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CHAPTER 2
IDENTIFICATION AND ESTIMATING COSTS AND BENEFITS
TRUE/FALSE
1. The benefits and costs that arise from the decision-maker’s choice of a particular option are
controllable.
LO1 – True
2. Because they seek to maximize profit, commercial organizations measure the value of a decision
option as the change in profit relative to change in revenue.
LO1 – False Commercial organizations measure the value of a decision option as the change in profit
relative to current profit.
3. The principle of relevance helps decision makers compare options by focusing on those costs and
benefits that matter, and ignoring items that are common and irrelevant.
LO1 – True
4. Given a choice of using relevance or controllability to make effective decisions, when one wants to
identify the best choice quickly and efficiently, relevance is the operative principle.
LO1 – True
5. Sunk costs influence value because they have already occurred.
LO1 – False Sunk do not influence value because we cannot change the past.
6. A decision maker’s control over costs and benefits decreases as the time horizon increases.
LO2 – False A decision maker’s control over costs and benefits increases as the time horizon
increases.
7. In the short-run, organizations often are not able to substantially alter their abilities to deliver
products or services, making levels of capacity resources non-controllable.
LO2 – True
8. Few short-term decisions are recurring.
LO2 – False Many short-term decisions are recurring.
9. Changing our minds about our choice for a long-term decision can be difficult and costly.
LO2 – True
10. Many decisions are difficult to classify as they contain elements of both the short- and long-term.
LO2 – True
11. The core idea underlying estimation is that costs and benefits are the result of performing activities.
LO3 – True
12. The principles of timeliness and traceability underlie the estimation of costs and benefits.
LO3 – False The principles of variability and traceability underlie the estimation of costs and
benefits.
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13. A fixed cost does not change as the volume of activity changes.
LO3 – True
14. If only a portion of the cost or revenue pertains to a particular decision option, then it is referred to
as a traceable cost or traceable revenue.
LO3 – False If only a portion of the cost or revenue pertains to a particular decision option, then it is
an indirect cost or an indirect benefit.
15. The principle of variability means that, when estimating costs and benefits, the first step is to
estimate the change in activity.
LO3 – True
16. Step costs change in proportion to the volume of activity.
LO4 – False Step costs stay at the same level for a certain activity range, but jump to a higher
amount if the volume of activity increases beyond the range.
17. Classifying all costs as fixed or variable with respect to sales volume is practical and frequently used,
but the assumption often results in imprecise measurements.
LO4 – True
18. Costs that do not vary at the unit level, the batch level, or the product level are administrative costs.
LO4 – False Costs that do not vary at the unit level, the batch level, or the product level are facilitylevel costs.
19. Step costs relate only to variable costs.
LO4 – False Step costs relate to fixed costs and variable costs.
20. The cost hierarchy divides costs into unit-, batch-, product-, and facility-level costs.
LO4 – True
Identification and Estimating Costs and Benefits
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MULTIPLE CHOICE
21. Controllable costs are:
A. Costs that a decision maker chooses to incur, relative to doing nothing.
B. The incremental expenditures relative to current expenditures.
C. Not relevant.
D. Both A and B.
E. A, B and C.
LO1 – D
22. Relevant benefits are:
A. The controllable benefits that differ across decision options.
B. Past expenditures that cannot be changed.
C. Benefits that do not change as the volume of activity changes.
D. Always created by variable costs.
E. None of the above.
LO1 – A
23. A sunk cost is:
A. A cost that can be directly traced to a decision option.
B. A past expenditure that cannot be changed.
C. A cost that does not change as the volume of activity changes.
D. A controllable cost.
E. None of the above.
LO1 – B
24. The principle of relevance helps decision makers compare options:
A. By focusing on those cost and benefits that matter.
B. By ignoring items that are common and irrelevant.
C. By reducing the number of costs and benefits to consider.
D. Both A and B.
E. A, B, and C.
LO1 – D
25. Which of the following statements relating to relevance and controllability is not correct?
A. Using the concept of relevance does not reduce the number of costs and benefits to consider.
B. If the status quo is a feasible option, then all controllable costs and benefits are relevant.
C. When using the principle of controllability to identify the incremental costs and benefits relative
to the status quo, calculate the value of each option, and choose the one with the lowest value.
D. Both A and C are incorrect.
E. A, B, and C are incorrect.
LO1 – C
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26. Steve Johnson has decided to lease a vehicle as opposed to purchasing it. The lease agreement calls
for a monthly payment of $400. Any mile driven above 1,000 per month will cost an additional $.10
per mile. If Steve drives 1,240 miles in the month of January his total cost will be:
A. $400
B. $640
C. $524
D. $424
LO1 – Self-Test – D
27. Steve Johnson has decided to lease a vehicle as opposed to purchasing it. The lease agreement calls
for a monthly payment of $400. Any mile driven above 1,000 per month will cost an additional $.10
per mile. Steve’s lease cost in January can be considered to be:
A. Fixed.
B. Variable.
C. Mixed.
D. Both B and C.
LO1 – Self-Test – C
28. Jason is going to play golf this afternoon and has to choose between two different golf courses. The
greens fees to play each are both $18, the cart fees at each course is $9. One course, however, is
located 20 miles further than the other. Therefore it would cost approximately an additional $4 in
gas to play the course that is further away. Relevant costs total:
A. $18
B. $27
C. $9
D. $4
LO1 – Self-Test – D
29. The Rich Company leases its copier on an annual basis. The lease fee is $1,600 per year plus $.01
per copy for any copies made over 750,000. If the company made 800,000 copies in 2008, its total
cost was:
A. $1,600
B. $2,100
C. $2,400
D. $1,650
LO1 – Self-Test – B
30. The Criders Company has 12,000 units of obsolete inventory. The units originally cost $6,000. The
company can either sell them for scrap at $.20 per unit or they can invest $2,000 to be able to sell
them at a price of $.60 per unit. With regard to this decision, relevant costs or benefits include:
A. $6,000 only.
B. $2,000 and $.20 per unit only.
C. $.20 per unit, $.60 per unit, and $2,000.
D. $2,000 and $6,000 only.
LO1 – Self-Test – C
Identification and Estimating Costs and Benefits
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31. Which one of the following best represents a controllable benefit for a manufacturing plant?
A. Reduce the number of security guards during holiday periods.
B. Increasing the selling price of the company’s best selling product by $1.00 per unit.
C. Reduce the medical benefit coverage for employees.
D. Eliminate one copy machine for the human resources department.
LO1 – Pre-Test – B
32. Which of the following best represents a controllable cost for a manufacturing plant?
A. Reducing the number of pages in a product brochure.
B. Increasing the price of two of the best selling products.
C. Billing customers for delivery fuel surcharges.
D. Charging customers for additional production runs of a special ordered product.
LO1 – Post-Test – A
33. Assume you are the owner of a video-rental store. Which of the following would be classified as a
long-term decision?
A. Purchase of children’s video inventory.
B. Purchase of cleaning supplies.
C. Deciding whether to purchase a new building.
D. Deciding whether to hire a new hourly employee for the summer.
E. None of the above is a long-term decision.
LO2 – C
34. A decision maker’s control over costs and benefits:
A. Decreases as the time horizon increases.
B. Increases as the time horizon increases.
C. Does not change regardless of the time horizon.
D. Changes in proportion to the volume capacity.
E. None of the above.
LO2 – B
35. An example of a cost that may be non-controllable in the short-run, but controllable in the long-run
is:
A. Salaries.
B. Office lease.
C. Both A and B.
D. Neither A nor B.
LO2 – C
36. It is important to keep the time horizon in mind when making decisions because:
A. Short term decisions are generally more costly than long term decisions.
B. We always want to identify choices quickly.
C. When making future decisions, costs incurred in the past must be considered.
D. The horizon affects whether a cost or benefit is controllable for the decision.
E. All of the above are important.
LO2 – D
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37. Which of the following is a not a correct statement?
A. A decision maker’s control over costs and benefits decrease as the time horizon increases.
B. A decision maker’s control over costs increases as the time horizon increases.
C. A decision maker’s control over benefits increases as the time horizon increases.
D. Both B and C are incorrect statements.
LO2 – A
38. Variable costs per unit are as follows:
Raw materials $2.15
Direct labor $1.45
Fixed costs are $5,000 per month
If the company produces 4,000 units in the month of March their total costs will be:
A. $14,400
B. $19,400
C. $13,600
D. $18,000
LO2 – Self-Test – B
39. The owner of Mom & Pop’s Hardware Store purchased a knife sharpener last year in order to allow
the store to offer services in sharpening all types of blades. The cost of the equipment was $5,200
but Pop now feels that the store needs to generate additional revenue of $200 per month in order
to have made the purchase worthwhile. With regard to making the decision of whether to continue
to offer the service, the original cost of the sharpener can be considered:
A. Controllable.
B. Mixed.
C. Sunk.
D. Relevant.
LO2 – Self-Test – C
40. When making decisions, a general rule would be:
A. Fixed costs are always relevant.
B. Variable (unit-level) costs are always irrelevant.
C. Future costs and revenues are always relevant.
D. Future costs and revenues which differ are always relevant.
LO2 – Self-Test – D
41. Which one of the following is the best example of a long-term decision for management of a
manufacturing company?
A. Increasing the amount of caffeine in the company’s soft drink products.
B. Eliminating excessive use of company supplies.
C. Building an assembly line for its energy drinks.
D. Removing manufacturing byproducts that are deemed hazardous for storage.
LO2 – Pre-Test – C
Identification and Estimating Costs and Benefits
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42. Which of the following is the best example of a long-term capacity cost for a trucking company?
A. Performing tune-ups on older trucks.
B. Installing a GPS unit in each truck to monitor efficient routes and fuel efficiency in order to serve
more customers on a daily basis.
C. Changing the oil annually in each delivery truck.
D. Replacing torn seats in several of the trucks in which truckers have complained
LO2 – Post-Test – B
43. Variability deals with:
A. The degree to which we can directly relate a cost or benefit to a specific option.
B. How activities influence costs and benefits.
C. The result of performing activities.
D. The difference across decision options.
E. None of the above.
LO3 – B
44. Traceability is:
A. The degree to which we can directly relate a cost or benefit to a specific option.
B. How activities influence costs and benefits.
C. The result of performing activities.
D. The difference across decision options.
E. None of the above.
LO3 – A
45. A cost that is proportional to the volume of activity is a:
A. Mixed cost.
B. Fixed cost.
C. Variable cost.
D. Volume cost.
E. Break-even cost.
LO3 – C
46. Organizations frequently refer to indirect costs as:
A. Volume costs.
B. Variable costs.
C. Common costs.
D. Special costs.
E. Fixed costs.
LO3 – C
47. Which of the following items is not an example of a direct cost in the production of a refrigerator?
A. Raw materials.
B. The cost of a machine used only for manufacturing this line of refrigerators.
C. Salary of factory assembly line workers.
D. Maintaining the sales office.
E. All of the above could be direct costs.
LO3 – D
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48. Variable (unit-level) costs per unit:
A. Increase as production increases.
B. Decrease as production decreases.
C. Stay the same at any level of production.
D. Increase as production decreases.
LO3 – Self-Test – C
49. During the month of March the Richards Company, which operates one factory location and one
administrative location, reported the following costs:
Postage on bills sent to customers $100
Rent on its factory building $3,800
Depreciation used on administrative office computers $600
Bonuses paid to the Vice-President of Sales $1,500
Indirect costs total:
A. $700
B. $3,800
C. $2,200
D. $2,100
LO3 – Self-Test – C
50. Considering only controllable costs and benefits in an analysis:
A. Always reduces the number of costs and benefits needing to be measured.
B. Never reduces the number of costs and benefits needing to be measured.
C. Reduces only the number of costs to be measured if they are controllable.
D. Will not reduce the number of costs and benefits to be measured if the status quo is an available
option.
LO3 – Self-Test – D
51. Which of the following is the best example of a variable cost?
A. Monthly loan payment on a plant generator.
B. Labor cost for plant employees.
C. Lease payment for the office copy machine.
D. General manager’s salary.
LO3 – Pre-Test – B
52. In June, Ace Manufacturing Plant produced 100 units of propane canisters for sale. The total variable
costs were $5,000 and the fixed costs for the plant amounted to $3,000. How much is the unit
variable cost for canisters if 120 canisters are produced?
A. $50.00
B. $66.67
C. $80.00
D. $41.67
LO3 – Pre-Test – A
Identification and Estimating Costs and Benefits
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53. Which of the following will least likely be a variable cost for Pizza Hut?
A. Dough, sauce, and cheese.
B. Boxes for ‘to go’ pizza orders.
C. Cooking ovens.
D. Cashiers’ hourly wages
LO3 – Post-Test – C
54. During May, Mayer Company’s total fixed costs were $5,000 and variable costs were $7,000 when
500 units were produced. How much is total cost for June if 600 units are produced?
A. $13,400
B. $12,000
C. $7,000
D. $14,400
LO3 – Post-Test – A
55. Which of the following is the best example of product-level costs?
A. Property taxes of a factory.
B. Cost of plastic for bottled water.
C. Research and development costs.
D. Setup of machine drivers
LO3 – Post-Test – C
56. Which of the following statements describes how step costs relate to fixed and variable costs?
A. A step cost behaves more like a variable cost as the step size decreases.
B. A step cost behaves more like a fixed cost as the step size decreases.
C. A step cost behaves like a variable cost, but not like a fixed cost.
D. A step cost behaves like a fixed cost, but not like a variable cost.
LO4 – A
57. Suppose fixed costs are $500, variable cost is $5 per unit, and step costs are $50 for every 20 unit
produced. What is the total cost of producing 25 units?
A. $675
B. $688
C. $725
D. $800
E. $625
LO4 – C $500 + ($5 x 25) + ($50 x 2) = $725
58. Factory rent is an example of:
A. Product-level cost.
B. Facility-level cost.
C. Unit-level cost.
D. Batch-level cost.
E. None of the above.
LO4 – B
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59. Production planning required to prepare the production process for the next product is an example
of:
A. Product-level cost.
B. Facility-level cost.
C. Unit-level cost.
D. Batch-level cost.
E. None of the above.
LO4 – D
60. Advertising and research and development costs are examples of:
A. Product-level cost.
B. Facility-level cost.
C. Unit-level cost.
D. Batch-level cost.
E. None of the above.
LO4 – A
61. The HomeAmour Company operates their production and administrative activities from a single
facility. Which of the following would be an example of a facility-level cost?
A. Salary of the Chief Operating Officer.
B. Raw materials used to produce units.
C. Depreciation on the equipment used in the factory.
D. Freight paid on finished units shipped to customers.
LO4 – Self-Test – A
62. If a production facility increases its production by 1,500 units, its:
A. Variable (unit-level) cost per unit will increase.
B. Fixed cost per unit will increase.
C. Total fixed costs will decrease.
D. Fixed cost per unit will decrease.
LO4 – Self-Test – D
63. During the month of September the Gaffney Company, which operates one factory location and one
administrative location, reported the following costs:
Repair costs for the factory’s air conditioning system $3,500
Property taxes on its administrative office building $ 900
Rent on factory building $1,400
Bonuses paid to a factory manager $ 500
Facility costs total:
A. $5,300
B. $5,400
C. $2,800
D. $4,900
LO4 – Self-Test – B
Identification and Estimating Costs and Benefits
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64. A direct cost can be:
A. Only fixed.
B. Only variable (unit-level).
C. Either fixed or variable (unit-level).
D. Neither fixed nor variable (unit-level).
LO4 – Self-Test – C
65. Which one of the following is the best example of a step cost for Ace Manufacturing?
A. Paying a higher factory utility bill for the month of June.
B. Cutting back health care coverage for employees.
C. Terminating the manufacturing quality control employees.
D. Opening a new assembly line for one of the company’s most popular products as a result of its
original assembly line continually operating at capacity.
LO4 – Pre-Test – D
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Problems
1. The following table lists five decisions you might encounter as owner of a dance studio when
determining whether to add a class of South American steps to their offerings.
Required:
Indicate by placing an “X” in the appropriate column whether each of the following items describes
a controllable or non-controllable cost.
Controllable Noncontrollable
Type of Cost
a. _____ _____ Increase in instructors’ salaries.
b._____ _____ Increase in selling price per lesson.
c._____ _____ Lease payment on building.
d._____ _____ Depreciation on office computer.
e_____ _____ Liability insurance premiums.
2. A decision’s horizon significantly influences the controllable costs and benefits we need to consider.
The following table lists five items you are likely to encounter during your college career.
Required:
Indicate by placing an “X” in the appropriate column whether each of the following items describes
a short-term or long-term decision.
ShortTerm
LongTerm
Decision
a. _____ _____ Choosing to attend a two-year technical college or a fouryear traditional university.
b._____ _____ Choosing an Art Appreciation or Music Appreciation to fulfill
your general education culture requirement.
c._____ _____ Deciding whether to change majors.
d._____ _____ Deciding whether to purchase a Dell or IBM laptop computer
for use in class next semester.
e_____ _____ Choosing whether to eat lunch in the cafeteria or offcampus.
Identification and Estimating Costs and Benefits
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3. Julie’s Baby Creations makes heirloom party dresses and smocked play clothes for children.
Although each item is made to order, Julie uses the same sewing machines and supplies for both
products. The following table lists five costs incurred by Julie to make a party dress.
Required:
Indicate by placing an “X” in the appropriate column whether each of the following items describes
a direct or indirect cost.
Direct Indirect Item
a. _____ _____ Eight yards of French lace for trim.
b._____ _____ Three yards of silk dupioni material for dress.
c._____ _____ Use of sewing machine.
d._____ _____ Supplies: needles, thread, pins.
e_____ _____ Commission of 5% of selling price to local seamstress for
smoking yoke.
4. Deluxe Yard Art manufacturers and sells high-end metal lawn statues. The selling price per statue is
$200. Fixed costs include insurance of $300 and administrative cost of $800, direct costs of $82 per
unit ($47 direct material; $35 direct labor), and step costs of $420 for every 30 units. Deluxe expects
to produce 53 units.
Required
a. Indicate the following total costs for producing 53 units.
Total Fixed Costs ________________
Total Variable Costs ______________
Total Step Costs _________________
Total Costs ______________________
b. If Deluxe anticipates increasing volume by 10 units, what is the net effect of the additional sales?
Balakrishnan Managerial Accounting
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Problem Solutions
1. Controllable Costs (LO1)
a. Controllable.
b. Controllable.
c. Non-controllable.
d. Non-controllable.
e. Non-controllable.
2. Classifying Decisions According to Time Horizon (LO2)
a. Long-term.
b. Short-term.
c. Long-term.
d. Short-term.
e. Short-term.
3. Classifying costs as direct or indirect (LO3)
a. Direct.
b. Direct.
c. Indirect.
d. Indirect.
e. Direct.
4. Calculating Fixed, variable, and step costs (LO4)
a. Total Fixed Costs $1,100 ($300 + $800)
Total Variable Costs $4,346 ($82 x $53)
Total Step Costs $840 ($420 x 2)
Total Costs $6,286
b. Revenue $2,000
Variable costs 820
Step costs 420
Net effect $ 760 additional profit.
Identification and Estimating Costs and Benefits
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END OF CHAPTER HOMEWORK CONTENT
Short Answer
1. What does it mean for a cost or benefit to be controllable?
2. How is value related to controllable costs and benefits?
3. What does it mean for a cost or benefit to be relevant?
4. When is a controllable cost relevant? When is a controllable cost not relevant?
5. Why does time influence the controllability of costs and benefits?
6. What is the key difference between a long-term and a short-term decision?
7. Why is it not possible to sharply distinguish between short- and long-term decisions?
8. What is the central principle underlying the estimation of revenues and costs?
9. Are revenues usually variable, mixed, or fixed? Why?
10. What are variable, fixed, and mixed costs?
11. What is traceability?
12. What are direct and indirect costs?
13. What is a step cost?
14. How many kinds of costs are there in the cost hierarchy? List these kinds of costs.
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Solutions to Short Answer
1. (LO-1) Controllable benefits and costs are, respectively, the incremental revenues and
expenditures relative to current revenues and expenditures.
2. (LO-1) Value equals controllable benefits less controllable costs.
3. (LO-1) Relevant costs and benefits are controllable costs and benefits that differ across
decision options.
4. (LO-1) A controllable cost is relevant when the status quo is an option or when the amount
differs for at least one option. A controllable cost is not relevant when the status quo is not an
option and when the cost does not differ across viable options.
5. (LO-2) Because previously made commitments and contractual obligations expire with the
passage of time.
6. (LO-2) The ability to change the levels of capacity resources related to plant, equipment, and
salaried staff.
7. (LO-2) Because many decisions contain elements of both the short- and long-term. Consider
sleeping through a test – this has both immediate and, perhaps, long-term consequences.
8. (LO-3) Costs and benefits are the result of performing activities.
9. (LO-3) Revenues typically vary with sales volume.
10. (LO-3) Variable costs are proportional to the volume of activity, whereas fixed costs do not
change as the volume of activity changes. Mixed costs contain both fixed and variable components.
11. (LO-3) Traceability is the degree to which we can directly relate a cost or revenue to a decision
option.
12. (LO-3) A cost or revenue that we can uniquely relate to a decision option is a direct cost or a
direct benefit. If only a portion of the cost or revenue pertains to a particular decision option, then it
is an indirect cost or an indirect benefit.
13. (LO-4) Step costs stay at the same level for a certain activity range, but jump to a higher
amount if the volume of activity increases beyond this range.
14. (LO-4) There are four kinds of costs in the cost hierarchy – unit, batch, product, and facility.
Identification and Estimating Costs and Benefits
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Short Essay
1. We know that the controllable benefits less the controllable costs of an option equal its value. Can
focusing only on relevant costs and benefits ever give us value?
2. Many decisions often involve qualitative factors. How can you reconcile this fact with the concept
of relevant costs?
3. Every relevant cost is controllable. However, not all controllable costs are relevant. Why are both
statements correct?
4. When might the magnitude of a sunk cost be relevant for a decision? How do you reconcile this
answer with the maxim that a sunk cost is not relevant for decision making? (Hint: Consider taxes or
a decision maker’s reputation.)
5. Television manufacturers such as Pioneer, Sony, Toshiba, and Mitsubishi introduce new models
constantly. In your judgment, how long is the short-term horizon for such television companies?
Identify two short-term decisions that these companies might make to improve their profit.
6. Consider the decision to purchase an automobile to commute to school and/or to work. What costs
do you commit to/do not commit to when making your choice?
7. If a firm drops a product line, it will lose the revenue from that product. This loss is controllable and
direct with respect to the decision to keep or drop the product. Dropping a product might also affect
the sales of the firm’s other products. Give two examples—one in which the spillover effect
increases the revenue from other products and one in which the spillover effect decreases the
revenue from other products. Are these spillover effects controllable and direct to the decision to
drop the product?
8. We can think of a cost or revenue estimate as a draw from many possible values of some
distribution. Evaluate the following statement, “Variability is helpful in assessing the mean of the
probability distribution while traceability speaks to the variance.”
9. Some companies impose a minimum charge for services. For example, a caterer may charge $12 per
person, with a minimum charge of $120 to host a small dinner party. What is the rationale for a
minimum charge? (Hint: Think about the caterer’s costs in terms of the cost hierarchy).
10. Batch- and product-level costs are not relevant for decisions that only affect the volume of
production. Do you agree with this assertion? Why or why not.
Balakrishnan Managerial Accounting
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Solutions to Short Essay
1. (LO-1) When we define the value of an option as the controllable benefits from that
option less the controllable costs of the option, we are implicitly defining value relative to the status
quo of not doing anything (i.e., not taking any of the options associated with the decision being
considered). Such a definition allows us to equate the value of the option with net cash flow
associated with it. However, focusing on relevant costs and benefits will not give us the same value
because some costs and benefits may be common across all options. The only exception when
focusing only on relevant costs and benefits will give us the same value is when status quo of not
doing anything is a feasible option. In this case, all costs and benefits associated with any option are
relevant because there are no costs or benefits associated with the status quo.
2. (LO-1) Factors are as relevant as cash flows. Consider the decision of buying fruit in a
local grocery store. Let us say that your favorite grocery store is selling fresh grapes $3.99 a pound,
but in an adjacent store grapes are available for $1.99 a pound but they are not as fresh. The
decision to make is whether you are willing to pay the extra $2.00 a pound to enjoy fresh grapes.
You may well decide to do so. How did you make the trade-off? Clearly, the additional benefit that
you get from fresh grapes is not quantifiable. Yet, you are able to use your judgment to make the
trade-off.
3. (LO-1) Suppose you have decided to buy a car. You have set your heart on buying a
Cadillac Escalade. There are two Cadillac dealers nearby, and both offer exactly the same price. In
this case, the price of the car is controllable because you may choose not to buy the car (i.e., the
status quo). However, given that you have already made the decision to buy, the price of the car is
not relevant in deciding which dealer to buy from! This example establishes that not all controllable
costs are relevant unless the status quo is also an option. But every relevant cost is controllable
because, by definition, relevant costs are costs that differ across decision options. The fact that they
differ means that they are controllable. Refer to Exhibit 2.3 in the text for an illustration of these
concepts.
4. (LO-1) Generally speaking, sunk costs are not relevant for decision making because
these are costs incurred (or committed to) in the past, and, therefore, do not vary across decision
options. But, in some instances, there are future tax considerations that may arise from past
decisions, and that may be relevant. For example, consider a company that had invested $10 million
dollars five years ago to buy an important piece of equipment. The company enjoys a tax deduction
for depreciation for this equipment over the 20 year life of this equipment. Since five years have
gone by, 15 years of depreciation tax deduction remain. Let us say, now, the company is
contemplating selling this asset and moving into some other new business. While the $10 million
original cost of the equipment is a sunk cost for this decision, the company has to take into account
the fact that it will be foregoing the remaining 15 years of tax benefit from depreciation by selling
the equipment (the sale price has to be adjusted because the purchaser will now get the tax
benefit). Reputation is also another consideration. Let us say a builder implicitly commits to donate
his time to building affordable houses in a suburban community for a charity organization. Halfway
into the project, the builder gets a lucrative commercial contract from a local real estate developer.
While it may not seem financially wise to continue to devote time to the charity cause, switching has
potential long-term reputational consequences in the community. The builder must take these
consequences into account before pursuing more profitable avenues.
Identification and Estimating Costs and Benefits
2-19
5. (LO-2) Product life-cycle is relatively long–extending over several years–in some
industries and relatively short—sometimes just a year or two years—in other industries. Consumer
electronics is an example of the latter, television being a good example. For companies such as
Pioneer, Sony, Toshiba, and Mitsubishi, advertising, promotion, and pricing are short-term decisions
that have to be made almost on a weekly basis to stay ahead of the competition.
6. (LO-2) Assuming that you have decided which automobile to buy, you are committing to the
price of the automobile, the cost of car insurance, and the cost of expected routine maintenance.
You are not committing to driving the car every day or to buying gasoline on a weekly basis because
you can control these expenditures through your usage of the car.
7. (LO-3) Yes, spillover effects are controllable and must be considered in making decisions.
Consider an automobile company like GM which offers two similar SUVs but under different brand
names. The decision to drop one of these brands is likely to increase the revenues from the other
brand (but may decrease the total revenues from the two brands). On the other hand, consider an
auto repair shop that decides to stop doing simple brake jobs. Such a decision is likely to have
negative spillover effects because it will lose revenues from performing other maintenance services
that typically surface when cars are brought in by their owners to get their brakes serviced.
8. (LO-3) When costs or revenues vary, using many possible realizations helps us in estimating with
greater statistical confidence what these costs or revenues are going to be on average. That is, we
can estimate their means more reliably. On the other hand, inability to trace costs accurately
introduces measurement error or “noise” in our estimation. Such measurement increases the
variance because we now have to deal with the randomness in this error as well i.e., the error can
assume different values as well.
9. (LO-4) The minimum charge for a service represents the opportunity cost to the company for
committing resources for that service. By not providing that service, the company can use its
resources to make a profit by providing the same service to someone else. Consider the caterer
example. Let us say you have agreed to pay $120 to the caterer to host a small dinner party for 10
friends. The caterer charges $12 per person because s/he has to arrange for food items for each
individual and make some profit as well. In this case, the number of persons attending the dinner is
a good basis to estimate costs. That is, the caterer’s costs and charges are proportional to the
number of persons s/he is asked to serve.
10. (LO-4) This assertion is correct as long as the number of batches produced does not increase, and
the number of different products made does not increase. If the volume of production increases
because the number of units produced within each batch increases, then batch- and product-level
costs will not increase and are therefore not relevant.
Balakrishnan Managerial Accounting
2-20
Exercises
1. Sarah is not currently using the fitness loft, a special area of the gym that houses state-of-the-art
cardio and strength training equipment. Based on a visit as a friend’s guest, Sarah has decided to
enroll in the loft. She is deciding between buying a pass to the fitness loft (cost: $120 per semester)
and buying a pass for each use (cost: $4 per visit). She wants to work out at least three times a
week, which translates to 45 times for the semester. Towel rental at the loft is $0.50 per use. Sarah
pays a facilities fee of $175 per semester with her tuition; this fee entitles her to “free” use of one
locker.
Required:
a. Is the facilities fee of $175 relevant or controllable for Sarah’s decision?
b. Is the towel rental of $0.50 per visit controllable or relevant for this decision?
c. Is the per-use fee controllable or relevant for this decision?
2. Sam Walters is leaving tomorrow for a three-day business trip and is trying to decide the most
economical way to get to and from the airport and his home. Sam could either drive (using his own
car) or take the shuttle. If Sam drives, then he estimates that it will cost $0.30 per mile driven in
operating costs (e.g., for gas and oil) and $7.50 per day for parking. The one-way cost of the shuttle
is $25. Sam’s home is exactly 30 miles from the airport.
Required:
a. What are the controllable costs for Sam’s decision?
b. What are the relevant costs and benefits for Sam’s decision?
c. Are the controllable costs the same as the relevant costs for Sam’s decision? If so, why? Can
controllability and relevance give the same costs and benefits even when the status quo is not a
feasible option?
