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Cost-RevenueAnalysis for

Decision Making

Cost-RevenueAnalysis for

Decision Making

Section 1: The Decision Process

Chapter

30

Section Objectives1. Explain the basic steps in the decision-making

process.2. Prepare income statements using the

absorption costing and direct costing methods.3. Using the contribution approach, analyze the

profits of segments of a business.4. Determine relevant cost and revenue data for

decision-making purposes.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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Explain the basic steps in the decision-making process.

Objective 1

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1. Define the problem.

2. Identify workable alternatives.

3. Determine relevant cost and revenue data.

4. Evaluate the cost and revenue data.

5. Consider appropriate nonfinancial factors.

6. Make a decision.

The Decision-Making Process

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All manufacturing costs are included in the cost of goods manufactured.

The value of ending inventory includes fixed costs.

Absorption Costing

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Prepare income statements using the absorption costing and direct costing methods.

Objective 2

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Income Statement Using Absorption Costing

White Manufacturing CorporationIncome Statement

Year Ended December 31, 2010

Sales (9,000 units sold @ $40) 360,000Cost of Goods Sold Variable Manufacturing Costs (10,000 x $16) 160,000 Fixed Manufacturing Costs 50,000 Total Cost of Goods Mfgd. ($210,000/10,000 = $21/unit) 210,000 Less Finished Goods Inventory, Dec. 31 (1,000 x $21) 21,000 Costs of Goods Sold 189,000 Gross Profit on Sales 171,000 Selling and Administrative Expenses Variable Expenses (9,000 units @ $4) 36,000 Fixed Expenses 60,000 Total Selling and Administrative Expenses 96,000 Net Income 75,000

Fixed and variable manufacturing costs are included

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Only variable costs are included in the cost of goods manufactured.

Fixed manufacturing costs are charged to expense during the period.

Fixed manufacturing costs are not included in: Cost of goods sold, or Ending inventories.

Direct costing is not acceptable for GAAP financial reporting purposes.

Direct Costing (also called Variable Costing)

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Manufacturing Margin:

Direct Costing

Sales minus the variable cost of goods sold.

Marginal Income on Sales:

Net Income:

Manufacturing margin minus variable operatingexpenses.

Marginal income on sales minus fixed manufacturing costs and fixed selling and administrative expenses.

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Income Statement Using Direct Costing

Only variable manufacturing costs are included

White Manufacturing CorporationIncome Statement

Year Ended December 31, 2010

Sales (9,000 units @ $40) 360,000Cost of Goods Sold Variable Manufacturing Costs (10,000 units @ $16) 160,000 Less Finished Goods Inventory, Dec. 31 (1,000 @ $16) 16,000Costs of Goods Sold 144,000

Manufacturing Margin 216,000

Variable Selling and Administrative Expenses (9000 units @ $4) 36,000Marginal Income on Sales 180,000

Fixed Costs and Expenses Fixed Manufacturing Costs 50,000 Fixed Selling and Administrative Expenses 60,000 110,000Net Income 70,000

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Using the contribution approach, analyze the profits of segments of a business.

Objective 3

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Contribution margin is the excess of revenues over variable costs of the business segment.

Profitability of a business segment is judged by its contribution toward covering common costs.

Controllable fixed costs of each segment are deducted to determine the segment’s contribution to the overall profit.

Common costs are not considered when computing the contribution margin.

Contribution Margin

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Controllable fixed costs are costs that the segment manager can control.

ANSWER:

QUESTION:

What are controllable fixed costs?

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Common costs are costs not directly traceable to a specific segment of the business.

ANSWER:

QUESTION:

What are common costs?

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Determine relevant cost and revenue data for decision-making purposes.

Objective 4

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Relevant Cost: Future or expected cost that will change as a result of a decision.

Sunk Cost: A cost that has already been incurred.

Types of Costs

When making decisions, sunk costs are irrelevant.

Differential Cost: The difference between one alternative and another.

Opportunity Cost: The potential earnings or benefits that are given up because a certain course of action is taken.

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Opportunity CostOpportunity Cost

Dilemma Decision Opportunity Cost

To purchase equipment or invest in securities.

Purchase equipment.

Amount of interest or dividends received on securities if they had been purchased.

Cost-RevenueAnalysis for

Decision Making

Cost-RevenueAnalysis for

Decision Making

Section 2: Cost-Revenue Analysis

Chapter

30

Section Objectives

5. Apply an appropriate decision process in three situations:

a. Pricing products in special cases.b. Deciding whether to purchase new

equipment.c. Deciding whether to make or buy a part.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

30-19

Apply An Appropriate Decision Process In Three Situations:

a. Pricing products in special cases.

b. Deciding whether to purchase new equipment.

c. Deciding whether to make or to buy a part.

Objective 5

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Direct costing is often useful in setting prices and considering purchase offers in special situations.

Product Pricing in Special Situations

I better talk to accounting about this?

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* Includes fixed costs, which are not relevant in this situation.

Customer offers to buy 1,000 units at $25 per unit. The order will require $1 per unit in shipping costs.

Management’s Analysis using Absorption Costing:

Manufacturing costs ($210,000 ÷ 10,000 units) $21.00

Selling and administrative costs ($96,000 ÷ 9,000 units) 10.67

Management’s Analysis using Direct Costing:

Variable manufacturing costs $16.00

Variable selling and administrative expenses 4.00

Variable costs per unit $20.00

Additional shipping cost 1.00

Potential Profit

$25 - $21 = $4 per unit

Total average cost per unit * $31.67

Total variable cost per unit $21.00

Product Pricing in Special Situations

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Does the company have sufficient manufacturing capacity?

Will the special order jeopardize sales to existing customers?

Do federal laws prohibit price differentials?

Management needs to consider all relevant factors when analyzing special pricing situations:

Product Pricing in Special Situations

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Purchasing New Equipment

The net income under each alternative must be calculated and compared.

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* Includes depreciation for the new machine and effects of other changes in fixed costs.

SUS Industries Inc. is considering the purchase of new machinery.

If Machine If Machine Differential Is Not Purchased Is Purchased

Annual Sales $350,000 $350,000

Variable costs

Materials $120,000 $120,000

Labor 100,000 90,000 ($10,000)

Manufacturing overhead 30,000 30,000

Total variable costs $250,000 $240,000

Contribution margin $100,000 $110,000 10,000

Fixed costs 19,000 22,000* (3,000)

Net Income $ 81,000 $ 88,000 $ 7,000

Purchasing New Equipment

Income would increase by $7,000 per year.

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Employee morale, and

Product quality with the new machine.

Before purchasing the new equipment however, management needs to consider all relevant factors, including:

Purchasing New Equipment

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Making or Buying a Part

Fixed manufacturing overhead costs are not considered because they remain the same whether the part is purchased or made.

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Making or Buying a Part

SUS Industries Inc. is weighing the alternatives of buying a part from an outside vendor, or making the part themselves.

Cost to purchase part $16.00

Cost to manufacture part

Variable costs only

Materials $8.00

Labor (1/4 hour at $16 per hour) 4.00

Manufacturing overhead (1/4 hour at $8 per hour) 2.00 14.00

Differential cost (savings per unit if part is manufactured) $ 2.00

Number of parts per year x 20,000

Total annual savings $40,000

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Thank Youfor using

College Accounting, 12th Edition

Price • Haddock • Farina