Cooper Final Questions Ch 12

What is the danger in allocating common fixed costs among products or other segments of an organization?

Allocations of common fixed costs can make a product (or other segment) appear to be unprofitable, whereas in fact it may be profitable.

What guideline should be used in determining whether a joint product should be sold at the split-off point or processed further?

If the incremental revenue from further processing exceeds the incremental costs of further processing, the product should be processed further.

From a decision-making point of view, should joint costs be allocated among joint products?

Joint costs should not be allocated among joint products for decision-making purposes. If joint costs are allocated among the joint products, then managers may think they are avoidable costs of the end products. However, the joint costs will continue to be incurred as along as the process is run regardless of what is done with one of the end products. Thus, when making decisions about the end products, the joint costs are not avoidable and are irrelevant.

Airlines sometimes offer reduced rates during certain times of the week to members of a businessperson's family if they accompany him or her on trips. How does the concept of relevant costs enter into the decision by the airline to offer reduced rates of this type?

Most costs of a flight are either sunk costs or costs that do not depend on the number of passengers on the flight. Depreciation of the aircraft, slaries of personnel on the ground and in the air, and fuel costs, for example, are the same whether the flight is full or almost empty. Therefore, adding more passengers at reduced fares when seats would otherwise be empty does little to increase the total costs of operating the flight, but increases the total contribution and total profit.

"Variable costs and differential costs mean the same thing." Do you agree? Explain.

No. A variable cost is a cost that varies in total amount in direct proportion to changes in the level of activity. A differential cost is the difference in cost between two alternatives. If the level of activity is the same for the two alternatives, a variable cost will not be affected and it will be irrelevant.

"Sunk costs are easy to spot - they're fixed costs associated with a decision." Do you agree? Explain.

No. Not all fixed costs are sunk - only those for which the cost has already been irrevocably incurred. A variable cost can be a sunk cost if it has already been incurred.

"All future costs are relevant in decision making." Do you agree? Why?

No. Only those future costs that differ between the alternatives are relevant.

"If a product is generating a loss, then it should be discontinued." Do you agree? Explain.

Not necessarily. An apparent loss may be the result of allocated common costs or of sunk costs that cannot be avoided if the product is dropped. A product should be discontinued only if the contribution margin that will be lost as a result of dropping the product is less than the fixed costs that would be avoided. Even in that situation the product may be retained if it promotes the sale of other products.

Prentice Company is considering dropping one of its product lines. What costs of the product line would be relevant to this decision? What costs would be irrelevant?

Only those costs that would be avoided as a result of dropping the product line are relevant in the decision. Costs that will not be affected by the decision are irrelevant.

What is a relevant cost?

Those costs that differ in total between alternatives. AKA differential cost.

Define the following terms: incremental cost, opportunity cost, and sunk cost.

incremental cost: the change in cost that will result from some proposed action Opportunity cost: the potential benefit that is given up when one alternative is selected over another. Sunk cost: a cost that has already been incurred and cannot be avoided regardless of what a manager decides to do.

Give at least four examples of possible constraints.

Any resource that is required to make products and get them into the hands of customers could be a constraint. Some examples are machine time, direct labor time, floor space, raw materials, investment capital, supervisory time, and storage space.

How will relating product contribution margins to the amount of the constrained resource they consume help a company maximize its profits?

Assuming that fixed costs are not affected, profits are maximized when the total contribution margin is maximized. A company can maximize its total contribution margin by focusing on the products with the greatest among of contribution margin per unit of the constrained resource.

How does opportunity cost enter into a make or buy decision?

If a company decides to make a part internally rather than to buy it from an outside supplier, then a portion of the company's facilities have to be used to make the part. The company's opportunity cost is measured by the benefits that could be derived from the best alternative use of the facilities.

Define the following terms: joint products, joint costs, and split-off point.

Joint products: two or more products that are produced from a common input Joint costs: the costs that are incurred up to the split-off point split off point: the point in the manufacturing process where joint products can be recognized as individual products.

Are variable costs always relevant costs? Explain.

No. Variable costs are relevant costs only if they differ in total between the alternatives under consideration.