ACCA PM · Chapter 8
Make or buy and other short-term decisions MCQs with Answers
10 multiple-choice questions on Make or buy and other short-term decisions for ACCA PM Performance Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which of the following best defines a relevant cost for decision-making?
- A) A future, incremental cash flow that arises as a direct result of the decision
- B) Any cost recorded in the accounting records for the period
- C) A cost that has already been incurred and cannot be recovered
- D) A share of general fixed overheads apportioned to the decision
Show answer & explanation
Answer: A) A future, incremental cash flow that arises as a direct result of the decision
Relevant costs are future, cash-based and incremental: they change as a result of the decision being taken. Sunk costs, committed costs and apportioned fixed overheads that will be incurred anyway are not relevant.
Question 2
A one-off contract requires 800 kg of material K. The company holds 500 kg of K in inventory, bought for $4.00 per kg. The current replacement cost is $5.20 per kg and the resale value is $3.10 per kg. Material K is used regularly in the company's normal production. What is the relevant cost of material K for the contract?
- A) $3,560
- B) $3,110
- C) $4,160
- D) $3,200
Show answer & explanation
Answer: C) $4,160
Because K is in regular use, any inventory used on the contract must be replaced, so all 800 kg are valued at replacement cost. Relevant cost = 800 x $5.20 = $4,160. The historical cost of $4.00 is a sunk cost.
Question 3
A one-off contract requires 800 kg of material K. The company holds 500 kg of K in inventory, bought for $4.00 per kg. The current replacement cost is $5.20 per kg and the resale value is $3.10 per kg. Material K is NOT used for any other purpose, and if not used on the contract the inventory would be sold. What is the relevant cost of material K for the contract?
- A) $3,110
- B) $4,160
- C) $3,560
- D) $1,550
Show answer & explanation
Answer: A) $3,110
The 500 kg in inventory would otherwise be sold, so their relevant cost is the lost resale value: 500 x $3.10 = $1,550. The remaining 300 kg must be bought at $5.20: 300 x $5.20 = $1,560. Total relevant cost = $3,110.
Question 4
A special order needs 200 hours of skilled labour. Skilled workers are paid $15 per hour and are fully employed making product Q, which earns a contribution of $12 per labour hour after charging labour costs. If the order is accepted, production of Q will be reduced. What is the relevant cost of the skilled labour for the order?
- A) $3,000
- B) $2,400
- C) $5,400
- D) $8,400
Show answer & explanation
Answer: C) $5,400
Labour is scarce, so diverting it to the order costs both the wage and the contribution lost from product Q. Relevant cost per hour = $15 + $12 = $27. Total = 200 x $27 = $5,400. Adding the wage on top of a contribution figure that already includes it ($15 + $27 = $42 per hour, giving $8,400) double-counts the labour cost.
Question 5
A company spent $35,000 last month on market research into a possible new product. When deciding whether to launch the product, how should the $35,000 be treated?
- A) Included in full as a cost of the launch
- B) Included only if the product is launched
- C) Spread over the expected life of the product as a relevant cost
- D) Ignored, because it is a sunk cost
Show answer & explanation
Answer: D) Ignored, because it is a sunk cost
The market research has already been paid for and will not change whatever decision is made. It is a sunk cost and is therefore irrelevant to the launch decision.
Question 6
A company makes 10,000 units per year of a component at a variable cost of $18 per unit. Specific fixed costs of $40,000 per year would be avoided if the component were bought in, and general fixed overheads of $30,000 are currently absorbed into the component's cost. An outside supplier offers the component at $21 per unit. What should the company do?
- A) Make the component, saving $30,000 per year
- B) Make the component, saving $10,000 per year
- C) Buy the component, saving $10,000 per year
- D) Buy the component, saving $40,000 per year
Show answer & explanation
Answer: C) Buy the component, saving $10,000 per year
Relevant cost of making = (10,000 x $18) + $40,000 avoidable fixed costs = $220,000. Cost of buying = 10,000 x $21 = $210,000. Buying saves $10,000 per year. The $30,000 of general overheads is unavoidable and therefore irrelevant.
Question 7
A company needs both components P and Q but has insufficient labour hours to make all its requirements, so it must buy in some units. Details per unit are: Component P: variable cost to make $14, price to buy $20, labour 2 hours Component Q: variable cost to make $10, price to buy $18, labour 4 hours Which component should be bought in first, and why?
- A) Component P, because its extra cost of buying is only $6 per unit
- B) Component Q, because its variable cost of making is lower
- C) Component Q, because the extra cost of buying is only $2.00 per labour hour saved
- D) Component P, because the extra cost of buying is only $3.00 per labour hour saved
Show answer & explanation
Answer: C) Component Q, because the extra cost of buying is only $2.00 per labour hour saved
When labour is scarce, buy the component with the lowest extra cost per hour of labour saved. P: ($20 - $14) / 2 hours = $3.00 per hour. Q: ($18 - $10) / 4 hours = $2.00 per hour. Q should be bought first, even though its extra cost per unit ($8) is higher than P's ($6).
Question 8
A division of a retail chain reports annual contribution of $30,000. Its fixed costs comprise $45,000 that would be avoided if it closed and $25,000 of head office costs that would continue regardless. If the division is closed, what will happen to the company's annual profit?
- A) It will decrease by $30,000
- B) It will increase by $40,000
- C) It will increase by $15,000
- D) It will decrease by $10,000
Show answer & explanation
Answer: C) It will increase by $15,000
Closing the division loses $30,000 of contribution but saves $45,000 of avoidable fixed costs. Profit therefore rises by $45,000 - $30,000 = $15,000. The $25,000 of head office costs is unavoidable and irrelevant.
Question 9
A joint product can be sold at the split-off point for $6.00 per kg. Alternatively it can be processed further at an incremental cost of $2.50 per kg and sold for $9.20 per kg. Joint costs are allocated at $3.00 per kg. Output is 10,000 kg. What is the effect of processing further?
- A) Profit increases by $7,000
- B) Profit decreases by $23,000
- C) Profit increases by $67,000
- D) Profit increases by $32,000
Show answer & explanation
Answer: A) Profit increases by $7,000
Incremental revenue = $9.20 - $6.00 = $3.20 per kg; incremental cost = $2.50 per kg. Gain = $0.70 x 10,000 = $7,000, so the product should be processed further. Joint costs are incurred whatever the decision and are irrelevant.
Question 10
A manufacturer is considering outsourcing the production of a key component to an overseas supplier at a lower cost. Which of the following is a non-financial factor that should be considered?
- A) The difference between the supplier's price and the internal variable cost
- B) The avoidable fixed costs of in-house production
- C) The contribution that the released capacity could earn on other work
- D) The reliability of supply and the consistency of quality from the supplier
Show answer & explanation
Answer: D) The reliability of supply and the consistency of quality from the supplier
Price differences, avoidable fixed costs and the opportunity cost of freed capacity are all financial factors included in the relevant cost calculation. Supply reliability, quality, loss of skills and confidentiality are qualitative factors that are harder to quantify but can be decisive.