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Chapter 25: 25-4RQ (page 1406)

What are sunk costs? Give an example.

Short Answer

Expert verified

Sunk costs are the costs incurred in the past by the business entities, and they are also consideredto be irrelevantto the decision-making process.

Step by step solution

01

Meaning of Cost

In accounting, cost refers to the amount of money spent by the business to acquire goods or services. Costs are incurred to generate revenues and flow the money out of business.

02

The meaning of sunk cost and its example

Sunk costs refer to the costs spent by the business in the past, and based on that, future activities are decided, which cannot be changed. Such costs are irrelevant to the business concerns while making a decision.

For instance, a business bought furniture for $10,000 5 years ago and deals in old furniture. Now the business is planning to buy new furniture. In the given scenario,$10,000 spent in the past is a sunk cost as the business cannot do anything to change that.

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Most popular questions from this chapter

What is the most common constraint faced by merchandisers?

Nautical manufactures flotation vests in Tampa, Florida. Nautical’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

NAUTICAL

Income Statement

For the Month Ended December 31, 2018

Sales in Units 29,000

Net Sales Revenue \(551,000

Variable Costs:

Manufacturing 116,000

Selling and Administrative 111,000

Total Variable Costs 227,000

Contribution Margin 324,000

Fixed Costs:

Manufacturing 123,000

Selling and Administrative 92,000

Total Fixed Expenses 215,000

Operating Income \)109,000

Suppose Water Works wishes to buy 4,800 vests from Nautical. Nautical will not incur any variable selling and administrative expenses on the special order. The Nautical plant has enough unused capacity to manufacture the additional vests. Water Works has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements

1. Identify each cost in the income statement as either relevant or irrelevant to Nautical’s decision.

2. Prepare a differential analysis to determine whether Nautical should accept this special sales order.

3. Identify long-term factors Nautical should consider in deciding whether to accept the special sales order.

Snow Ride manufactures snowboards. Its cost of making 1,900 bindings is as follows:

Direct materials \(17,590

Direct labor 3,200

Variable overhead 2,080

Fixed overhead 6,300

Total manufacturing costs for 1,900 bindings \)29,170

Suppose Livingston will sell bindings to Snow Ride for \(13 each. Snow Ride would pay \)3 per unit to transport the bindings to its manufacturing plant, where it would add its own logo at a cost of \(0.50 per binding.

Requirements

1. Snow Ride’s accountants predict that purchasing the bindings from Livingston will enable the company to avoid \)2,100 of fixed overhead. Prepare an analysis to show whether Snow Ride should make or buy the bindings.

2. The facilities freed by purchasing bindings from Livingston can be used to manufacture another product that will contribute $3,100 to profit. Total fixed costs will be the same as if Snow Ride had produced the bindings. Show which alternative makes the best use of Snow Ride’s facilities: (a) make bindings, (b) buy bindings and leave facilities idle, or (c) buy bindings and make another product.

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