Ch 07 PowerPoint Presentation 3rd Edition

Ch 07 PowerPoint Presentation 3rd Edition - Chapter 7...

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Unformatted text preview: Chapter 7 Making Decisions Using Relevant Information ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 1 ­ Relevant Costs and Benefits LO1 Identify the characteristics of a relevant cost and relevant benefit. • A relevant information is a cost that is pertinent relevant to a particular decision. • A relevant cost possesses two important characteristics: relevant 1. It must be a future cost. 2. It must differ between decision alternatives. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 2 LO1 Relevant Costs and Benefits • A relevant benefit is a benefit relevant (revenue or cash inflow) that is pertinent to a particular business decision. • A relevant benefit is a future benefit relevant that differs between alternatives. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 3 Sunk Costs LO2 Explain why sunk costs and costs that do not differ between alternatives are irrelevant costs. • Expenditures that have already occurred Expenditures and cannot be changed by current or future actions are called sunk costs. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 4 LO2 Irrelevant Information • Irrelevant information possesses Irrelevant either of the following qualities: 1. It is a sunk cost or revenue. 2. It does not differ between alternatives. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 5 Quantitative or Qualitative? LO3 Describe the qualitative factors that decision makers should consider when making a business decision. • Quantitative factors can be expressed Quantitative as a number. • Qualitative factors cannot be expressed Qualitative numerically and must be described in words. • Most management decisions require the Most consideration of both quantitative and qualitative factors. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 6 LO3 Determining Relevant Cost and Benefit Is the item a future cost or benefit? No The cost or benefit is not a relevant item. Yes Does the cost or benefit differ from decision alternatives? No The cost or benefit is not a relevant item. Yes The cost or benefit is a relevant item. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 7 Equipment Replacement – Gather Relevant Information LO4 Use accounting information to determine the relevant cost of various decisions. • Bill Smith & Partners purchased computer Bill equipment two weeks ago for $35,500. • Estimated useful life is 5 years with a residual Estimated value of $500. • Depreciation method is straight-line at Depreciation $7,000 per year. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 8 LO4 Equipment Replacement – Gather Relevant Information • Cost of operating equipment is two Cost operators at $18,000 per year each. • There is a cancelable maintenance There contract which costs $1,000/year. • Equipment can be sold now for $10,000. Equipment ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 9 LO4 Equipment Replacement – Gather Relevant Information • A new model can be purchased for $76,000. can • Estimated useful life is 5 years with a Estimated residual value of $1,000. • Depreciation method is straight-line at Depreciation $15,000 per year. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 10 LO4 Equipment Replacement – Gather Relevant Information • Cost of operating equipment is one Cost operator at $18,000 per year. • There is a cancelable maintenance There contract which costs $1,000/year. • A summary of the cost and benefit of summary each system can now be made. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 11 LO4 Replacement Cost Summary Old System Start-up: Cost of system Operating: Annual depreciation Total depreciation Annual labor cost Total labor cost Annual maintenance cost Total maintenance cost Shutdown: Residual value Current sale price New System $ 35,500 $76,000 $ 7,000 35,000 36,000 180,000 1,000 5,000 $15,000 75,000 18,000 90,000 1,000 5,000 $ 500 10,000 $ 1,000 ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 12 LO4 Relevant Cost and Benefit Relevant of Each Alternative Relevant Total labor cost Residual value Current sale price $180,000 $ 500 $ 10,000 Irrelevant Cost of system Depreciation Maintenance cost $ 35,500 $ 35,000 $ 5,000 ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 13 LO4 Relevant Cost and Benefit Relevant of Each Alternative • The $35,500 cost of the old system The is not a relevant consideration in deciding whether to replace the system. • Because it is a past, not a future, cost. Because ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 14 LO4 Determine the Relevant Cost and Benefit of Each Alternative • Depreciation is an allocation of the cost of the Depreciation system which is spread over (or charged to) the future periods in which the equipment is expected to be used. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 15 LO4 Determine the Relevant Cost and Benefit of Each Alternative Relevant Cost of system Total labor cost Residual value $76,000 $90,000 $ 1,000 Irrelevant Depreciation $75,000 Maintenance cost $ 5,000 ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 16 LO4 Replacement Cost Comparison Keep Old System Start-up: Cost of new system Operating: Labor cost: Old system New system Shutdown: Residual value of old system Sale price of old system Residual value of new system Total relevant costs Replace Old System $ (76,000) $(180,000) (90,000) 500 $(179,500) 10,000 1,000 $(155,000) $24,500 in favor of buying the new system ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e 7 ­ 17 LO4 Special Orders • Manufacturing business must often consider Manufacturing whether to accept a special order. • Such an order usually includes a discounted Such price for the items being ordered. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 18 LO4 Gather Relevant Information • Sears offers Alumafloat Company Sears $125 each for 1,000 boats. • Alumafloat’s normal selling price Alumafloat’s is $160 per boat. • The production cost per boat is $130. The • Expected sales (excluding the Expected special order) are 5,500 boats. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 19 LO4 Gather Relevant Information Alumafloat Expected sales Normal selling price Direct material costs Direct labor costs Variable production costs Fixed production costs Total cost of goods sold Per Unit 1 $160 Total 5,500 $880,000 $ 50 $275,000 55 302,500 10 55,000 15 82,500 $130 $715,000 Expected gross margin: $880,000 – $715,000 = $165,000 ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 20 LO4 Gather Relevant Information • At first glance, the order appears At to be an unacceptable offer. • The special price is below the The normal cost per unit of $130. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 21 LO4 Gather Relevant Information Alumafloat Special order units Special selling price Per Unit Total 1 1,000 $ 125 $125,000 Direct material costs Direct labor costs Variable production costs Total relevant costs Total increase in profit $ (50) (55) (10) ($115) $ 10 ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones $ (50,000) (55,000) (10,000) ($115,000) $ 10,000 7 ­ 22 LO4 Special Order Final Analysis • Although the special order price is below Although the normal full cost per unit, Alumafloat can experience a $10,000 increase in operating profit this period by accepting the special order. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 23 LO4 Make or Buy Decisions • Often companies purchase subcomponents Often instead of manufacturing them. • Buying services, products, or components Buying from outside vendors instead of producing them is called outsourcing. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 24 LO4 Make or Buy Decisions • The basic make or buy question is whether The a company should make its own parts to be used in its products or buy them from vendors. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 25 LO4 Gather Relevant Information • The product manager of Microbake is The approached by an outside vendor offering to supply a timer for $12. • Currently Microbake makes the timer. Currently • The company uses 80,000 timers each year. The • The cost sheets indicate that each The timer costs $14 to produce. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 26 LO4 Gather Relevant Information Cost per Unit Direct material Direct labor Variable overhead Fixed overhead Total costs Total Cost for 80,000 Units $5 4 1 4 $14 $ 400,000 320,000 80,000 320,000 $1,120,000 ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 27 LO4 Gather Relevant Information • Although the $14 unit cost shown seemingly Although indicates that the company should buy, the answer is rarely so obvious. • The essential question is the difference in The expected future costs between the alternatives. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 28 LO4 Selecting Relevant Costs Future? Direct material Differs? Relevant? yes yes yes ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 29 LO4 Relevant Cost Comparison Make Cost to purchase Direct material Direct labor Variable overhead Total relevant costs Buy $960,000 $400,000 320,000 80,000 $800,000 $960,000 $160,000 in favor of making the oven timers in-house ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 30 LO4 Relevant Cost Comparison With Fixed Costs Shown Make Cost to purchase Direct material Direct labor Variable overhead Fixed overhead Total relevant costs Buy $ 960,000 $ 400,000 320,000 80,000 320,000 $1,120,000 320,000 $1,280,000 $160,000 in favor of making the oven timers in-house ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 31 Consumers of Management Consumers Accounting Information Accounting LO5 Explain the effects of fixed costs and opportunity costs on outsourcing decisions. • Assume that Microbake could Assume reduce fixed costs by $195,000. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 32 LO5 Relevant Cost Comparison Make Cost to purchase Direct material Direct labor Variable overhead Fixed overhead Total relevant costs Buy $960,000 $400,000 320,000 80,000 195,000 $995,000 $960,000 $35,000 in favor of buying $35,000 buying the oven timers from the outside vendor ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 33 LO5 Relevant Cost Comparison Make Cost to purchase Direct material Direct labor Variable overhead Fixed overhead Total relevant costs Buy $ 960,000 $ 400,000 320,000 80,000 320,000 $1,120,000 125,000 $1,085,000 $35,000 in favor of buying $35,000 buying the oven timers from the outside vendor ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 34 LO5 Opportunity Costs • An opportunity cost is something of value is that is given up when one alternative is chosen over another. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 35 LO5 Opportunity Cost Example • Assume that if Microbake purchases Assume the timers from the outside vendor, they could use the released production capacity to make electronic alarm clocks. • The alarm clocks will provide an annual The contribution margin of $200,000. • Fixed costs remain at $320,000. Fixed ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 36 LO5 Relevant Cost with Opportunity Cost Make Cost to purchase Direct material Direct labor Variable overhead Opportunity cost Total relevant costs Buy $960,000 $ 400,000 320,000 80,000 200,000 $1,000,000 $960,000 $40,000 in favor of buying $40,000 buying the oven timers from the outside vendor ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 37 LO5 Opportunity Cost Analysis • The $200,000 opportunity cost is added to The the relevant cost of the make decision. • If they make the timers, they are unable If to make the clocks and unable to realize the increased profits from the clock sales. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 38 LO5 Opportunity Cost Analysis • Without the opportunity cost, Without the choice is to make the timers. • With the opportunity cost, With the choice is to buy the timers. ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 39 End of Chapter 7 ©2009 Michael Werner and Kumen Jones, Introduction to Management Accounting, 3e Werner/Jones 7 ­ 40 ­ ...
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