Managerial Accounting Quiz: Relevant Vs Sunk Costs
20 questions · exam conditions
0:00
Relevant Vs Sunk CostsQuestion 1 of 20

A company produces a component internally. The costs per unit are: direct materials $10, direct labor $8, variable overhead $4, and fixed overhead $6. A third-party supplier has offered to sell the component to the company for $25 per unit. If the company buys the component, 40% of the fixed overhead would be avoided. The facility and equipment used to produce the component have no alternative use and a book value of $100,000. In deciding whether to make or buy, what is the relevant per-unit cost of making the component?

$24.40
$25.00
$28.00
$22.00
← Back to quizzes

Managerial Accounting Quiz

Managerial Accounting Quiz: Relevant Vs Sunk Costs

Practice Relevant Vs Sunk Costs in Managerial Accounting with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Relevant Vs Sunk Costs, giving you a quick way to practice the rules, question types, and explanations that matter most for Managerial Accounting.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

A company produces a component internally. The costs per unit are: direct materials $10, direct labor $8, variable overhead $4, and fixed overhead $6. A third-party supplier has offered to sell the component to the company for $25 per unit. If the company buys the component, 40% of the fixed overhead would be avoided. The facility and equipment used to produce the component have no alternative use and a book value of $100,000. In deciding whether to make or buy, what is the relevant per-unit cost of making the component?

  1. $24.40 (correct answer)
  2. $25.00
  3. $28.00
  4. $22.00
Explanation: Relevant costs are future costs that differ between alternatives. The relevant costs of making the component are direct materials (10),directlabor(10), direct labor (8), variable overhead ($4), and the avoidable portion of fixed overhead (40% of $6 = $2.40). The total relevant cost is $10 + $8 + $4 + $2.40 = $24.40. The unavoidable fixed overhead and the book value of the equipment are sunk/irrelevant.

Question 2

A pharmaceutical company has invested $10 million in the initial research for a new drug. The next phase, clinical trials, will cost an additional $4 million. The company's analysts project a 70% chance of success. If successful, the drug will generate net future profits of $20 million. If it fails, the company will lose the entire investment. What is the expected value of proceeding with the clinical trials?

  1. Gain of $14,000,000
  2. Loss of $4,000,000
  3. Gain of $0
  4. Gain of $10,000,000 (correct answer)
Explanation: The $10 million initial investment is a sunk cost and is irrelevant to the decision to proceed. The decision should be based on the expected value of the future outcomes versus the future costs. Expected future profit = (Probability of Success * Profit if Successful) + (Probability of Failure * Profit if Failure) = (0.70 * $20,000,000) + (0.30 * $0) = $14,000,000. The cost to proceed is the $4,000,000 for clinical trials. Expected value = Expected future profit - Future cost = $14,000,000 - $4,000,000 = $10,000,000.

Question 3

A consulting firm spent $50,000 last year developing a proprietary financial modeling template. The firm is now bidding on a project that will require $30,000 in labor costs and $5,000 in travel costs. The project will also require 100 hours of computer time on the firm's server. The server has excess capacity, and the variable costs of running the server are negligible. The firm's policy is to allocate server overhead at a rate of $20 per hour. In determining the minimum bid price for the project, what total cost figure should be used?

  1. $37,000
  2. $85,000
  3. $87,000
  4. $35,000 (correct answer)
Explanation: The minimum bid price should be based on the relevant, incremental costs of the project.
  • The $50,000 spent developing the template is a sunk cost and irrelevant.
  • The labor costs (30,000)andtravelcosts(30,000) and travel costs (5,000) are future, incremental costs and are relevant.
  • The server overhead allocation ($20/hour * 100 hours = $2,000) is irrelevant because it is an allocation of existing costs and using the server does not incur any additional variable costs as there is excess capacity. Therefore, the total relevant cost is $30,000 + $5,000 = $35,000.

Question 4

A company is considering launching a new product. The following costs have been identified: (1) $100,000 for R&D completed last year; (2) $250,000 for new manufacturing equipment; (3) $15,000 for a marketing study completed last month; (4) $50,000 for an initial advertising campaign. Which of these items is a sunk cost at the time of the launch decision?

  1. Items (1) and (3) only. (correct answer)
  2. Item (1) only.
  3. Items (1), (3), and (4).
  4. Items (1), (2), and (3).
Explanation: Sunk costs are costs that have already been incurred and cannot be changed by any future decision. At the time of the launch decision: (1) The $100,000 R&D cost was incurred last year and is a sunk cost. (2) The $250,000 for new equipment is a future cost that is relevant to the decision. (3) The $15,000 for the marketing study was incurred last month and is a sunk cost. (4) The $50,000 advertising campaign is a future cost required for the launch and is relevant. Therefore, only the R&D and marketing study costs are sunk.

Question 5

Five years ago, a company bought a machine for $250,000. It has been fully depreciated for tax purposes and has a book value of zero. The machine can be sold today for $30,000. Alternatively, it can be retooled for $40,000 and used on a three-year project, which would generate incremental cash inflows of $25,000 per year. After three years, the machine would have no salvage value. What is the net financial advantage or disadvantage of retooling the machine for the project?

  1. Advantage of $35,000
  2. Disadvantage of $5,000
  3. Advantage of $5,000 (correct answer)
  4. Disadvantage of $215,000
Explanation: The original cost and book value are sunk and irrelevant. The decision is to retool or sell. The analysis should compare the incremental benefits and costs of retooling. Incremental benefit = $25,000/year * 3 years = $75,000. Incremental costs = $40,000 (retooling cost) + $30,000 (opportunity cost of not selling today). Total incremental costs = $70,000. Net financial advantage = $75,000 - $70,000 = $5,000.

Question 6

A company is considering replacing an old machine with a new one. The old machine was purchased for $80,000, has accumulated depreciation of $50,000, and a current book value of $30,000. Its current salvage value is $12,000. If kept, it will have a remaining useful life of 5 years with no salvage value. The new machine costs $70,000 and will reduce annual operating costs by $15,000 over its 5-year life. In the decision analysis to replace the machine, which of the following represents the total amount of sunk costs?

  1. $12,000
  2. $30,000
  3. $80,000 (correct answer)
  4. $18,000
Explanation: A sunk cost is a cost that has already been incurred and cannot be recovered. In this equipment replacement decision, the only true sunk cost is the original purchase price of the old machine ($80,000). The book value is an allocation of this sunk cost, and the salvage value is a future relevant cash flow.

Question 7

Apex Manufacturing has spent $2.5 million developing a new industrial product. The project is experiencing technical difficulties. Management estimates that an additional $900,000 is required to complete the development. If completed, the project is expected to generate future net cash flows of $1.2 million. If the project is abandoned now, some of the intellectual property can be sold for $200,000. A manager argues for completion, stating, "We cannot let the $2.5 million we've already spent go to waste." What is the financial advantage or disadvantage of completing the project instead of abandoning it?

  1. Advantage of $100,000 (correct answer)
  2. Disadvantage of $2,200,000
  3. Advantage of $300,000
  4. Disadvantage of $2,400,000
Explanation: The $2.5 million already spent is a sunk cost and irrelevant. The decision should be based on future costs and benefits. The relevant incremental benefit of completion is the future cash flow of $1,200,000. The relevant incremental costs are the additional development cost of $900,000 and the opportunity cost of forgoing the $200,000 from selling the intellectual property. Therefore, the net financial outcome of completing is $1,200,000 - $900,000 - $200,000 = $100,000 advantage.

Question 8

A division is evaluating a special project that requires the use of an existing machine. The machine was purchased 4 years ago for $200,000 and has a current book value of $80,000. Its current market value is $50,000. If used for the project, the machine's market value in three years will be $20,000. The annual depreciation expense on the machine is $20,000. For purposes of deciding whether to accept the project, what is the total relevant cost of using the machine for the three-year project, ignoring the time value of money?

  1. $30,000 (correct answer)
  2. $60,000
  3. $80,000
  4. $50,000
Explanation: The relevant cost of using an existing asset is the opportunity cost, which is the decline in its market value from being used in the project. The book value (80,000)andtheassociateddepreciation(80,000) and the associated depreciation (20,000 per year) are based on the original sunk cost and are irrelevant. The relevant cost is the difference between the machine's current market value (50,000)anditsmarketvalueaftertheproject(50,000) and its market value after the project (20,000). The cost is $50,000 - $20,000 = $30,000.

Question 9

A company signed a five-year, non-cancelable lease for office space at a cost of $10,000 per month. Two years into the lease, the company decides to move to a new location. The old office space cannot be sublet. The company must continue to pay the rent on the old space for the remaining three years. The cost of the new office space is $12,000 per month. In the analysis of whether to move, the rent on the old office space is considered:

  1. A relevant cost because the payments must still be made.
  2. A sunk cost because the decision to sign the lease was made in the past.
  3. An irrelevant cost because the payments will be made regardless of the decision to move. (correct answer)
  4. An opportunity cost because the space could have been used for other purposes.
Explanation: While the decision to sign the lease is in the past, the payments themselves are future cash outflows. However, because the lease is non-cancelable and the space cannot be sublet, the company must pay the $10,000 per month for the next three years whether they move or stay. Since this cost does not differ between the alternatives, it is an unavoidable future cost and is therefore irrelevant to the decision. It is not technically a sunk cost, which is a past cost.

Question 10

A firm paid a non-refundable fee of $20,000 for a market research study. The study concluded that launching a new service would likely generate $500,000 in revenues, with associated future costs of $475,000. Just before the launch decision, a key employee essential to the service, who was on a month-to-month contract, resigned. Replacing this employee will add an unexpected $30,000 to the service's costs. Which costs are relevant to the decision to launch the service now?

  1. The $475,000 in associated costs and the $20,000 study fee.
  2. The $500,000 in revenues and the 525,000intotalcosts(525,000 in total costs (475k + $30k + $20k).
  3. The $500,000 in revenues and the 505,000infuturecosts(505,000 in future costs (475k + $30k). (correct answer)
  4. The $500,000 in revenues and the $475,000 in originally estimated costs.
Explanation: Relevant costs and revenues are those that will occur in the future and will differ based on the decision. The 20,000feeforthemarketresearchstudyisasunkcostbecauseitwaspaidinthepastandcannotberecovered.Therelevantitemsarethefuturerevenues(20,000 fee for the market research study is a sunk cost because it was paid in the past and cannot be recovered. The relevant items are the future revenues (500,000) and all future costs that will be incurred if the project proceeds. This includes the initially estimated costs (475,000)andthenew,additionalcostforthereplacementemployee(475,000) and the new, additional cost for the replacement employee (30,000). Thus, total relevant costs are $505,000.

Question 11

A company owns a patent with a book value of $50,000 that is currently unused. The company is considering a new project that would make use of this patent. If the project is not pursued, the company can sell the patent to another firm for $75,000. If the project is pursued, the patent will be fully utilized and have no value at the end of the project's life. How should the patent be treated in the project evaluation?

  1. As a sunk cost of $50,000, which is irrelevant to the decision.
  2. As a relevant opportunity cost of $75,000. (correct answer)
  3. As a relevant cost of $50,000, representing its book value.
  4. As having no cost, since the company already owns it.
Explanation: The book value of the patent ($50,000) is an allocation of a past (sunk) cost and is irrelevant. However, by using the patent in the project, the company forgoes the opportunity to sell it for $75,000. This foregone cash inflow is an opportunity cost, which is a relevant cost for decision-making. Therefore, a cost of $75,000 should be included in the project analysis.

Question 12

A company is evaluating whether to drop its electronics product line, which has reported a net loss for the past year. The income statement for the product line is as follows:

Sales: $800,000 Variable Expenses: $500,000 Contribution Margin: $300,000 Fixed Expenses: Direct Fixed Expenses (salaries, advertising): $220,000 Allocated Common Fixed Expenses (rent, admin): $90,000 Net Operating Loss: ($10,000)

If the electronics product line is dropped, the direct fixed expenses would be eliminated. The common fixed expenses would continue, as they are allocated from corporate headquarters. What would be the impact on the company's overall net operating income if the product line is dropped?

  1. Income would increase by $10,000.
  2. Income would decrease by $80,000. (correct answer)
  3. Income would decrease by $300,000.
  4. Income would decrease by $90,000.
Explanation: The decision to drop the product line should be based on its segment margin, which is the contribution margin less direct fixed expenses. The allocated common fixed expenses are irrelevant because they will continue regardless. The segment margin is $300,000 (Contribution Margin) - $220,000 (Direct Fixed Expenses) = $80,000. This $80,000 represents the product line's contribution to covering the company's common fixed costs. If the line is dropped, this contribution is lost, and overall company income will decrease by $80,000.

Question 13

A company produces two products, A and B, from a joint process that costs $100,000. At the split-off point, Product A can be sold for $70,000. Product B can be processed further at a cost of $20,000 and then sold for $45,000. A manager suggests that because the joint cost allocated to Product B would be 50,000(basedona50/50split),anditsfinalprofitwouldbe(50,000 (based on a 50/50 split), and its final profit would be (45,000 - $20,000 - 50,000)=−50,000) = -25,000, it should be discarded. Which statement is correct?

  1. The manager is correct; Product B is unprofitable and should be discarded.
  2. The manager's analysis is flawed; the decision should be based on Product B's incremental revenue of $45,000 versus its total costs of $70,000.
  3. The manager's analysis is flawed; the $100,000 joint cost is a sunk cost with respect to the decision to process B further. (correct answer)
  4. The manager is correct, but only if the joint costs are allocated based on sales value rather than a 50/50 split.
Explanation: The decision to process a joint product further should be based only on the incremental costs and revenues from that point forward. The joint cost of $100,000 is a sunk cost in this context and is irrelevant to the decision. For Product B, the incremental revenue from processing further is $45,000, and the incremental cost is $20,000. Since the incremental revenue exceeds the incremental cost by $25,000, Product B should be processed further. The manager's inclusion of the allocated sunk cost led to the wrong conclusion.

Question 14

A company spent $30,000 to train its workforce on a specific software system. A year later, a new, more efficient system is available. Adopting the new system costs $50,000 but is expected to generate cost savings of $20,000 per year for its 4-year life. What is the net financial benefit of adopting the new system over the 4-year period?

  1. Benefit of $30,000 (correct answer)
  2. Benefit of $80,000
  3. Benefit of $0
  4. Benefit of $50,000
Explanation: The $30,000 spent on training for the old system is a sunk cost and irrelevant to the decision to switch. The decision should be based on the future costs and benefits of the new system. The total benefit (cost savings) over 4 years is $20,000/year * 4 years = $80,000. The cost to adopt the new system is $50,000. The net financial benefit is $80,000 (total savings) - $50,000 (cost) = $30,000.

Question 15

A movie studio spent $100 million producing a film. Before its release, market tracking suggests it will be a flop. The studio must now decide whether to spend an additional $30 million on a marketing campaign. With the campaign, box office revenues are projected to be $50 million. Without the campaign, they are projected to be $10 million. In this decision, the $100 million production cost is:

  1. A relevant cost that makes the marketing campaign financially unwise.
  2. A sunk cost, and the campaign should be approved because it generates $50 million in revenue.
  3. A sunk cost, and the campaign should be approved because its incremental benefit exceeds its incremental cost. (correct answer)
  4. An opportunity cost of not abandoning the film entirely before release.
Explanation: The $100 million production cost is a sunk cost and should be ignored. The decision to market the film should be based on incremental revenues and costs. The incremental cost of the campaign is 30million.Theincrementalrevenuefromthecampaignisthedifferencebetweenrevenuewiththecampaign(30 million. The incremental revenue from the campaign is the difference between revenue with the campaign (50 million) and revenue without it ($10 million), which is $40 million. Since the incremental benefit of $40 million exceeds the incremental cost of $30 million, the campaign is financially justified.

Question 16

A company is evaluating a project with the following estimated annual financial data: Sales revenue of $300,000, variable costs of $180,000, and direct fixed costs of $50,000 for equipment rental. In addition, $40,000 of existing corporate overhead would be allocated to the project. The project also requires a project manager who is currently employed by the company at a salary of $80,000; if the project is not undertaken, the manager will be laid off. What is the expected annual financial impact of undertaking the project?

  1. Profit of $30,000
  2. Loss of $10,000 (correct answer)
  3. Profit of $70,000
  4. Loss of $50,000
Explanation: To find the project's financial impact, we must sum all relevant revenues and costs. Relevant items are those that change as a result of the decision. Relevant Revenue: $300,000 Relevant Costs:
  • Variable costs: $180,000
  • Equipment rental: $50,000 (This is a direct, future cost)
  • Manager's salary: $80,000 (This is a relevant, avoidable cost because the manager would otherwise be laid off) The allocated corporate overhead ($40,000) is irrelevant as it is not an incremental cost. Net Impact = 300,000−(300,000 - (180,000 + $50,000 + $80,000) = $300,000 - 310,000=−310,000 = -10,000 loss.

Question 17

A company has 500 units of a raw material in its inventory that were purchased for $10 per unit. Due to a change in product design, this material is no longer needed for its original purpose. The material has no scrap value. However, it can be used as a substitute for another material in a different production process. The other material currently costs $7 per unit. In an analysis of the new production process, what is the relevant cost of the 500 units of obsolete material?

  1. $5,000
  2. $3,500 (correct answer)
  3. $1,500
  4. $0
Explanation: The original purchase price of 10perunit(10 per unit (5,000 total) is a sunk cost. The relevant cost of using an asset is its opportunity cost. In this case, by using the obsolete material in the new process, the company avoids having to buy the substitute material at $7 per unit. This cost saving is the opportunity cost. Therefore, the relevant cost of using the 500 units is 500 units * $7/unit = $3,500.

Question 18

A company manufactures a product that has generated 1,000 defective units. The cost to manufacture these units was $15,000. The units can be sold as scrap for $2,000. Alternatively, they can be reworked for an additional cost of $6,000. If reworked, the units can be sold for $9,000. What is the net financial advantage or disadvantage of reworking the units compared to selling them as scrap?

  1. Disadvantage of $12,000
  2. Advantage of $1,000 (correct answer)
  3. Disadvantage of $6,000
  4. Advantage of $3,000
Explanation: The original manufacturing cost of $15,000 is a sunk cost and is irrelevant to the decision. The decision should compare the incremental revenues and costs of the two alternatives.
  • Reworking: Incremental Revenue $9,000 - Incremental Cost $6,000 = Net inflow of $3,000.
  • Selling as scrap: Incremental Revenue $2,000. The financial advantage of reworking is the difference between these two outcomes: $3,000 - $2,000 = $1,000.

Question 19

AutoParts Inc. has been producing Component X internally at a cost of $18 per unit (including $6 allocated fixed overhead). An outside supplier offers to provide Component X for $15 per unit. AutoParts produces 10,000 units annually and would eliminate 60% of the allocated fixed overhead if production stops. The freed-up capacity could be used to produce Component Y, which would generate a contribution margin of $45,000. What is the total relevant cost of continuing to make Component X internally?

  1. $120,000 (10,000 units × $12 variable cost per unit)
  2. 156,000(156,000 (120,000 variable costs + $36,000 unavoidable fixed overhead)
  3. 165,000(165,000 (120,000 + $45,000 opportunity cost) (correct answer)
  4. 201,000(201,000 (120,000 + $36,000 + $45,000)
Explanation: Relevant costs of internal production include: variable costs $120,000 (10,000 × $12) plus opportunity cost of 45,000fromforegoneComponentYproduction.Theunavoidablefixedoverhead(45,000 from foregone Component Y production. The unavoidable fixed overhead (24,000 = 40% × $60,000 total) continues regardless and is irrelevant. Choice A omits opportunity cost, Choice B includes irrelevant unavoidable overhead, Choice D double-counts by including both unavoidable overhead and opportunity cost.

Question 20

TechCorp is considering whether to accept a special order for 1,000 units at $45 per unit. The company's normal selling price is $60 per unit. Current production is 8,000 units, and maximum capacity is 10,000 units. The company has already spent $25,000 on market research for this potential customer and $15,000 on equipment modifications that would be required regardless of whether this order is accepted. Variable costs per unit are $30, and fixed costs are $120,000 per year. If the order is accepted, additional shipping costs of $3 per unit would be incurred.

Which of the following costs should be considered relevant for the special order decision?

  1. Variable costs of $30 per unit and additional shipping costs of $3 per unit only (correct answer)
  2. Variable costs of $30 per unit, shipping costs of $3 per unit, and the $15,000 equipment modification costs
  3. Variable costs of $30 per unit, shipping costs of $3 per unit, and allocated fixed costs of $12 per unit
  4. All costs including the $25,000 market research, $15,000 equipment modifications, and per-unit costs
Explanation: Relevant costs are future costs that differ between alternatives. The variable costs (30)andadditionalshippingcosts(30) and additional shipping costs (3) are the only costs that will change if the order is accepted. The $25,000 market research is a sunk cost (already incurred). The $15,000 equipment modification is also sunk since it's required regardless of the decision. Fixed costs don't change with this decision since there's excess capacity.