Chapter 21
DIFFERENTIAL COST ANALYSIS
MULTIPLE CHOICE
Question Nos. 9, 11-13, 15-20, and 29 are AICPA adapted.
Question Nos. 21, 22, 28, and 32-34 are ICMA adapted.
Question Nos. 10, 14, 30, and 31 are CIA adapted.
B 1. Additional output that results in a positive difference between differential
revenues and differential costs is beneficial to a company if and only if:
A. other sales are affected
B. other sales are unaffected and other unit costs are unaffected
C. other unit costs are increased and idle capacity is decreased
D. other sales are unaffected but other unit costs are increased
E. there is no idle capacity
C 2. The effect of discontinuing a department with a contribution to overhead of
$30,000 and allocated overhead of $48,000, of which $26,000 cannot be
eliminated, would be to:
A. increase profit by $8,000
B. decrease profit by $26,000
C. decrease profit by $ 8,000
D. decrease profit by $22,000
E. increase profit by $ 4,000
SUPPORTING CALCULATION:
($48,000 - $26,000) - $30,000 = ($8,000)
D 3. Gizmo Manufacturing is considering dropping a product line. It currently
produces a multipurpose woodworking clamp in a simple manufacturing process
that uses special equipment. Variable costs amount to $6.00 per unit. Fixed
factory overhead costs, exclusive of depreciation, have been allocated to this
product at a rate of $3.50 a unit and will continue whether or not production
ceases. Depreciation on the special equipment amounts to $20,000 a year. If
production of the clamp is stopped, the special equipment can be sold for
$18,000; if production continues, however, the equipment will be useless for
further production at the end of one year and will have no salvage value. The
clamp has a unit sales price of $10. Ignoring income tax effects, the minimum
number of units that would have to be sold in the current year to make it
worthwhile to keep the equipment (on a cash-flow basis) is:
A. 20,000
B. 5,000
C. 3,000
D. 4,500
E. 36,000
313
, SUPPORTING CALCULATION:
x ($10 - $6) = $18,000
$4x = $18,000
x = 4,500
B 4. The costing method used to determine the lowest price that could be quoted for
a special order that would use idle capacity within a production area is:
A. process
B. direct
C. standard
D. absorption
E. job order
E 5. In deciding whether to manufacture a part or buy it from an outside vendor, a
cost that is irrelevant to the short-run decision is:
A. indirect materials
B. direct labor
C. variable factory overhead
D. fixed factory overhead that will be avoided if the part is bought from an
outside vendor
E. fixed factory overhead that will continue even if the part is bought from an
outside vendor
C 6. Faced with a long-run make-or-buy decision, the manager should do all of the
following except:
A. compare the making of the parts with alternative uses that could be made
of the firm's own facilities if the parts are purchased
B. compare the cost of making the parts with the cost of buying them
C. use a cost study with only the differential costs and with no allocation of
existing fixed overhead or profit
D. consider differences in the required capital investment and the timing of
cash flows
E. consider the quantity and quality of the parts as well as the technical know-
how required
E 7. An opportunity cost is:
A. a cost that may be saved by not adopting an alternative
B. a cost that may be shifted to the future with little or no effect on current
operations
C. a cost that cannot be avoided because it has already been incurred
D. the difference in total costs that results from selecting one alternative
instead of another
E. the profit foregone by selecting one alternative instead of another
E 8. The term "differential cost" refers to:
A. the profit foregone by selecting one alternative instead of another
B. a cost that does not entail any dollar outlay but that is relevant to the
decision-making process
C. a cost that continues to be incurred even though there is no activity
D. a cost common to all alternatives in question and not clearly or practically
allocable to any of the alternatives
E. the difference in total costs that results from selecting one alternative
instead of another
314
,Differential Cost Analysis 315
A 9. In a make-or-buy decision:
A. fixed costs that can be avoided in the future are relevant
B. only variable costs are relevant
C. only prime costs are relevant
D. fixed costs that will continue regardless of the decision are relevant
E. only conversion costs are relevant
D 10. For the past 12 years, the Jolt Company has produced the small electric motors
that fit into its main product line of dental drilling equipment. As materials costs
have steadily increased, the controller of the Jolt Company is reviewing the
decision to continue to make the small motors and has identified the following
facts:
1. The equipment used to manufacture the electric motors has a book value
of $150,000.
2. The space now occupied by the Electric Motor Manufacturing Department
could be used to eliminate the need for storage space now being rented.
3. Comparable units can be purchased from an outside supplier for $59.75.
4. Four of the people who work in the Electric Motor Manufacturing
Department would be terminated and given eight weeks of severance pay.
5. A $10,000 unsecured note is still outstanding on the equipment used in the
manufacturing process.
Which of the items above are relevant to the decision that the controller has to
make?
A. 1, 2, 4, and 5
B. 1, 3, 4, and 5
C. 1, 3, and 4
D. 2, 3, and 4
E. 2, 3, 4, and 5
, 316 Chapter 21
D 11. Ely Electronics has the following standard costs and other data:
Part A4 Part B5
Direct materials................................................................... $ .40 $ 8.00
Direct labor.......................................................................... 1.00 4.70
Factory overhead................................................................. 4.00 2.00
Unit standard cost............................................................... $ 5.40 $
14.70
Units needed per year......................................................... 6,000 8,000
Machine hours per unit........................................................ 4 2
Unit cost if purchased.......................................................... $5.00 $
15.00
In past years, Ely has manufactured all of its required components; however, this
year only 30,000 hours of otherwise idle machine time can be devoted to the
production of components. Accordingly, some of the parts must be purchased
from outside suppliers. In producing parts, factory overhead is applied at $1.00
per standard machine hour. Fixed capacity costs that will not be affected by any
make-or-buy decision represent 60% of the applied overhead.
The 30,000 hours of available machine time are to be scheduled so that Ely
realizes maximum potential cost savings. The relevant unit production costs
that should be considered in the decision to schedule machine time are:
A. $5.40 for A4 and $14.70 for B5
B. $5.00 for A4 and $15.00 for B5
C. $1.40 for A4 and $12.70 for B5
D. $3.00 for A4 and $13.50 for B5
E. none of the above
SUPPORTING CALCULATION:
A4 = $.40 + $1.00 + .40($4.00) = $3.00
B5 = $8.00 + $4.70 + .40($2.00) = $13.50
E 12. Production of a special order will increase the contribution margin when the
additional revenue from the special order is greater than:
A. the nonvariable costs incurred in producing the order
B. the direct materials and labor costs in producing the order
C. the fixed costs incurred in producing the order
D. the indirect costs of producing the order
E. the marginal cost in producing the order
C 13. In considering a special order that will enable a company to make use of present
idle capacity, which of the following costs would be irrelevant?
A. fixed factory overhead that can be avoided
B. materials
C. depreciation of the factory building
D. direct labor
E. variable overhead
DIFFERENTIAL COST ANALYSIS
MULTIPLE CHOICE
Question Nos. 9, 11-13, 15-20, and 29 are AICPA adapted.
Question Nos. 21, 22, 28, and 32-34 are ICMA adapted.
Question Nos. 10, 14, 30, and 31 are CIA adapted.
B 1. Additional output that results in a positive difference between differential
revenues and differential costs is beneficial to a company if and only if:
A. other sales are affected
B. other sales are unaffected and other unit costs are unaffected
C. other unit costs are increased and idle capacity is decreased
D. other sales are unaffected but other unit costs are increased
E. there is no idle capacity
C 2. The effect of discontinuing a department with a contribution to overhead of
$30,000 and allocated overhead of $48,000, of which $26,000 cannot be
eliminated, would be to:
A. increase profit by $8,000
B. decrease profit by $26,000
C. decrease profit by $ 8,000
D. decrease profit by $22,000
E. increase profit by $ 4,000
SUPPORTING CALCULATION:
($48,000 - $26,000) - $30,000 = ($8,000)
D 3. Gizmo Manufacturing is considering dropping a product line. It currently
produces a multipurpose woodworking clamp in a simple manufacturing process
that uses special equipment. Variable costs amount to $6.00 per unit. Fixed
factory overhead costs, exclusive of depreciation, have been allocated to this
product at a rate of $3.50 a unit and will continue whether or not production
ceases. Depreciation on the special equipment amounts to $20,000 a year. If
production of the clamp is stopped, the special equipment can be sold for
$18,000; if production continues, however, the equipment will be useless for
further production at the end of one year and will have no salvage value. The
clamp has a unit sales price of $10. Ignoring income tax effects, the minimum
number of units that would have to be sold in the current year to make it
worthwhile to keep the equipment (on a cash-flow basis) is:
A. 20,000
B. 5,000
C. 3,000
D. 4,500
E. 36,000
313
, SUPPORTING CALCULATION:
x ($10 - $6) = $18,000
$4x = $18,000
x = 4,500
B 4. The costing method used to determine the lowest price that could be quoted for
a special order that would use idle capacity within a production area is:
A. process
B. direct
C. standard
D. absorption
E. job order
E 5. In deciding whether to manufacture a part or buy it from an outside vendor, a
cost that is irrelevant to the short-run decision is:
A. indirect materials
B. direct labor
C. variable factory overhead
D. fixed factory overhead that will be avoided if the part is bought from an
outside vendor
E. fixed factory overhead that will continue even if the part is bought from an
outside vendor
C 6. Faced with a long-run make-or-buy decision, the manager should do all of the
following except:
A. compare the making of the parts with alternative uses that could be made
of the firm's own facilities if the parts are purchased
B. compare the cost of making the parts with the cost of buying them
C. use a cost study with only the differential costs and with no allocation of
existing fixed overhead or profit
D. consider differences in the required capital investment and the timing of
cash flows
E. consider the quantity and quality of the parts as well as the technical know-
how required
E 7. An opportunity cost is:
A. a cost that may be saved by not adopting an alternative
B. a cost that may be shifted to the future with little or no effect on current
operations
C. a cost that cannot be avoided because it has already been incurred
D. the difference in total costs that results from selecting one alternative
instead of another
E. the profit foregone by selecting one alternative instead of another
E 8. The term "differential cost" refers to:
A. the profit foregone by selecting one alternative instead of another
B. a cost that does not entail any dollar outlay but that is relevant to the
decision-making process
C. a cost that continues to be incurred even though there is no activity
D. a cost common to all alternatives in question and not clearly or practically
allocable to any of the alternatives
E. the difference in total costs that results from selecting one alternative
instead of another
314
,Differential Cost Analysis 315
A 9. In a make-or-buy decision:
A. fixed costs that can be avoided in the future are relevant
B. only variable costs are relevant
C. only prime costs are relevant
D. fixed costs that will continue regardless of the decision are relevant
E. only conversion costs are relevant
D 10. For the past 12 years, the Jolt Company has produced the small electric motors
that fit into its main product line of dental drilling equipment. As materials costs
have steadily increased, the controller of the Jolt Company is reviewing the
decision to continue to make the small motors and has identified the following
facts:
1. The equipment used to manufacture the electric motors has a book value
of $150,000.
2. The space now occupied by the Electric Motor Manufacturing Department
could be used to eliminate the need for storage space now being rented.
3. Comparable units can be purchased from an outside supplier for $59.75.
4. Four of the people who work in the Electric Motor Manufacturing
Department would be terminated and given eight weeks of severance pay.
5. A $10,000 unsecured note is still outstanding on the equipment used in the
manufacturing process.
Which of the items above are relevant to the decision that the controller has to
make?
A. 1, 2, 4, and 5
B. 1, 3, 4, and 5
C. 1, 3, and 4
D. 2, 3, and 4
E. 2, 3, 4, and 5
, 316 Chapter 21
D 11. Ely Electronics has the following standard costs and other data:
Part A4 Part B5
Direct materials................................................................... $ .40 $ 8.00
Direct labor.......................................................................... 1.00 4.70
Factory overhead................................................................. 4.00 2.00
Unit standard cost............................................................... $ 5.40 $
14.70
Units needed per year......................................................... 6,000 8,000
Machine hours per unit........................................................ 4 2
Unit cost if purchased.......................................................... $5.00 $
15.00
In past years, Ely has manufactured all of its required components; however, this
year only 30,000 hours of otherwise idle machine time can be devoted to the
production of components. Accordingly, some of the parts must be purchased
from outside suppliers. In producing parts, factory overhead is applied at $1.00
per standard machine hour. Fixed capacity costs that will not be affected by any
make-or-buy decision represent 60% of the applied overhead.
The 30,000 hours of available machine time are to be scheduled so that Ely
realizes maximum potential cost savings. The relevant unit production costs
that should be considered in the decision to schedule machine time are:
A. $5.40 for A4 and $14.70 for B5
B. $5.00 for A4 and $15.00 for B5
C. $1.40 for A4 and $12.70 for B5
D. $3.00 for A4 and $13.50 for B5
E. none of the above
SUPPORTING CALCULATION:
A4 = $.40 + $1.00 + .40($4.00) = $3.00
B5 = $8.00 + $4.70 + .40($2.00) = $13.50
E 12. Production of a special order will increase the contribution margin when the
additional revenue from the special order is greater than:
A. the nonvariable costs incurred in producing the order
B. the direct materials and labor costs in producing the order
C. the fixed costs incurred in producing the order
D. the indirect costs of producing the order
E. the marginal cost in producing the order
C 13. In considering a special order that will enable a company to make use of present
idle capacity, which of the following costs would be irrelevant?
A. fixed factory overhead that can be avoided
B. materials
C. depreciation of the factory building
D. direct labor
E. variable overhead
