class note - chpt12 decision making
TRANSCRIPT
-
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.
-
7/31/2019 Class Note - Chpt12 Decision Making
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
-
7/31/2019 Class Note - Chpt12 Decision Making
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
-
7/31/2019 Class Note - Chpt12 Decision Making
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
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?
-
7/31/2019 Class Note - Chpt12 Decision Making
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!
One-Time-OnlySpecial Order Example
One-Time-OnlySpecial Order Example
,
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!
-
7/31/2019 Class Note - Chpt12 Decision Making
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?
-
7/31/2019 Class Note - Chpt12 Decision Making
7/19
1
Make-or-Buy DecisionMake-or-Buy Decision
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!
Make-or-Buy DecisionMake-or-Buy Decision
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!
-
7/31/2019 Class Note - Chpt12 Decision Making
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
-
7/31/2019 Class Note - Chpt12 Decision Making
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
-
7/31/2019 Class Note - Chpt12 Decision Making
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.
-
7/31/2019 Class Note - Chpt12 Decision Making
11/19
11
Utilization of a Constrained
Resource
Utilization of a Constrained
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.
-
7/31/2019 Class Note - Chpt12 Decision Making
12/19
11
Quick CheckQuick Check
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
-
7/31/2019 Class Note - Chpt12 Decision Making
13/19
11
Utilization of a Constrained
Resource
Utilization of a Constrained
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 $24 for Product 1.
on r u on marg n per m nu e m n. m n.
Utilization of a ConstrainedResource
Utilization of a ConstrainedResource
Alloting Our Constrained Recource (Machine A1)
Weekly demand for Product 2 2,200 units
Time required per unit 0.50 min.
Total time required to make
Product 2 1,100 min.
, .
Time used to make Product 2 1,100 min.
Time available for Product 1 1,300 min.
Time required per unit 1.00 min.Production of Product 1 1,300 units
-
7/31/2019 Class Note - Chpt12 Decision Making
14/19
11
Utilization of a Constrained
Resource
Utilization of a Constrained
Resource, ,, ,
of Product 2 and 1,300 of Product 1. Ourof Product 2 and 1,300 of Product 1. Our
contribution margin looks like this.contribution margin looks like this.
Product 1 Product 2
Production and sales (units) 1,300 2,200
on r u on marg n per unTotal contribution margin 31,200$ 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
Quick CheckQuick Check
..
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
-
7/31/2019 Class Note - Chpt12 Decision Making
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
-
7/31/2019 Class Note - Chpt12 Decision Making
16/19
11
Quick CheckQuick Check
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
Quick CheckQuick Check
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
-
7/31/2019 Class Note - Chpt12 Decision Making
17/19
11
Optimal Product-Mix Decisions under
Capacity Constraints Linear
Programming
Optimal Product-Mix Decisions under
Capacity Constraints Linear
Programming
Storage constraints limit 110 boat engine per day
Optimum Product-Mix Decisions under
Capacity Constraints Linear
Programming
Optimum Product-Mix Decisions under
Capacity Constraints Linear
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
-
7/31/2019 Class Note - Chpt12 Decision Making
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)
Solve Linear Model Graphic MethodSolve Linear Model Graphic Method
200
150
BoatEngine
(
Feasible Product
Mix Region
0 50 75 100 150 200 250 300 350
Snowmobile Engine (units)
100
50
nits) 90
-
7/31/2019 Class Note - Chpt12 Decision Making
19/19
Solve Linear Model Graphic MethodSolve Linear Model Graphic Method
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
Snowmobile Engine (units)
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