Lecture2_complete_6p - ACCT3104 Managerial Costing and Control Lecture Overview Cost Concepts for decision making Revision Fixed and Variable Costs

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ACCT3104 Managerial Costing and Control Lecture 2 Lecture 2 Decision Making and Relevant Information (contd.) Reading: HDF Chapter 11 2 Lecture Overview ± Cost Concepts for decision making ² Revision: Fixed and Variable Costs, Contribution Margin and CVP Analysis ² Relevant vs Irrelevant Costs ± Decisions ² Accept or reject a special order ² Retain or replace equipment ² Eliminate an unprofitable segment Drop an unprofitable customer ² Make or buy decisions ² Product mix decisions: - with no constrained resources - with a constrained resource - with more than one constraining factor ± Linear Programming ² Graph (two products) ² Simplex Model (multiple products) ² Sell or process further (Week 4) 3 Decision: Retain or Replace Equipment ± Continue using an asset or replace it? ± book value of the current asset is a sunk cost ² irrelevant ± trade-in or salvage value? ² relevant 4 A manager at H, F &Co. wants to replace an old machine with a new, more efficient machine. New machine: List price 90,000 $ Annual variable expenses 80,000 Expected life in years 5 Old machine: Original cost 72,000 Remaining book value 60,000 Disposal value now 15,000 Annual variable expenses 100,000 Remaining life in years 5 Retain or Replace Equipment – Example ± Sales are $200,000 per year. ± Fixed costs, other than depreciation, are $70,000 per year. Should the manager purchase the new machine? Assume no time value of money. Incorrect Analysis The manager recommends that the company not purchase the new machine since disposal of the old machine would result in a loss: Remaining book value 60,000 $ Disposal value (15,000) Loss from disposal 45,000 $ 6 Correct Analysis Comparative costs and revenue for the next five years (Note: we are assuming there is no time value of money ) For Five Years Keep Old Machine Purchase New Machine Difference Revenue Variable costs Other fixed costs Depreciation - new Depreciation - old (60,000) [remaining book value – old] Disposal of old machine Total net profit 1,000,000 [$200,000 per year x 5 years] (500,000) [$100,000 per year x 5 years] (350,000) [$70,000 per year x 5 years]
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For Five Years Keep Old Machine Purchase New Machine Difference Sales 1,000,000 $ 1,000,000 $ - $ Variable costs (500,000) (400,000) 100,000 Other fixed costs (350,000) Depreciation - new Depreciation - old (60,000) Disposal of old machine Total net profit 90,000 $ Correct Analysis $80,000 per year × 5 years Comparative costs and revenue for the next five years 8 For Five Years Keep Old Machine Purchase New Machine Difference Sales 1,000,000 $ 1,000,000 $ - $ Variable costs (500,000) (400,000) 100,000 Other fixed costs (350,000) (350,000) - Depreciation - new (90,000) (90,000) Depreciation - old (60,000) Disposal of old machine Total net profit 90,000 $ Correct Analysis The total cost will be depreciated over the five year period. Comparative costs and revenue for the next five years 9 For Five Years Keep Old Machine Purchase New Machine Difference Sales 1,000,000 $ 1,000,000 $ - $ Variable costs (500,000) (400,000) 100,000 Other fixed costs (350,000) (350,000) - Depreciation - new (90,000) (90,000) Depreciation - old (60,000) (60,000) - Disposal of old machine 15,000 15,000 Total net profit 90,000 $ 115,000 $ 25,000 $ Correct Analysis The remaining book value of the old machine is a sunk cost and is not relevant to the decision.
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This note was uploaded on 08/27/2009 for the course BUSINESS ACCT3104 taught by Professor Sandra during the Spring '09 term at École Normale Supérieure.

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Lecture2_complete_6p - ACCT3104 Managerial Costing and Control Lecture Overview Cost Concepts for decision making Revision Fixed and Variable Costs

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