250,000

Bricks
RM
800,000
480,000
320,000

Tile
RM
150,000
140,000
10,000

Total
RM
1,450,000
570,000
580,000

(10,000)
(37,000)
(53,000)
150,000

(10,000)
(40,000)
(40,000)
230,000

(10,000)
(35,000)
(10,000)
(45,000)

(30,000)
(112,000)
(103,000)
335,000

The roofing tile lines has a contribution margin of RM10,000 (sales of RM150,000 minus total variable
costs of RM140,000). All variable costs are relevant. Relevant fixed costs associated with this line include
RM10,000 in advertising and RM35,000 in supervision salaries. Assume that dropping the product line
reduces sales of blocks by 10 percent and sales of bricks by 8 percent.
Required
(a) If the roofing tile line is dropped, what is the contribution margin for the block line? For the brick line?
(b) Which alternative (keep or drop the roofing tile line) is now more cost effective and by how much?
19. Kimhawk Bhd manufactures and sells four products. Details of the four products are as follows:
Product
Selling price
Less costs:
Direct materials (at RM24 per kg)
Direct labour (at RM16 per hour)
Variable overheads
Fixed overheads
Profit per unit
Forecast sales demand in the next period

Alpha
RM
214

Beta
RM
178

Delta
RM
262

Gamma
RM
186

72
40
30
50
192
22

48
32
24
40
144
34

60
64
48
80
252
10

36
48
36
60
180
6

1,200 units

4,250 units

2,100 units

3,600 units

Fixed overheads are absorbed on the basis of the direct labour hours required to satisfy the sales demand.
The same type of material and grade of labour are used in the manufacture of the four products. The
availability of direct material will be limited to 18,500 kg and of direct labour to 32,000 hours, for the
next period. No finished foods or direct material stocks are held.
Required For the next period:
(a) Determine which of the resources (direct material or direct labour) is the limiting factor, show clearly
your workings.
(b) Prepare a production schedule that will maximize profit and calculate the amount of profit.
8

THE RELEVANT COSTS OF MATERIALS

In any decision situation the cost of materials relevant to a particular decision is their opportunity cost.
This can be represented by a decision tree.
Any materials
already in inventory?

No

Yes

Will they
be replaced?

No

Yes

Will they be used for

other purposes

Yes

No

Example 1
A new contract requires the use of 50 tons of metal ZX81. This material is used regularly on all of the
firms projects. There are 100 tons of ZX81 held in inventory at the moment, which were bought for
RM200 per ton. The current purchase price is RM210 per ton, and the metal could be disposed of for net
scrap proceeds of RM150 per ton. With what cost should the new contract be charged for the ZX81?
Example 2
Suppose the organization has no use for the ZX81 held in inventory. What is the relevant cost of using it
on the new contract?
Example 3
Suppose that there is no alternative use for the ZX81 other than a scrap sale, but that there is only 25 tons
held in inventory.
9

THE RELEVANT COSTS OF LABOUR

A similar problem exists in determining the relevant costs of labour. In this case the key question is
whether spare capacity exists and on this basis another decision tree can be produced.

Does spare
capacity exist?

Yes

No

Can extra employees

be hired?

No

Yes

Example 1
A mining operation uses skilled labour costing RM4 per hour, which generates a contribution, after
deducting these labour costs, of RM3 per hour.
A new project is now being considered which requires 5,000 hours of skilled labour. There is a shortage
of the required labour. Any used on the new project must be transferred from normal working. What is the
relevant cost of using the skilled labour on the project?
Example 2
A mining operation uses skilled labour costing RM4 per hour, which generates a contribution, after
deducting these labour costs, of RM3 per hour.
A new project is now being considered which requires 5,000 hours of skilled labour. There is a surplus of
skilled labour already employed (and paid) by the business and sufficient to cope with the new project.
The presently idle men are being paid full wages.

10