CPA CFE Management Accounting 3 — Questions and Answers
Question 1: A company is considering outsourcing a component currently manufactured in-house. Which costs are relevant to this make-or-buy decision?
- All manufacturing costs including allocated corporate overhead
- Only the avoidable costs of manufacturing compared to the purchase price (Correct answer)
- The sunk costs of equipment already purchased for manufacturing
- Only the fixed costs of the manufacturing department
Correct answer: Only the avoidable costs of manufacturing compared to the purchase price
In a make-or-buy decision, only avoidable costs (those that would be eliminated by outsourcing) are relevant. Unavoidable allocated overhead and sunk costs of existing equipment are irrelevant because they will continue regardless of the decision.
Question 2: What does the economic order quantity (EOQ) model minimize?
- Purchase cost of inventory
- Total of ordering costs and carrying costs (Correct answer)
- Only carrying (holding) costs
- Stockout costs exclusively
Correct answer: Total of ordering costs and carrying costs
The EOQ model determines the order quantity that minimizes the total of ordering costs (costs per order × number of orders) and carrying costs (cost per unit per year × average inventory). As order size increases, ordering costs decrease but carrying costs increase.
Question 3: In cost-volume-profit (CVP) analysis, what is the margin of safety?
- The difference between selling price and variable cost per unit
- The excess of actual or budgeted sales over the break-even point (Correct answer)
- The minimum profit required by management
- The maximum loss a company can sustain
Correct answer: The excess of actual or budgeted sales over the break-even point
The margin of safety represents how much sales can decline from the current or budgeted level before the company reaches its break-even point. It can be expressed in dollars, units, or as a percentage of current sales.
Question 4: Under the theory of constraints (TOC), what is the recommended approach to maximize throughput?
- Maximize efficiency at every workstation equally
- Identify and exploit the bottleneck resource, subordinating all other resources to the constraint (Correct answer)
- Increase batch sizes at all workstations to reduce setup time
- Outsource all non-core activities
Correct answer: Identify and exploit the bottleneck resource, subordinating all other resources to the constraint
TOC focuses on identifying the system's constraint (bottleneck) and managing it effectively. The five-step process is: identify, exploit, subordinate, elevate, and repeat. Non-bottleneck resources should be subordinated to support the bottleneck's pace.
Question 5: A responsibility center manager is evaluated on return on investment (ROI). What is a potential problem with using ROI as the sole performance measure?
- ROI always encourages managers to accept all projects with positive NPV
- Managers may reject projects that earn above the company's cost of capital but below the division's current ROI (Correct answer)
- ROI cannot be calculated for divisions with assets
- ROI eliminates the incentive to manage costs
Correct answer: Managers may reject projects that earn above the company's cost of capital but below the division's current ROI
A key weakness of ROI is that division managers may reject profitable projects (ones earning above the cost of capital) if those projects would lower the division's current ROI. This suboptimal behavior can be mitigated by using residual income instead.
Question 6: What is target costing?
- Setting a cost target equal to current production costs
- Determining the allowable cost of a product by subtracting the desired profit from the target selling price (Correct answer)
- A method of allocating overhead costs to products
- Setting the selling price by adding a markup to full production cost
Correct answer: Determining the allowable cost of a product by subtracting the desired profit from the target selling price
Target costing starts with the market-driven target selling price, subtracts the desired profit margin, and determines the maximum allowable cost. The company then designs the product and processes to meet this cost target, using value engineering and cost reduction techniques.
CPA CFE Management Accounting 3
A company is considering outsourcing a component currently manufactured in-house.
Which costs are relevant to this make-or-buy decision?