Easy Practice Test

Short Term Decisions

Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.

1. The opportunity cost of a company with no excess capacity is

a. total variable cost
b. total fixed cost
c. total manufacturing costs
d. the benefit lost from not choosing a better alternative use for the capacity

Answer

D. An opportunity cost is something that is not received because you choose a different alternative. If you chose a lesser benefit than the best use, you have given up the difference which is an opportunity cost. Opportunity costs are not actually incurred, so the other costs can not be the answer.

2. A company with a production constraint effecting all products should

a.make more of the products with the highest contribution margin per unit
b. make more of the products with the highest contribution margin per the restrained resource
c. make more of the products with the highest contribution margin ratio
d. make more of the products with the highest fixed costs

Answer

B. The company should make the products that give them the most profit from the constrained resource that is used. Using the resource will limit the quantity of other products that can be produced. The higher contribution margin per unit product may use too much of the constrained resource and reduce the total profits of the company.

3. Which of the following is not relevant to deciding if you should accept a special order?

a. direct labor used to make the product that is part of the order
b. direct material used to make the product that is part of the order
c. fixed costs that are allocated to all products
d. opportunity costs related to the order

Answer

C. All variable product costs are relevant because they are incurred when the products in the special order are produced (a. and b.). Fixed costs that are allocated will be incurred even if the special order is not accepted and therefore, the special order will not change these costs and they are not relevant. Opportunity costs are always relevant.

4. When deciding to make or buy a product part, you should not consider

a. any of the manufacturing overhead costs incurred to make the part
b. direct labor used to make the part
c. equipment costs that are avoidable if the parts are purchased
d. costs associated with the general operation of the manufacturing facility

Answer

D. You should not consider costs that are irrelevant and will not change if you decide to buy the order, which is d. Manufacturing overhead costs can be variable and all variable costs associated with the production are relevant. Costs that are avoidable are always relevant because they will differ if you make or buy.

5. If there is excess capacity, the price to the customer for a special order should be equal to or higher than

a. all variable costs only
b. variable costs plus any added fixed costs associated with the order
c. variable costs plus unavoidable fixed costs
d. all unavoidable costs

Answer

B. Unavoidable costs are always irrelevant and should not be considered (c. & d.). You must consider all relevant costs, so only variable costs is not correct. Added fixed costs must be considered.

6. A joint product should be process further if added revenue after processing further is higher than

a. added costs of processing further
b. the total sales dollars after processing further
c. allocated joint costs plus added further processing costs
d. fixed costs to produce the final product

Answer

A. You should compare incremental revenues to incremental costs and if incremental revenues are higher it should be process further. Added and incremental are the same term. The total sales dollars after processing further is not enough information by itself to make a decision. Allocated joint costs are not relevant and should not be considered because they will be the same regardless.

7. The store manager’s salary is a differential cost when the decision at hand is

a. how to increase sales
b. how to reduce variable costs
c. whether or not to close the store
d. whether or not to add square feet to the store

Answer

C. The only decision listed above that would impact the cost of the store manager’s salary is closing the store. All other decisions would not change the salary and it is not relevant to those decisions.

8. A product line that consistently incurs losses should

a. definitely be dropped
b. be dropped if the contribution to overall profits is negative
c. be dropped if the contribution margin is positive and unavoidable fixed costs are lower than contribution margin
d. be dropped if direct and allocated fixed costs are less than contribution margin

Answer

B. The decision to drop a product line should be analyzed based on impact to the profits of the total. A product line can consistently incur total losses and provide contribution margin necessary to cover allocated shared costs of the company. Both c. and d. would be a profitable product line.

9. Income from renting space that would not be used if a part was purchased rather than made is

a. an opportunity revenue
b. a joint company revenue
c. an opportunity cost
d. an avoidable cost

Answer

C. Income or cash flows that would not be received if another alternative is chosen is the definition of an opportunity cost. There is no such thing as an opportunity revenue, it is always referred to as an opportunity cost.

10. When making a short-term decision, you should first

a. identify relevant costs and irrelevant costs
b. do a customer survey
c. identify unavoidable costs to use in the decision
d. identify incremental costs that won’t be used in the decision

Answer

A. You should first identify relevant and irrelevant costs and ignore irrelevant costs. Unavoidable costs are always irrelevant and are never used. Incremental costs are always relevant and always used. Customer surveys are used for more long-term strategic decisions.

11. A manufacturing company has determined that a particular product has the following costs:

Direct materials	$300,000
Direct labor	$250,000
Manufacturing overhead:
Manager salaries	$100,000
Benefits for direct labor	$ 70,000
Depreciation	$ 50,000
Allocated Insurance	$ 10,000
Allocated Rent	$ 20,000
Total Costs	$800,000

The product had sales of $750,000 consisting of 75,000 units.

Should the company stop producing and selling this product?

Answer

Sales	$750,000
– Variable Costs:
Direct materials	$300,000
Direct labor	$250,000
Benefits for direct labor	$ 70,000
=Contribution Margin lost if discontinued	$130,000
– Fixed costs avoided if discontinued:
Manager salaries	$100,000
Product operating income	$ 30,000

In this case, the company will lose $130,000 in contribution margin and save $100,000 in fixed costs, giving a total company net loss of $30,000 if the product line is dropped. Direct fixed costs are lower than contribution margin, so keep the product line.

Relevant information is sales, all variable costs, and direct fixed costs.

Allocated fixed costs are not relevant and should not be considered because they will be incurred by the company regardless.

Depreciation is a sunk cost and is never relevant.

12. A manufacturing company makes the motors that are used to produce small
motorcycles marketed to 10 to 15-year old boys. The costs for the current production
level of 10,000 units are as follows:

Direct materials	$72 per unit
Direct labor	$58 per unit
Variable manufacturing overhead	$ 8 per unit
Fixed M/OH avoidable	$10
Fixed M/OH unavoidable	$30
Fixed selling costs	$95,000
Variable selling costs	$12 per unit

The purchasing manager has located a supplier who will supply the motor to the company for a cost of $160 per unit.

What would be the change in operating income if the company buys the motor from the supplier at $160 per unit.

Answer

Make	Buy
$72	$160
$58	($10)
$ 8	$150
$138 per unit
x 10,000 units	x 10,000_units
$1,380,000	$1,500,000

The company’s operating income will be $120,000 less if the motor is purchased. Income will be less because the cost will be higher.

Relevant costs are those listed above under make and buy.
Irrelevant costs that are ignored are unavoidable and selling costs.
Selling costs are will be incurred to sell the product regardless.

13. A manufacturing company makes and sells portable arm band radios. Each radio normally sells for $15 to the retailer. The following costs are incurred at production levels of 50,000:

Direct materials	$2 per unit
Direct labor	$4 per unit
Variable manufacturing overhead	$0.25 per unit
Fixed Manufacturing overhead:	$300,000
20% direct to radios
80% allocated to ratios
Salesman sales commission	$0.60 per unit
Fixed selling and administration costs	$275,000

The company has received a special order to manufacture radios with a YMCA logo on them. The national YMCA office is offering to pay the company $11 per radio for 10,000 radios. The order would be bulk shipped to national headquarters at a cost of $3,600. The additional cost of putting the logo on the radio is $0.30 per unit. The company will pay no sales commission because the order came unsolicited.

What would be the change in operating income given the company has the capacity to produce the order if the order is accepted?

Answer

Sales $ per unit	$11
– Variable cost per unit	$6.55 (2+4+.25+.30)
= CM per unit	$4.45
x Total units	10,000
= Total contribution margin	$44,500
– Additional total fixed costs	$ 3,600
= Impact on profits	$40,900 Accept the order

All fixed overhead costs and the fixed selling and administration costs are not considered because they will not change and are therefore not relevant.

Sales commission will not be incurred, so it is not part of variable costs.

Accepting the order will increase total profits by $40,900.

14. A company makes two products which are made from materials that are in very short supply. The company can purchase 10,000 yards of this material each month. Information related to the two products is as follows:

	Product D	Product G
Contribution margin per unit	$10	$15
Yards required per unit	2	4
Market demand in unit	8,000	16,000

What is the maximum contribution margin the company can achieve for the month?

Answer

To determine this, you must first determine the contribution margin per yard.

	Product D	Product G
CM per units	$10	$15
Divided by yards required	2	4
= Contribution margin per yard	$5	$3.75

The company should make as many as it can, and not exceed demand, of the product with the highest CM per yard, the constrained resource.

The company can make 5,000 units of product D and sell all of them
(10,000 total yards available / 2 yards for each unit)

Maximum contribution margin will be:

5,000 units of product D
x $10 CM per unit
= $50,000 total CM

15. The manufacturing company produces 3 products from a joint process.
Budgeted information is as follows:

	Product
	A	B	C
Units produced	1,000	2,000	3,000
Further processing costs	$10	$12	$15
Sales value at split-off	$22	$27	$12
Sales value – process further	$36	$32	$30
Total fixed costs per unit	$8	$10	$12
Total variable costs per unit	$5	$7	$3

Determine which of the products should be sold at split off and which products should be sold after further processing.

Answer

		Product
Use the common format:		A	B	C
	Final Sales $ after further processing	$36	$32	$30
Less Sales $ at the split-off point		$22	$27	$12
	Incremental Revenue from further processing	$14	$5	$18
Less Cost of further processing		$10	$12	$15
	Profit or Loss from further processing	$4	($7)	$3

The company should process further products A and C.
Product B should be sold at split off.

Fixed costs will not change and are irrelevant, ignored them. Total variable costs are not relevant as they will be included in joint and process further costs and you can’t determine how much is where so it is not usable information.

Units produced does not matter because if it is more profitable per unit to process further it will be more profitable in total no matter how many units are processed.

16. A hardware store is considering adding a new line of carpet to its current product lines. The company has estimated the following revenues and costs from the line of carpet.

Average sales price per yard		$3.50
Variable costs per yard
	Purchase price:	$1.30
	Selling	$0.25
Fixed costs:
	Avoidable	$15,000
	Unavoidable – allocated	$6,000
Allocated administrative costs		$8,000
Expected sales in yards		5,000

What is the expected change to operating income if the new line of carpets is added? Should the company add the carpet product line?

Answer

Sales	$3.50
– All variable costs	$1.55 (1.30+0.25)
= CM per unit	$1.95
x units	5,000
= Total CM	$9,750
– Added fixed costs	($15,000)
= Change in income	($5,250)

Use only relevant costs: variable costs plus added direct fixed costs.
Allocated costs are not relevant as they will be incurred by the company by some product line regardless.

Avoidable means it won’t be incurred if the line is not added, so it is relevant.
Avoidable means the same thing as direct to the product line.

Company total profits will be $5,250 less if the line of carpets is added.
Do not add the product line.

Short Term Decisions