Chapter 12 Pre-Class Notes

Chapter 12 Pre-Class Notes - 12-1 MANAGERIAL ACCOUNTING...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 12-1 MANAGERIAL ACCOUNTING RSM222 Relevant Costs for Decision Making Chapter 12 12-2 Cost Concepts for Decision Making A relevant cost is a cost that ______between alternatives. 12-3 Relevant Cost Analysis: A Two-Step Process Step 1 Eliminate costs and benefits that do not ______ between alternatives. Step 2 Use the remaining costs and benefits that ______ between alternatives in making the decision. The costs that remain are the ______, or ______, costs. 12-4 Different Costs for Different Purposes Costs that are relevant in one decision situation may not be relevant in another context. 12-5 Identifying Relevant Costs An avoidable cost iis a cost that can be ______,, An avoidable cost s a cost that can be iin whole or in part, by choosing one alternative n whole or in part, by choosing one alternative over another. over another. Avoidable costs are ______ costs. costs. Avoidable costs are Unavoidable costs are ______ costs. costs. Unavoidable costs are Two broad categories of costs are never Two broad categories of costs are never relevant in any decision. They include: relevant in any decision. They include: ______ costs. costs. ______ costs that do not differ between the alternatives. costs that do not differ between the alternatives. Example: Relevant Costs, purchase (replace) vs. repair 12-6 Which costs (information) are not relevant to the decision Which not Which costs (information) are not relevant to the decision Which not to keep the old machine or replace it with a new one? to keep the old machine or replace it with a new one? keep replace keep replace •• •• •• •• •• •• •• •• Old machine cost $4,200 when purchased Old machine cost $4,200 when purchased Old machine has a book value of $2,100 Old machine has a book value of $2,100 Purchase price of a new machine is $7,000 Purchase price of a new machine is $7,000 New machine is expected to last two years New machine is expected to last two years Repairs to old machine would be $3,500 and would allow Repairs to old machine would be $3,500 and would allow ttwo more years of productivity wo more years of productivity Power for either machine is expected to be $2.50 Power for either machine is expected to be $2.50 New machine will reduce labor costs from $10 to $9.5 per New machine will reduce labor costs from $10 to $9.5 per hour hour Expected labor level per year: 1,000 hours with either Expected labor level per year: 1,000 hours with either machine machine Decision making with a strategic emphasis Relevant cost information iis often an important input for Relevant cost information s often an important input for management decisions management decisions Other types of crucial information should also be considered Other types of crucial information should also be considered ______ iinformation (long term) ______ nformation (long term) ______ usage and vcost ______ usage and vcost The ______ ______ of money The ______ ______ of money Make or buy decisions Make or buy decisions Add, keep or drop a product line or segment Add, keep or drop a product line or segment Accept or reject a special order Accept or reject a special order Sell it or process it further Sell it or process it further 12-7 12-8 Adding/Dropping Segments One of the most important decisions managers make is whether to add or drop a business segment, such as a product or a store. Let’s see how relevant costs should Let’s see how relevant costs should be used in this type of decision. be used in this type of decision. 12-9 Adding/Dropping Segments Due to the declining popularity of digital Due to the declining popularity of digital watches, Lovell Company’s digital watch watches, Lovell Company’s digital watch lline has not reported a profit for several ine has not reported a profit for several years. Lovell is considering discontinuing years. Lovell is considering discontinuing this product line. this product line. 12-10 A Contribution Margin Approach DECISION RULE DECISION RULE Lovell should drop the digital watch segment only if its Lovell should drop the digital watch segment only if its ______ would increase. This would only happen if ______ would increase. This would only happen if tthe fixed cost savings ______ tthe lost contribution he fixed cost savings ______ he lost contribution margin. margin. Let’s look at this solution. Let’s look at this solution. 12-11 Example: Adding/Dropping Segments Segment Income Statement Digital Watches Sales Less: variable expenses Variable manufacturing costs Variable shipping costs Commissions Contribution margin Less: fixed expenses General factory overhead Salary of line manager Depreciation of equipment Advertising – direct Rent – factory space General admin. expenses Net operating loss $ 500,000 $ 120,000 5,000 75,000 $ 60,000 90,000 50,000 100,000 70,000 30,000 200,000 $ 300,000 400,000 $ (100,000) 12-12 A Contribution Margin Approach Contribution Margin Solution Contribution margin lost if digital w atches are dropped Less fixed costs that can be avoided Net ______ Re Re tta aii n n $ (300,000) 12-13 Comparative Income Approach The Lovell solution can also be obtained by preparing comparative income statements showing results with and without the digital watch segment. 12-14 The Make or Buy Decision When a company is involved in more than one When a company is involved in more than one activity in the entire value chain, it is vertically activity in the entire value chain, it is vertically iintegrated. A decision to carry out one of the ntegrated. A decision to carry out one of the activities in the value chain internally, rather activities in the value chain internally, rather tthan to buy externally from a supplier is called han to buy externally from a supplier is called a “make or buy” decision. a “make or buy” decision. 12-15 Example: The Make or Buy Decision Essex Company manufactures part 4A that is used in one of its products. The unit product cost of this part is: Direct materials Direct labour Variable overhead Depreciation of special equip. Supervisor's salary General factory overhead Unit product cost $ 9 5 1 3 2 10 $ 30 12-16 The Make or Buy Decision The special equipment used to manufacture part 4A has no resale value. The total amount of general factory overhead, which is allocated on the basis of direct labour hours, would be unaffected by this decision. The $30 unit product cost is based on 20,000 parts produced each year. An outside supplier has offered to provide the 20,000 parts at a cost of $25 per part. Should we accept the supplier’s offer? Should we accept the supplier’s offer? 12-17 The Make or Buy Decision Cost Per Unit Outside purchase price $ 25 Cost of 20,000 Units Buy Make $ 500,000 Direct materials Direct labour Variable overhead Depreciation of equip. Supervisor's salary General factory overhead Total cost Should we make or buy part 4A? $ 500,000 12-18 Special Orders Jet, Inc. makes a single product whose normal selling Jet, Inc. makes a single product whose normal selling price is $20 per unit. price is $20 per unit. A foreign distributor offers to purchase 3,000 units for A foreign distributor offers to purchase 3,000 units for $10 per unit. $10 per unit. This is a one-time order that would not affect the This is a one-time order that would not affect the company’s regular business. company’s regular business. Annual capacity is 10,000 units, but Jet, Inc. is Annual capacity is 10,000 units, but Jet, Inc. is currently producing and selling only 5,000 units. currently producing and selling only 5,000 units. Should Jet accept the offer? 12-19 Example: Special Orders Jet, Inc. Contribution Income Statement Revenue (5,000 × $20) $ 100,000 V ariable costs: Direct materials $ 20,000 Direct labour 5,000 Manufacturing overhead 10,000 Marketing costs 5,000 Total variable costs 40,000 Contribution margin 60,000 Fixed costs: Manufacturing overhead $ 28,000 Marketing costs 20,000 Total fixed costs 48,000 Net operating income $ 12,000 12-20 Special Orders If Jet accepts the special order, the incremental revenue will ______ the incremental costs. In other words, net operating income will ______ by ______. This suggests that Jet should ______ the order. Increase in revenue Increase in costs ______ in net operating income $ - Note: This answer assumes that the fixed costs are unavoidable and that variable marketing costs must be incurred on the special order. 12-21 Key Terms and Concepts A special order is a ______ order that is not considered part of the company’s normal ongoing business. When analyzing a special order, only the ______ costs and benefits are relevant. 12-22 Key Terms and Concepts When a limited resource of some type restricts the company’s ability to satisfy demand, the company is said to have a ______. The machine or process that is limiting overall output is called the ______– it is the constraint. 12-23 Utilization of a Constrained Resource When a constraint exists, a company should When a constraint exists, a company should select a product mix that maximizes the select a product mix that maximizes the ______ contribution margin earned since fixed contribution margin earned since fixed costs usually remain unchanged. costs usually remain unchanged. A company should not necessarily promote A company should not necessarily promote tthose products that have the ______ unit hose products that have the unit contribution margin. contribution margin. Rather, it should promote those products that Rather, it should promote those products that earn the highest contribution margin in ______ earn the highest contribution margin in tto the constraining resource. o the constraining resource. Example: Utilization of a Constrained Resource Ensign Company produces two products and selected data are shown below: 12-24 12-25 Utilization of a Constrained Resource Machine A1 is the constrained resource and is Machine A1 is the constrained resource and is being used at 100% of its capacity. being used at 100% of its capacity. There is excess capacity on all other There is excess capacity on all other machines. machines. Machine A1 has a capacity of 2,400 minutes Machine A1 has a capacity of 2,400 minutes per week. per week. Should Ensign focus its efforts on Should Ensign focus its efforts on Product 1 or Product 2? Product 1 or Product 2? 12-26 Utilization of a Constrained Resource The key is the contribution margin per unit of the constrained resource. IIff there are no other considerations, the best If there are no other considerations, the best If plan would be to produce to meet current plan would be to produce to meet current demand for Product 2 and then use remaining demand for Product 2 and then use remaining capacity to make Product 1. capacity to make Product 1. capacity capacity 12-27 Utilization of a Constrained Resource According to the plan, we will produce 2,200 units According of Product 2 and 1,300 of Product 1. Our contribution margin looks like this. contribution Product 1 Product 2 Production and sales (units) Contribution margin per unit Total contribution margin The total contribution margin for Ensign is $ ______. 12-28 Questions? ...
View Full Document

Ask a homework question - tutors are online