Short Term Decisions

Self Test

Self Test

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

Do You Understand the Terms and Definitions?

1. Opportunity costs are

a. never used for short-term decision making
b. the same as sunk costs
c. the same as variable costs
d. always a relevant cost
D. Relevant costs are different from one alternative to another. An opportunity cost is what you give up if you chose another alternative and is always relevant. It is always considered in Short-term decision making. It is not sunk as it is not actually paid. An opportunity cost is most likely fixed.

2. Costs that are a result of a past decision and cannot be changed are

a.sunk costs
b. avoidable costs
c. opportunity costs
d. relevant costs
A. This is the technical definition of sunk costs. They are not avoidable and they are not ever relevant since they will not differ among future alternatives.

3. Joint products are

a. products that are distinguishable before the split-off point
b. products that are not distinguishable until the split off point
c. never processed further
d. related to manufacturing one product only
B. Joint products are distinguishable as separate products at the split off point. They involve more than one product and It is a management decision to process further.

4. Products become distinguishable when produced through a joint process at

a. the break-even point
b. the split off point
c. the point costs are allocated to one product
d. the point the sales price is established
B. After joint processing, at the split off point, you can distinguish products. Break even point and establishing the sales price are totally different ideas. Joint costs are allocated to more than one product, not one.

5. A company with scarce/constrained resources should produce the product that

a. has the highest contribution margin per unit
b. has the highest contribution margin per unit of constrained resources
c. has the lowest contribution margin per unit
d. has the lowest contribution margin per unit of constrained resources
B. The company should attempt to get the most profit from their constrained resources. Maximizing the contribution margin to be gained from each unit of the limited resource will maximize profits. Highest CM per unit is not correct because the unit may consume much more of the constrained resource and limit the amount of units that can be produced.

6. Which of the following decisions is not a short-term decision?

a. make or buy
b. sell at split off or process further
c. the purchase of a machine
d. accept a special order
C. A machine is a long-term capital expenditure and is not a short-term decision. The other answers will impact the company this year, for the short-term.

7. Incremental fixed costs are not relevant in which of the following decisions

a. make or buy
b. add a product line
c. special orders
d. none of the above
A. Fixed costs are not added in a make or buy situations. Fixed costs are often increased to add a product line or make a special order and are relevant.

8. Costs that are differential are

a. avoidable
b. unavoidable
c. not opportunity costs
d. joint
A. An avoidable cost can be incurred with one alternative and not incurred with another alternative. Differential costs are different for the alternatives. Unavoidable costs are incurred no matter what decision is made and are not differential. Joint costs are not differential since they apply to all products and must be incurred to make the product before deciding whether to process further.
Do you understand what information is required to make Short-term decisions?

1. A general rule to follow when you make a short-term decision is

a. opportunity costs are never relevant
b. fixed costs are never relevant
c. variable production costs are always relevant
d. sunk costs are always variable costs
C. Variable production costs are incurred when you produce or sell another unit. These costs are always relevant because they are incurred based on the decision to produce. Sunk costs are typically fixed. Fixed costs that are added or are avoidable are relevant. Opportunity costs are always relevant since it is something that does not occur because you chose a different alternative.

2. Which of the following is relevant to a make or buy decision?

a. the cost of production equipment currently used to make the product
b. depreciation expense on production equipment
c. direct labor rate per hour paid last year
d. cash received if the production equipment is sold if you decide to buy
D. The only thing above that will be different if you make the product or buy it will be the cash you receive if you sell the equipment because you don’t need it anymore. All other things will not change and are not relevant.

3. Which of the following is relevant to a decision to sell a product at the split off point or process the product further?

a. costs to sell the product which will not change
b. the selling price of the product if processed further
c. unavoidable fixed joint costs
d. joint product costs
B. The selling price if processed further will change and therefore is relevant. All other items will be the same if you sell at split off or if you process further and are not relevant.

4. A company should keep a product line if the

a. product line revenues exceed all variable costs
b. product line revenues are higher than all associated costs
c. the product line gives a negative contribution margin
d. product line revenues are higher than all allocated costs
B. The product line with revenues higher than all costs will always be profitable and should be kept. a. and d. leave out other types of costs and these costs may make the product line unprofitable. A negative contribution margin will always lead to the product being unprofitable.

5.   When pricing a special order to a customer, management should consider a.  total additional fixed costs to manufacture the product and deliver it to the customer only

a. total variable costs only
c. total avoidable costs related to the order if the order is not accepted
d. total opportunity costs of losing the customer only
C. Management should make sure the revenue will cover all additional costs, fixed and variable incurred to make and deliver the special order. This is the same thing as the costs that would be avoided if the order is not accepted. Costs will most likely consist of both fixed and variable costs.

6. A company should consider dropping a product line that

a. has a positive contribution margin
b. is essential to the company’s overall profitability
c. if dropped will increase overall company profitability
d. has strong competition
C. A product line should be dropped only if dropping it will increase overall company profits. There are times that a product line is not profitable by itself, but the contribution margin from the product line is necessary to help cover all shared costs.

7. Allocated costs

a. are always irrelevant costs
b. are always variable costs
c. are most important when determining whether to make or buy
d. are most important in determining whether to drop a product line
D. Allocated costs are relevant when determining whether or not to drop a product line. The company needs to determine if the contribution margin from the product line should be kept available to cover allocated fixed costs. Allocated costs are fixed and relate to the general operations of the business and are not direct to a product line. Allocated costs are not relevant to a make or buy decision as they will be incurred with either decision.