ICAEW BIP · Chapter 12
Relevant costs and short-term decisions MCQs with Answers
7 multiple-choice questions on Relevant costs and short-term decisions for ICAEW BIP Business Insight and Performance. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
A contract needs 800 kg of material T. The company holds 500 kg, which originally cost £6.00 per kg. Material T is used regularly in the company's production. Its current replacement cost is £7.50 per kg and its resale value is £4.00 per kg. What is the relevant cost of material T for the contract?
- A) £4,800
- B) £4,250
- C) £5,250
- D) £6,000
Show answer & explanation
Answer: D) £6,000
Because material T is used regularly, any inventory used on the contract will have to be replaced. All 800 kg are therefore valued at replacement cost: 800 x £7.50 = £6,000. The original cost of £6.00 is a sunk cost and is not relevant.
Question 2
A contract needs 800 kg of material V. The company holds 500 kg, which originally cost £6.00 per kg. Material V is no longer used in the company's production and, if not used on the contract, would be sold for £4.00 per kg. The current purchase price is £7.50 per kg. What is the relevant cost of material V for the contract?
- A) £6,000
- B) £5,250
- C) £4,250
- D) £2,250
Show answer & explanation
Answer: C) £4,250
The 500 kg held have no other use, so the relevant cost of using them is the sale proceeds given up: 500 x £4.00 = £2,000. The remaining 300 kg must be bought at £7.50, costing £2,250. Total relevant cost = £4,250. The original cost is sunk.
Question 3
A special order needs 200 hours of skilled labour. Skilled workers are paid £18 per hour and are fully employed on other work, which earns a contribution of £10 per labour hour after charging labour cost. Workers would be moved from this other work to the special order. What is the relevant cost of skilled labour for the special order?
- A) £5,600
- B) Nil, because the workers are paid regardless
- C) £2,000
- D) £3,600
Show answer & explanation
Answer: A) £5,600
Moving workers means the other work is lost. Relevant cost = labour cost + contribution forgone = 200 x (£18 + £10) = £5,600. The wage cost is included because, when the other work is given up, its contribution is measured after charging that wage.
Question 4
Market research costing £12,000 has already been carried out and paid for in connection with a possible new product. In deciding whether to launch the product, how should the £12,000 be treated?
- A) Spread over the expected sales volume of the product
- B) Ignored, because it is a sunk cost
- C) Included as a relevant cost, because it relates to the product
- D) Included only if the product is launched
Show answer & explanation
Answer: B) Ignored, because it is a sunk cost
A sunk cost has already been incurred and cannot be changed by any future decision, so it is not relevant to the launch decision. Only future, incremental cash flows that differ between the alternatives are relevant.
Question 5
A company makes 10,000 components a year at a variable cost of £28 per unit. An outside supplier offers to supply them for £32 per unit. If the components are bought in, specific fixed costs of £15,000 a year would be saved. Other fixed costs would not change. What should the company do?
- A) Buy the components, saving £15,000 a year
- B) Buy the components, saving £25,000 a year
- C) Continue to make the components, saving £25,000 a year
- D) Continue to make the components, saving £40,000 a year
Show answer & explanation
Answer: C) Continue to make the components, saving £25,000 a year
Relevant cost of making = (10,000 x £28) + avoidable fixed costs £15,000 = £295,000. Cost of buying = 10,000 x £32 = £320,000. Making is cheaper by £25,000. Fixed costs that will not change are irrelevant. Non-financial factors such as quality and reliability of supply should also be considered.
Question 6
A product line earns a contribution of £45,000 a year and is charged fixed costs of £60,000, so it shows a loss of £15,000. Of these fixed costs, £20,000 would be saved if the product line were closed. The rest are general overheads that would be reallocated to other products. What would be the effect on company profit of closing the product line?
- A) Profit would rise by £15,000
- B) Profit would rise by £20,000
- C) Profit would fall by £45,000
- D) Profit would fall by £25,000
Show answer & explanation
Answer: D) Profit would fall by £25,000
Closing loses contribution of £45,000 and saves avoidable fixed costs of £20,000, so profit falls by £25,000. The other £40,000 of general overheads would still be incurred and so is irrelevant. The reported loss is misleading because it includes unavoidable allocated costs.
Question 7
Ashby Ltd has spare capacity. A customer offers to buy 2,000 units of a product at £21 each as a one-off order that will not affect other sales. The variable cost is £17 per unit and fixed production overhead is absorbed at £6 per unit; total fixed overheads will not change. Special packaging costing £1,500 in total would be needed for the order. What is the effect on profit of accepting the order?
- A) A decrease of £5,500
- B) An increase of £6,500
- C) An increase of £8,000
- D) A decrease of £4,000
Show answer & explanation
Answer: B) An increase of £6,500
Only incremental cash flows are relevant. Extra contribution = 2,000 x (£21 - £17) = £8,000. Less the specific packaging cost of £1,500 gives an increase in profit of £6,500. The absorbed fixed overhead of £6 per unit is not relevant because total fixed costs do not change; using full cost of £23 gives the wrong answer of a £5,500 decrease.