Strategic Cost Management MIDTERM

Is the expected future data that differ among alternative courses of action.

Relevant Information

A cost that is applicable to a particular decision in the sense that it will have a bearing on which alternative the manager selects.

Relevant Cost

Is the process of studying and evaluating two or more available alternatives leading to a final choice.

Decision Making

Any cost that is _______________ is relevant for decision purposes.

avoidable

Cost that can be eliminated as a result of choosing one alternative over another in a decision-making situation.

Avoidable Cost

Are expected future costs which differ between a decision alternatives.

Relevant Cost

Cost that are never relevant in decisions because they are not avoidable and therefore they must be eliminated from manager’s decision framework.

Sunk or historical costs

Are the profits lost by the diversion of an input factor from one use to another.

Opportunity Cost

They are the net economic benefit given up when an alternative is rejected.

Opportunity cost

Involve either an intermediate or near-future cash outlay; they are usually relevant to decisions.

Out-of-pocket costs

Frequently, variable costs fall into this classification of cost.

Out-of-pocket costs

Contrasts choices by comparing differential revenues, differential cost and differential contribution margin.

Incremental, Differential or Relevant cost analysis

Shows all the items of revenue and cost data under the different alternatives and compares the net income results.

Total Project Analysis approach

Types of Decisions

Make or Buy

Add or Drop a Product or Other Segments

Sell Now or Process Further

Special Sales Pricing

Utilization of Scarce Resources

Pricing

Is a management decision about whether an item should be made internally or bought from an outside supplier.

Make or Buy Decision

A great variety of end products produced from a common input are referred to as _______________.

joint products

Is used to describe those manufacturing costs that are occurring in producing the joint products up to the split-off point.

Joint product costs

Is that point in the manufacturing process at which the joint product can be recognized as separate products.

Split-off point.

Cost incurred after the split-off point for the benefit of only one particular product are called ______________.

Separable costs

Is a one-time order that is not considered part of a company's ongoing business.

Special Order

When capacity becomes pressed because of a scarce resource, the firm is said to have a ____________.

constraint

The most basic approach in pricing decision.

Cost-Plus Pricing

Products however, may be costed in at least two different ways:

Absorption Approach

Contribution Approach

This pricing approach is used when company will already know what price should be charged and the problem will be to produce the product that can be marketed profitably.

Target Costing

The process of determining the maximum allowable cost for a new product and then developing a sample that can be profitably manufactured and distributed for that maximum target cost figure.

Target Costing

Cost that do not appear in accounting records and that do not require peso outlays but do involve a foregone opportunity by the entity whose costs are being measured are

a. conversion costs.

b. differential costs.

c. imputed costs.

d. prime costs.

c. imputed costs.

Pear Company temporarily has unused production capacity. The idle plant facilities can be used to manufacture a low-margin item. The low-margin item should be produced if it can be sold for more than its

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a. fixed costs.

b. variable costs.

c. variable costs plus any opportunity cost of the idle facilities.

d. indirect costs plus any opportunity cost of the idle facilities.

c. variable costs plus any opportunity cost of the idle facilities.

As part of the data presented in support of a proposal to increase the production of clock-radios, the sales manager of Whittaker Electronics reported the total additional cost required for the proposed increased production level. The increase in total cost is known as

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a. controllable cost.

b. differential cost.

c. opportunity costs.

d. out-of-pocket cost.

b. differential cost.

An item whose entire amount is usually a differential cost is

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a. factory overhead.

b. direct cost.

c. conversion cost.

d. period cost.

b. direct cost.

In the development of accounting data for decision-making purpose, relevant costs are defined as

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a. future costs which will differ under each alternative course of action.

b. the change in prime cost under each alternative course of action.

c. standard costs which are developed by time and motion study techniques because of their relevance to managerial control.

d. historical costs which are the best available basis for estimating future costs.

a. future costs which will differ under each alternative course of action.

Which of the following costs are always irrelevant in decision making?

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a. avoidable costs.

b. sunk costs.

c. opportunity costs.

d. fixed costs.

b. sunk costs.

Consider the following statements:

I. Assemble all costs associated with each alternative being considered.

II. Eliminate those costs that are sunk.

III. Eliminate those costs that differ between alternatives.

Which of the above statements does not represent a step in identifying the relevant costs in a decision problem?

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a. Only I.

b. Only II.

c. Only III.

d. Only I and III.

c. Only III.

The acceptance of a special order will improve overall net operating income so long as the revenue from the special order exceeds:

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a. the contribution margin on the order.

b. the incremental costs associated with the order.

c. the variable costs associated with the order.

d. the sunk costs associated with the order.

b. the incremental costs associated with the order.

Allocated common fixed costs:

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a. can make a product line appear to be unprofitable.

b. are always incremental costs.

c. are always relevant in decisions involving dropping a product line.

d. responses a, b, and c are all correct.

a. can make a product line appear to be unprofitable.

Consider the following statements:

I. A division's net operating income, after deducting both traceable and allocated common corporate costs, is negative.

II. The division's avoidable fixed costs exceed its contribution margin.

III. The division's traceable fixed costs, plus its allocated common corporate costs exceed its contribution margin.

Which of the above statements give an economic reason for eliminating the division?

a. Only I

b. Only II.

c. Only III.

d. Only I and II.

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b. Only II.

In a make or buy decision:

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a. only the variable costs are relevant.

b. only the fixed costs are relevant

c. both the variable costs and the fixed costs which will continue regardless of the decision are relevant.

d. both the variable costs and the fixed costs which are avoidable are relevant.

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d. both the variable costs and the fixed costs which are avoidable are relevant.

Which of the following best describes an opportunity cost?

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a. It is a relevant cost in decision making, but it is not part of the traditional accounting records.

b. It is not a relevant cost in decision making, but is part of the traditional accounting records.

c. It is a relevant cost in decision making, and is part of the traditional accounting records.

d. It is not a relevant cost in decision making, and is not part of the traditional accounting records.

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a. It is a relevant cost in decision making, but it is not part of the traditional accounting records.

The opportunity cost of making a component part in a factory with excess capacity for which there is no alternative use is:

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a. the variable manufacturing cost of the component.

b. the total manufacturing cost of the component.

c. the fixed manufacturing cost of the component.

d. zero.

d. zero.

In a sell or process further decision, consider the following costs:

I. A variable production cost incurred prior to split-off.

II. A variable production cost incurred after split-off

III. An avoidable fixed production cost incurred after split-off.

Which of the above costs is (are) not relevant in a decision regarding whether the product should be processed further?

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a. Only I.

b. Only III.

c. Only I and II.

d. Only I and III.

d. Only I and III.

A _____________________ is one in which decision making is not confined to a few top executives but rather is spread throughout the organization.

decentralized organization

Is a specific unit of an organization assigned to a manager who he is held accountable for its operations and resources.

Responsibility center

Is the system that recognizes various decision centers throughout an organization and traces costs by areas of responsibility.

Responsibility accounting

Responsibility accounting is also known as ____________.

activity accounting and profitability accounting

Is a unit within the organization which has control over costs, revenues and/or investment funds.

Responsibility center

The responsibility centers are:

cost center, profit center, investment center and revenue center

This is a unit within the organization wherein the manager is responsible for minimizing costs subject to some output constraints.

Cost center

True or False:

Cost center has a control over generating revenue or the use of investment funds.

False

Performance of a cost center is evaluated using the performance reports or _______________ based on the standard costs and ________________.

variance analysis reports, flexible budget

This is a unit or segments within the organization wherein the manager is responsible for the generation of revenues and control of costs incurred in that center.

Profit center

Performance of a profit center is measured by preparing the income statements using the _______________________ approach, presenting both the actual results and budgeted figures.

contribution approach

This is a unit or segments within the organization where the manager is responsible for the control of revenues, costs and investments made in that center.

Investment center

Is generally used because it is consistent with the base to which it is applied, that is, operating assets.

Net operating income

Another approach to measuring performance in an investment center is a concept known as ________________.

Residual Income

Is the net operating income that an investment center is able to earn above some minimum return on the operating assets.

Residual Income

Is a business units income after taxes and after deducting the cost of capital.

Economic value added

In EVA, the expenses that contribute to the long-term value of the company are ______________.

capitalized

This is a unit or segments within an organization where the manager is responsible for selling budgeted quantities of various products or services at budgeted price.

Revenue center

Expense control is a/an ______________ goal in revenue center.

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a. primary

b. secondary

c. important

d. none of the above

b. secondary

Three types of variances that are useful in revenue center:

Sales Price Variance

Sales Volume Variance

Sales Mix Variance

Is the price charged when one segment of a company provides goods or services to another segment of the company.

Transfer Price

Is the value assigned to goods and services transferred between segments within the company.

Transfer Price

To the department selling goods and services, the transfer price is its ________________________.

Revenue

Under this approach, the transfer price is the price at which the goods are sold on the open market.

Market-Based Transfer Price

Considered as the best transfer price.

Market-Based Transfer Price

Under this approach the transfer price is based only on variable or differential costs.

Variable -Cost Transfer Price

Is the process of deciding whether or not to commit resources to projects whose costs and benefits are spread over several time periods.

Capital Budgeting

Is used to describe actions related to the planning and financing capital outlays for such purposes as the purchase of new machinery.

Capital Budgeting

Capital Budgeting is a/n ______________ concept.

Investment

Is a long-term commitment of resources to realize future benefits and budgeting for them is one of the most important areas of managerial decision.

Capital expenditures

Are projects that are evaluated individually against predetermined corporate standard of acceptability resulting in an accept-or-reject decision.

INDEPENDENT capital investment projects (meant for SCREENING decisions) 

These are projects which require the company to choose from among specific alternatives.

Mutually Exclusive capital investments or Preference decisions

Represents the initial cash outlay that is required to obtain future returns or the net cash outflow to support a capital investment project.

Net Investment

The most commonly used methods of evaluating capital investment projects:

Non-discounted cash flow (unadjusted) approach


1. Payback Period
2. ARR (book value rate of return)
3. Payback Reciprocal

Discounted cash flow (time-adjusted) approach


1. NPV
2. Discounted Rate of Return or Internal Rate of Return
3. Profitability Index
4. Discounted Payback Period

Measures the length of time required for covered amount of initial investment

Payback Period

An approach which incorporates the salvage value in payback computations.

Bail-out Period

This is reached with the cumulative cash earnings plus the salvage value at the end of a particular year equals the original investment.

Bail-out period

It measures profitability from the convention accounting standpoint by relating the required investment of the future annual net income.

ARR or Simple Rate of Return

Is the excess of the present value of cash inflows generated by the project over the amount of initial investment.

NPV

Is the rate which equates the present value of the future cash inflows with the cost of the investment which produces them.

Discounted Rate of Return

The rate of recovery of investment during the payback period

Payback Reciprocal

Is the ratio of the total present value of future cash inflows to the initial investment.

Profitability Index

Used to compute the payback in terms of discounted cash flows received in the future

Discounted Payback Period

The relevance of a particular cost to a decision is determined by

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a. riskiness of the decision.

b. number of decision variables.

c. amount of the cost.

d. potential effect on the decision.

d. potential effect on the decision.

In equipment-replacement decisions, which one of the following does not affect the decision-making process?

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a. Current disposal price of the old equipment.

b. Operating costs of the old equipment.

c. Original fair market value of the old equipment.

d. Cost of the new equipment.

c. Original fair market value of the old equipment.

Which one of the following statements concerning cash flow determination for capital budgeting purposes is not correct?

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a. Tax depreciation must be considered because it affects cash payments for taxes.

b. Book depreciation is relevant because it affects net income.

c. Sunk costs are not incremental flows and should not be included.

d. Net working capital changes should be included in cash flow

b. Book depreciation is relevant because it affects net income.

A depreciation tax shield is

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a. an after-tax cash outflow.

b. a reduction in income taxes.

c. the cash provided by recording depreciation.

d. the expense caused by depreciation. .

b. a reduction in income taxes.

Del Corporation is evaluating a lease that takes effect on March 1. The company must make eight equal payments, with the first payment due on March 1. The concept most relevant to the evaluation of the lease is

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a. the present value of an annuity due.

b. the present value of an ordinary annuity.

c. the future value of an annuity due.

d. the future value of an ordinary annuity.

a. the present value of an annuity due.

Cruzer Corporation is expanding its plant, which requires an investment of P8 million in new equipment. Cruzer's sales are expected to increase by P6 million per year as a result of the expansion. Cash investment in current assets averages 30% of sales, and accounts payable and other current liabilities are 10% of sales.

What is the estimated total cash investment for this expansion?

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a. P6.8 million.

b. P8.6 million.

c. P9.2 million.

d. P9.8 million.

c. P9.2 million.

Of the following decisions, capital budgeting techniques would least likely be used in evaluating the

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a. acquisition of new aircraft by a cargo company.

b. design and implementation of a major advertising program.

c. trade for a star quarterback by a football team.

d. adoption of a new method of allocating nontraceable costs to product lines.

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d. adoption of a new method of allocating nontraceable costs to product lines.

The length of time required to recover the initial cash outlay of a capital project is determined by using the

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a. discontinued cash flow method.

b. payback method.

c. weighted net present value method.

d. net present value method.

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b. payback method.

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A characteristic of the payback method (before taxes) is that it

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a. incorporates the time value of money.

b. neglects total project profitability.

c. uses accrual accounting inflows in the numerator of the calculation.

d. uses the estimated expected life of the asset in the denominator of the calculation.

b. neglects total project profitability

Which one of the following statements about the payback method of investment analysis is correct? The payback method

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a. does not consider the time value of money.

b. considers cash flows after the payback has been reached.

c. uses discounted cash flow techniques.

d. generally leads to the same decision as other methods for long- term projects.

a. does not consider the time value of money.

The payback reciprocal can be used to approximate a project's

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a. profitability index.

b. net present value.

c. accounting rate of return if the cash flow pattern is relatively stable.

d. internal rate of return if the cash flow pattern is relatively stable.

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d. internal rate of return if the cash flow pattern is relatively stable.

The bailout payback method

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a. incorporates the time value of money.

b. equals the recovery period from normal operations

c. eliminates the disposal value from the payback calculation.

d. measures the risk if a project is terminated.

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d. measures the risk if a project is terminated.

When evaluating projects, breakeven time (discounted payback period) is best described as

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a. annual fixed costs + monthly contribution margin.

b. project investment + annual net cash inflows.

c. the point where cumulative cash inflows on a project equal total cash outflows.

d. the point at which discounted cumulative cash inflows on a project equal discounted total cash outflows.

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d. the point at which discounted cumulative cash inflows on a project equal discounted total cash outflows.

The net present value (NPV) method of investment project analysis assumes that the project's cash flows are reinvested at the

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a. computed internal rate of return.

b. risk-free interest rate.

c. discount rate used in the NPV calculation.

d. firm's accounting rate of return.

c. discount rate used in the NPV calculation.

The proper discount rate to use in calculating certainty equivalent net present value is the

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a. risk-adjusted discount rate.

b. cost of capital.

c. risk-free rate.

d. cost of equity capital.

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c. risk-free rate.

The rankings of mutually exclusive investments determined using the internal rate of return method (IRR) and the net present value method (NPV) may be different when

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a. the lives of the multiple projects are equal and the size of the required investments are equal.

b. the required rate of return equal the IRR of each project.

c. the required rate of return is higher than the IRR of each project.

d. multiple projects have unequal lives and the size of the investment for each project is different.

d. multiple projects have unequal lives and the size of the investment for each project is different.

When determining net present value in an inflationary environment, adjustments should be made to

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a. increase the discount rate only.

b. increase the estimated cash inflows and increase the discount rate.

c. increase the estimated cash inflows but not the discount rate.

d. decrease the estimated cash inflows and increase the discount rate.

b. increase the estimated cash inflows and increase the discount rate.

A management decision may be beneficial for a given profit center, but not for the entire company. From the overall company viewpoint, this decision could lead to action referred to as:

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a. Suboptimization.

b. Centralization.

c. Goal congruence.

d. Maximization.

c. Goal congruence.