Class Note - Chpt12 Decision Making

7/31/2019 Class Note - Chpt12 Decision Making

1/19

1

Dr. Charleston Tom,Assoc. Professor of Accounting

Relevant Cost Information and

Short Term Production Decision

Relevant Cost Information and

Short Term Production Decision

Information and theDecision Process

Information and theDecision Process

A decision model is a formal method

for making a choice, often involving

quantitative and qualitative analysis.


2/19

1

Five-Step Decision ProcessFive-Step Decision Process

Historical Costsa er n orma on

Make Predictions

Choose an Alternative

ep .

Step 2.

Step 3.

Other Information

Specific Predictions

eedback

Implement the Decision

Evaluate Performance

Step 4.

Step 5.

F

Identifying Relevant CostInformation

Identifying Relevant CostInformation

difference among alternatives:difference among alternatives:

Opportunity CostOpportunity Cost

Avoidable CostAvoidable Cost

Differential CostDifferential Cost additional cost incurred when choosing anadditional cost incurred when choosing analternativealternative

navo a e cos s are never re evan an nc u e:navo a e cos s are never re evan an nc u e:Sunk costs.Sunk costs.

Future costs thatFuture costs that do not differdo not differbetween the alternatives.between the alternatives.Common CostCommon Cost

Joint CostJoint Cost


3/19

1

Total and Differential Cost ApproachesTotal and Differential Cost Approaches

The management of a company is considering a new labor savingmachine that rents for $3,000 per year. Data about the companys

annual sales and costs with and without the new machine are:

Current

Situation

Situation

With New

Machine

Differential

Costs and

Benefits

Sales (5,000 units @ $40 per unit) 200,000$ 200,000$ -

Less variable expenses:

Direct materials (5,000 uni ts @ $14 per uni t) 70,000 70,000 -

Direct labor (5,000 units @ $8 and $5 per unit) 40,000 25,000 15,000

Variable overhead 5 000 units 2 er unit 10 000 10 000 -

Total variable expenses 120,000 105,000 -

Contribution margin 80,000 95,000 15,000

Less fixed expense:

Other 62,000 62,000 -Rent on new machine - 3,000 (3,000)

Total fixed expenses 62,000 65,000 (3,000)

Net operating income 18,000$ 30,000$ 12,000

Total and Differential Cost ApproachesTotal and Differential Cost Approaches

As you see, the only costs that differ between the alternatives are thedirect labor costs savings and the increase in fixed rental costs.

Current

Situation

Situation

With New

Machine

Differential

Costs and

Benefits

Sales (5,000 units @ $40 per unit) 200,000$ 200,000$ -

Less variable ex penses:

Direct materials (5,000 uni ts @ $14 per unit ) 70,000 70,000 -

Direct labor (5,000 units @ $8 and $5 per unit) 40,000 25,000 15,000

Var iable overhead (5,000 units @ $2 per unit) 10,000 10,000 -

Total variable expenses 120,000 105,000 -

Contribution margin 80,000 95,000 15,000

Less fixed expense:

Other 62,000 62,000 -

Rent on new machine - 3,000 (3,000)

We can efficiently analyze the decision byWe can efficiently analyze the decision by

looking at the different costs and revenues andlooking at the different costs and revenues and , , ,Net operating income 18,000$ 30,000$ 12,000arrive at the same solutionarrive at the same solution.

Decrease in direct labor costs (5,000 units @ $3 per unit) 15,000$

Increase in fixed rental expenses (3,000)

Net annual cost saving from renting the new machine 12,000$

Net Advantage to Renting the New Machine


4/19

1

Using Relevant Cost Information in

Decision Making

Using Relevant Cost Information in

Decision Making

Cases that highlight what is relevant costs:Cases that highlight what is relevant costs:

Accept / Reject a Special OrderAccept / Reject a Special Order

Make / Buy An InputMake / Buy An Input

Kee / Dro a Business Se mentKee / Dro a Business Se ment

Sell Now / Process FurtherSell Now / Process Further

Optimize Product Mix on Scarce ResourceOptimize Product Mix on Scarce Resource

One-Time-OnlySpecial Order Example


.

Revenue ($20) $20,000

- CGS ($15) 15,000

GM 5,000

- S&A Exp. (Fixed) 4,000

Operating Income 1,000

Unit CGS $15: UVC $12

UFMO $ 3

UC $15

Should we accept a sales order of 100,000 units at offered price of $13?


5/19

1

One-Time-Only

Special Order Example

One-Time-Only

Special Order Example

1Mil. Units 100K Units 1.1 Mil.

Revenue ($20) $20,000 $1,300 $21,300

- CGS ($15) 15,000 1,500 16,500

GM 5,000 -200 4,800

- S&A Exp. (Fixed) 4,000 0 4,000

Operating Income 1,000 -200 800

Conclusion: Reject!



,

Correct analysis:Existing Special Order Total

Revenue 20,000 1,300 $21,300

- Variable Cost 12,000 1,200 13,200

CM 8,000 100 8,100

- , ,- S&A Expense (all fixed) 4,000 0 4,000

Operating Income 1,000 100 1,100

Change in Profit = (Price UVC) x Units TFC= (13 12 ) x 100,000 0 = $100,000

Decision: Accept!


6/19

1

Outsourcing versus InsourcingOutsourcing versus Insourcing

Outsourcing is

purchasing goods

and services from

outside vendors.

Insourcing is

producing goods

or providing services

within the organization.

Make-or-Buy DecisionMake-or-Buy Decision

Direct Variable Costs $140,000 $200,000

FMO

- Traceable portion 20,000

- Unavoidable portion 60,000

Total Cost 220,000 $200,000

Should the Co. Outsourcing?

How about if the Co. could lease vacant facility for $50000?


7/19

1


Make Buy Differential CostDirect Variable Costs $140,000 $200,000 (60000)

FMO

- Traceable portion 20,000 0 20000

- Unavoidable portion 60,000 60,000 0

Total Cost $220,000 $260,000 (40000)

Net Amount to be Paid if Buy $200,000- Avoidable Costs if Buy = VC + Traceable FC = $160,000

Cost Differences $40,000

Conclusion Make!


What Happens if the company can rent the vacant space for $50,000?

Net Amount to be Paid if Buy (200k-50k=) $150,000- Avoidable Cost for Buy = VC + Traceable FC = $160,000Cost Differences -$10,000

Conclusion Buy!


8/19

1

Keep-or-drop DecisionKeep-or-drop DecisionBrick Mortar Company

, , ,- Store direct costs(VC + Traceable FC) 500 1,000 $1,500

Product Margin 500 3,000 3,500Amortized Common Cost (% rev) 600 2,400 3,000

Operating Income (100) 600 500

Should we drop the loser?

Revenue 0 $4,000 $4,000

- Store direct costs

(VC + Traceable FC) 0 1,000 $1,500Product Margin 0 3,000 $3,000

Amortized Common Cost - 3,000 3,000

Operating Income 0 0 0

Traceable or Common?Traceable or Common?

Fix Cost:Salary for brick product line manager

General factory overheadDepreciation on factory building

Property tax on factory

Advertising on brick products


9/19

1

Sell now or Process Further?Sell now or Process Further?

,

produced from a single raw material input.

Two or more products produced from a common

input are called joint productsjoint products.

The point in the manufacturing process where

each joint product can be recognized as a

separate product is called the splitsplit--off pointoff point.

Joint ProductsJoint Products

ButterJointJoint

Processing$280

20gl.@$25

Cond. Milk50gl.@$22

Joint Input$200

CommonProduction

Process $200

CostsCosts ream25 gl. @ $8

Skim Milk75 gl. @ $2

SeparateProcessing

SeparateProcessing

$520

Byproduct

SeparateSeparateProductProductCostsCosts

SplitSplit--OffOffPointPoint

Milky Liquid15gl. @$.1


10/19

11

Sell now or Process Further?Sell now or Process Further?

Sell Cream or Butter?Sell Cream or Butter?

Incremental Revenue: 20g.x$25-25gx$8=$500-$200=$300

Incremental Cost: ($280)

Extra Income if Process Further $20

Joint costs are common costs incurred toJoint costs are common costs incurred to

simultaneously produce a variety of endsimultaneously produce a variety of endproducts, irrelevant in this decisionproducts, irrelevant in this decision

Optimize Product Mix onConstrained Resource

Optimize Product Mix onConstrained Resource

Product

1 2

Selling price per unit $ 60 $ 50

Less variable expenses per unit 36 35Contribution margin per unit 24$ 15$

Current demand per week (units) 2,000 2,200

Contribution margin ratio 40% 30%

Processing time required

on machine A1 per unit 1.00 min. 0.50 min.

Total Time Required 2,000 min. 1,100 min.


11/19

11

Utilization of a Constrained

Resource


Resource

being used at 100% of its capacity.being used at 100% of its capacity.

There is excess capacity on all other machines.There is excess capacity on all other machines.

Machine A1 has a capacity of 2,400 minutes perMachine A1 has a capacity of 2,400 minutes perweek.week.

Should Ensign focus its efforts onShould Ensign focus its efforts on

Product 1 or 2?Product 1 or 2?

How many units of each product can

e rocessed throu h Machine A1 in

Quick CheckQuick Check

one minute?

Product 1 Product 2

a. 1 unit 0.5 unit

b. 1 unit 2.0 unitsc. 2 units 1.0 unit

d. 2 units 0.5 unit

I was just checking to make sure you are with us.I was just checking to make sure you are with us.


12/19

11


What generates more profit for the company, using

one m nute o mac ne A to process ro uct or

using one minute of machine A1 to process Product

2?

a. Product 1

b. Product 2

c. They both would generate the same profit

d. Cannot be determined

What generates more profit for the company, using

Quick CheckQuick CheckWith one minute of machine A1, we could make 1 unitWith one minute of machine A1, we could make 1 unit

of Product 1, with a contribution margin of $24, or 2of Product 1, with a contribution margin of $24, or 2

one m nute o mac ne to process ro uct or

using one minute of machine A1 to process Product

2?

a. Product 1

b. Product 2

,,

$15. 2$15. 2 $15 > $24$15 > $24

c. They both would generate the same profit

d. Cannot be determined


13/19

11


Resource


Resource

constrained resource.

Product

1 2

Contribution margin per unit $ 24 $ 15

Time required to produce one unit 1.00 min. 0.50 min.

Product 2 should be emphasized.Product 2 should be emphasized. Provides moreProvides morevaluable use of the constrained resource machine A1,valuable use of the constrained resource machine A1,

yielding a contribution margin of $30 per minute asyielding a contribution margin of $30 per minute asopposed to $24 for Product 1.opposed to $24 for Product 1.

on r u on marg n per m nu e m n. m n.

Utilization of a ConstrainedResource

Utilization of a ConstrainedResource

Alloting Our Constrained Recource (Machine A1)

Weekly demand for Product 2 2,200 units

Time required per unit 0.50 min.

Total time required to make

Product 2 1,100 min.

, .

Time used to make Product 2 1,100 min.

Time available for Product 1 1,300 min.

Time required per unit 1.00 min.Production of Product 1 1,300 units


14/19

11


Resource


Resource, ,, ,

of Product 2 and 1,300 of Product 1. Ourof Product 2 and 1,300 of Product 1. Our

contribution margin looks like this.contribution margin looks like this.

Product 1 Product 2

Production and sales (units) 1,300 2,200

on r u on marg n per unTotal contribution margin 31,200$ 33,000$

The total contribution margin for Ensign is $64,200.The total contribution margin for Ensign is $64,200.

Colonial Heritage makes reproduction colonialColonial Heritage makes reproduction colonial


..

Chairs TablesSelling price per unit $80 $400V ariab le cost per unit $30 $200Board feet per unit 2 10Monthly demand 600 100

able to supply 2,000 board feet this month. Is thisable to supply 2,000 board feet this month. Is this

enough hardwood to satisfy demand?enough hardwood to satisfy demand?

a. Yesa. Yes

b. Nob. No22 600 + 10600 + 10 100 = 2,200 > 2,000100 = 2,200 > 2,000


15/19

11

Quick CheckQuick Check Chairs TablesSelling price per unit $80 $400

The companys supplier of hardwood will only be able toThe companys supplier of hardwood will only be able to

supply 2,000 board feet this month. What plan wouldsupply 2,000 board feet this month. What plan would

maximize profits?maximize profits?

ar a e cos per unBoard feet per unit 2 10Monthly demand 600 100

a. 500 chairs and 100 tablesa. 500 chairs and 100 tables

b. 600 chairs and 80 tablesb. 600 chairs and 80 tablesc. 500 chairs and 80 tablesc. 500 chairs and 80 tables

d. 600 chairs and 100 tablesd. 600 chairs and 100 tables

Quick CheckQuick Check Chairs TablesSelling price per unit $80 $400

Chairs Tables

Selling price 80$ 400$

Variable cost 30 200

Contribution margin 50$ 200$

Board feet 2 10

The companys supplier of hardwood will only be able toThe companys supplier of hardwood will only be able to

supply 2,000 board feet this month. What plan wouldsupply 2,000 board feet this month. What plan would

maximize profits?maximize profits?

ar a e cos per unBoard feet per unit 2 10Monthly demand 600 100

CM per board foot 25$ 20$

Production of chairs 600

Board feet required 1,200

Board feet remaining 800

Board feet per table 10a. 500 chairs and 100 tablesa. 500 chairs and 100 tables

b. 600 chairs and 80 tablesb. 600 chairs and 80 tables

c. 500 chairs and 80 tablesc. 500 chairs and 80 tables

d. 600 chairs and 100 tablesd. 600 chairs and 100 tables

Production of tables 80


16/19

11


As before, Colonial Heritages supplier of hardwood

w on y e a e o supp y , oar ee s mon .

Assume the company follows the plan we have proposed.

Up to how much should Colonial Heritage be willing to

pay above the usual price to obtain more hardwood?

a. $40 per board foot

b. 25 er board foot

c. $20 per board foot

d. Zero

As before, Colonial Heritages supplier of hardwood


w on y e a e o supp y , oar ee s mon .

Assume the company follows the plan we have proposed.

Up to how much should Colonial Heritage be willing to

pay above the usual price to obtain more hardwood?

a. $40 per board foot

b. 25 er board foot

The additional wood would be used to make tables. InThe additional wood would be used to make tables. In

this use, each board foot of additional wood will allowthis use, each board foot of additional wood will allow

the company to earn an additional $20 of contributionthe company to earn an additional $20 of contribution

margin and profit.margin and profit.

c. $20 per board foot

d. Zero


17/19

11

Optimal Product-Mix Decisions under

Capacity Constraints Linear

Programming

Optimal Product-Mix Decisions under


Programming

Storage constraints limit 110 boat engine per day

Optimum Product-Mix Decisions under


Programming

Optimum Product-Mix Decisions under


Programming

Objective Function Max -> TCM = 240 S + 375 B

Subject to:

Storage constraint: B 110 unit

ssem y ep ons ra n :

Testing Dept Constraint: 1S + 0.5B 120 H

None negative output: S 0; B 0


18/19

11

Solve Linear Model Graphic MethodSolve Linear Model Graphic Method

200

150

BoatEngine( B=110

0 50 100 150 200 250 300 350

Snowmobile Engine (units)

100

50

nits)


200

150

BoatEngine

(

Feasible Product

Mix Region

0 50 75 100 150 200 250 300 350


100

50

nits) 90


19/19


200

150

BoatEngine(

Max TCM = $240 S + $375 B

= 240 x 75 + 375 x 90=$51,750

0 50 75 100 150 200 250 300 350


100

50

nits) 90

Equipment-ReplacementDecisions Example

Equipment-ReplacementDecisions Example

x st ng ep acement

Machine Machine

Original cost $80,000 $105,000

Useful life 4 years 4 years

Accumulated depreciation $50,000Book value $30,000

Disposal price $14,000

Annual costs $46,000 $ 10,000

Class Note - Chpt12 Decision Making

Documents

Transcript of Class Note - Chpt12 Decision Making