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income of $30,000 (65,000 – 35,000).
income
The decision is to drop the groceries.
Remember that the relevant costs are the
Remember
the
variable costs and the avoidable fixed costs.
variable
avoidable Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Optimal Use of Limited (scarce) Resources
Suppose a plant makes more than one product and is operating at capacity. If demand for its product exceeds the amount the company can produce, managers must decide which orders to accept. The decision is to accept the one that makes the biggest total profit contribution per unit
of limiting factor.
of A limiting factor or scarce resource restricts or constrains
A limiting factor or scarce resource restricts or constrains
the production or sale of a product or service. Limiting the production or sale of a product or service. Limiting factors include labor hours and machine hours that limit
factors include labor hours and machine hours that limit
production in manufacturing firms, and square feet of production in manufacturing firms, and square feet of floor space or cubic meters in department stores.
floor space or cubic meters in department stores.
Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Assume that the capacity of the facility is
Assume
determined by machine time (hour), and the
maximum capacity is 10,000 machine hours.
10,000
The facility can produce 10 pairs (capacity is
The
10
determined by machine hours) of Air Court
Shoes per hour or 5 pairs of Air Max shoes
per hour.
per
The question now is which shoe the company
The
should spend its resources/ or which shoe is
more profitable?
more Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Optimal Use of Limited Resources
Unit data follow: Selling price per pair
Variable costs per pair Contribution margin per pair
Contribution margin ratio Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Air Air
Court
Max $80 $120 60 84 $20 $36 25% 30% Optimal Use of Limited Resources
Which is more profitable?
If the limiting factor is demand, that is, pairs
of shoes, the more profitable product is Air Max. Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Air Max is the product with the higher contribution margin per unit.
The sale of a pair of Air Court shoes adds $20 to profit.
The sale of a pair of Air Max shoes adds
$36 to profit.
Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Suppose that demand for either shoe would fill the plant’s capacity. Now, capacity is the limiting factor. Which is more profitable?
If the limiting factor is capacity, the more profitable product is Air Court. Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Suppose that there is only one production facility
(limiting factor) that can either make 100,000 air
court pairs of shoes or 50,000 air max of shoes.
Air Court
Air Court $20 contribution margin per pair × 10 pair / hour × 10,000 hours = $2,000,000 contribution margin Air Max: $36 contribution margin per pair × 5 pair / hour × 10,000 hours = $1,800,000 contribution Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Air court
1. Pairs of shoes from 10,000
1.
hours X 10 pairs; X 5 pairs 100,000
hours
2. Contribution margin/pair
$20
3. Contribution margin from 10,000
hours of capacity, (1X2)
$2,000,000
hours
Contribution margin per hour
Contribution Air max
Air
50,000
$36
$1,800,000 3 ÷10,000
$200
$180
Each machine hour used to produce Air Court shoes generates
Each
$200 of con...
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This document was uploaded on 03/02/2014 for the course ACCOUNTING 221 at Alaska Pacific University.
 Spring '13

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