Cost Management and Decision Making

Chapter 13

Decision making process

Step 1: Goal setting

Provides guidance

Goals

Tangible

Quantifiable

Target profit, market share, enrollment, etc.

Decision making process

Step 2: Gather information

Relevant information

Capable of influencing a decision

Differs among alternatives

Occurs now or in the future

Sunk costs are never relevant

Decision making process

Tradeoffs

Qualitative vs. quantitative

Objective vs. subjective

Accuracy vs. timeliness

Quality vs. cost

Decision making process

Step 3: Identify and evaluate alternatives

Stay as is or change?

Consider the domino effect

What other changes will this alternative necessitate?

Decision making process

Costs and benefits of each

Qualitative vs. quantitative

Numbers may not tell the whole story

The past may be a guide

Prototype or pilot project may be appropriate

Common decisions

Make or buy?

Retain or drop?

Keep or replace?

Accept or reject?

Make or buy?

Make

Qualitative factors

Control

Worker morale

Reputation

Reduced risk

Buy

Qualitative factors

Dependence

Time and distance

Greater risk

Cultural differences

Make or buy?Unit cost based on

100,000 units

Unit cost based on

100,000 unitsMaterial 18.00$ Purchase price 22.50$ Labor 3.00 Shipping 0.50 Variable overhead 2.00 Inspection 0.25 Fixed overhead 8.00 Total 31.00$ Total 23.25$

100,000 units are required each year. Some special-purpose equipment can be eliminated, along with its operators, if the part is purchased, reducing fixed overhead by $80,000 per year. If purchased, the capacity freed up could be used to "insource" another component, saving the company $18,000 per year.

Make or buy?

Assume you chose to buy. Subsequent to your decision you discover you will need an interpreter ($30,000 per year) due to language differences. In addition, you incur travel costs ($60,000 per year) for your engineers to travel to the supplier to solve problems.

Retain or drop?

Retain

Profitable?

Support other products, locations?

Maintain image?

Drop

Revenue lost

Costs avoided

Shift to other products, locations

Impact on remaining workers, community

Retain or drop?Store A Store B Store C Total

Sales revenue 7,800,000$ 3,800,000$ 1,700,000$ 13,300,000$ Cost of goods sold 6,240,000 3,040,000 1,360,000 10,640,000 Gross margin 1,560,000 760,000 340,000 2,660,000 Operating costs -

Wages 530,000 300,000 230,000 1,060,000 Utilities 63,000 47,000 14,000 124,000 Rent 210,000 115,000 80,000 405,000 Fixture depreciation 114,000 87,000 52,000 253,000 Insurance 75,000 60,000 40,000 175,000

Operating profit 568,000$ 151,000$ (76,000)$ 643,000$

If store C is eliminated, 10% of its sales will migrate to the other two locations. In addition, one manager, paid $50,000, will be moved to another store. Should Store C be closed?

Keep or replace?

KeepServiceability

Operating costs

Capacity

Obsolescence

ReplaceCost

Available financing

Operating costs

Capacity

Useful life

Market value of old asset

Keep or replace?Existing machine

Proposed machine

Annual operating costsMaterials 38,000$ 38,000$ Labor 17,000 6,000 Utilities 3,000 1,400 Maintenance 4,000 500 Depreciation 4,500 18,000 Total annual operating costs 66,500$ 63,900$

Other informationCost 50,000$ 95,000$ Accumulated depreciation 22,500 - Current resale value 18,000 -$ Remaining useful life - years 5 5

What costs are relevant? Should the machine be replaced?

Accept or reject?

AcceptDoes incremental

revenue exceed incremental cost?Unit/batchProduct/facility

Impact on other products

Impact on other customers

RejectNot profitableNegative impact

on current salesDiscriminatoryNegative impact

on image

Accept or reject?Annual capacity 200,000 Current production, sales level 170,000 Selling price per unit 25.00$ Cost per unitMaterials 12.00$ Labor 3.50 Variable overhead 1.80 Fixed overheadTotal fixed overhead 391,000$ Current production level 170,000 Fixed overhead per unit 2.30 Total cost per unit 19.60$

A potential new customer asks the company to produce 50,000 units in special packaging and offers to pay $20.00 per unit. The special packaging will increase material cost by $0.10 per unit. Due to capacity limitations, the company will have to reduce its current sales by 20,000 units if the special order is accepted. Should the order be accepted? What is the minimum acceptable unit price for the special order?

Life cycle costing

At some point, all costs must be recovered

Previous examples only considered incremental costs

Life cycle costing considers all of the costs related to owning and using the asset

Costs are then charged to customers

Life cycle costing

Ownership costs

Net cost consumed (cost – salvage value)

Opportunity cost or cost of capital

Ongoing fixed costs (insurance, taxes, etc.)

Operating costs

Utilities, repairs, maintenance, etc. related to using the asset