CHAPTER - PowerPoint Presentation

Slide1

CHAPTER

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8

USING ACCOUNTING INFORMATION

TO MAKE MANAGERIAL DECISIONSSlide2

GOOD NEWS, BAD NEWS FOR C&C

CISD wants 1,000 standard practice jerseys, with a couple of special modificationsBonadeo Embroidery wants to supply chenille letters at a low costThere are problems with the jersey fabric order at Bradley Textile MillsIt looks like some sales territories are losing money and might need to be shut downWhat’s the real story on these issues?Slide3

IDENTIFYING RELEVANT

INFORMATION

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WHAT IS RELEVANT INFORMATION?

Information that is directly related to the decision being madeInformation about something that will happen in the futureInformation that differs between alternativesSlide5

LET’S IDENTIFY RELEVANT INFORMATION

Accord

Mazda 6

Relevant?

MSRP

$25,405

$23,370

MPG, City

27

21

MPG, highway

36

30

Warranty

36,000 miles,

36 months

36,000 miles,

36 months

Leg room (front)

42.5”

42.5”

Trunk capacity

15.8

ft

3

16.6

ft

3

✖

✖

✔

✔

✔

✔Slide6

SO WHEN IS A COST RELEVANT?Slide7

IMPORTANT TERMS TO KNOW

Avoidable costCost associated with a particular alternative that will be eliminated if alternative is eliminatedUnavoidable costCost that will continue regardless of the alternative selectedSlide8

LET’S PRACTICE

Is it cheaper to drive or to fly?You are getting ready to take a 500-mile trip and are trying to decide whether to drive or fly. You know that it costs you $1,000 per year plus $0.10/mile to operate your car. Based on the 20,000 miles you drive each year, you calculate total costs to be $0.15/mile. You have just gotten wind of a special $65 round trip airfare.Slide9

LET’S PRACTICE

Cost to Drive

Cost to Fly

500 miles @

$0.10

/mile =

$50

$65

You are getting ready to take a

500-mile trip and are trying to decide whether to drive or fly. You know that it costs you $1,000 per year plus $0.10/mile to operate your car. Based on the 20,000 miles you drive each year, you calculate total costs to be $0.15/mile. You have just gotten wind of a special $65 round trip airfare.

But, that comparison includes irrelevant costs…Slide10

WATCH OUT FOR SUNK COSTS

Sunk costs are NEVER relevant to a decisionThese costs have been incurred in the past and nothing you can do today can change themSlide11

A RELEVANT COST DECISION MODEL

Identify the decisionIdentify the alternativesIdentify the relevant revenues and costsIdentify the qualitative issues to considerIdentify the alternative with the greatest benefit or least costSlide12

SPECIAL ORDER

PRICING

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SPECIAL ORDER PRICING DECISIONS

Sometimes a company may get an order from a customer asking for a “special price” that is less than the stated selling priceCould be a grocery chain approaching Kleenex maker Kimberly-Clark to produce a “private label” facial tissueSometimes the price requested appears to be less than the full product costSlide14

WHY ACCEPT SPECIAL ORDER PRICING?

For product made to customer specsFor unusual order (quantity, packaging, means of delivery, etc.)For one-time jobTo utilize idle production facilitiesSlide15

QUALITATIVE ISSUES TO CONSIDER

What precedent does this special order set for future jobs?How will regular customers react?Is there enough capacity to produce the order without reducing normal production?Slide16

What costs are relevant? Should

Coopersmith accept the special order?

Fixed costs will not change with the special order. Accepting the special order will result in an extra $80,000 in contribution ($8/barrel x 10,000 barrels), so ACCEPT IT!

DM $ 5 DL 2

VOH 3 FOH 9 $ 19

AN EXAMPLE…

Coopersmith produces premium wooden barrels. A one liter barrel sells for $25, but a fancy Swiss ski resort has offered to buy 10,000 barrels for $18 each for its St. Bernard patrol. The barrel has the following product costs, based on annual production of 30,000 barrels:

DM $ 5

✔DL 2 ✔VOH 3 ✔FOH 9

✖

$ 19

$

10Slide17

Assume that the ski lodge requires special packaging that will cost Coopersmith $2 per barrel. Should Coopersmith accept the special order?

DM $ 5 ✔DL 2

✔VOH 3

✔FOH

9 ✖ $ 19

$ 10VS&A 2 ✔

$ 12

DM $ 5 ✔DL 2 ✔VOH 3 ✔

FOH

9

✖

$ 19

$ 10

VS&A

2

✔

$ 12

AN EXAMPLE…

Coopersmith

produces premium wooden barrels. A one liter barrel sells for $25, but a fancy Swiss ski resort has offered to buy 10,000 barrels for $18 each for its St. Bernard patrol. The barrel has the following product costs, based on annual production of 30,000 barrels:

Additional variable costs of $2/barrel will be incurred, thus the relevant cost per barrel is $12. The special order will result in an extra $60,000 in contribution margin:

($6/barrel x 10,000 barrels)ACCEPT IT!Slide18

RECAP OF SPECIAL ORDER PRICING

Decision: Should we accept an order at a price less than normal selling price?Factors: differential income for the orderQualitative issues: affect on regular sales, expectation of continued special treatmentWatch out: unavoidable fixed costs

Decision Rule: as long as the special order covers differential costs and provides profit, accept the orderSlide19

OUTSOURCING

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WHAT IS OUTSOURCING?

Moving production outside the organizationOffshoring is moving production to a foreign country (It may or may not be outsourcing)Outsourcing is a big trend in business todaySometimes referred to as a “make-or-buy” decisions (Do I make a component myself, or do I but it already fabricated from someone else?)Slide21

WHAT COSTS ARE RELEVANT?

Price we have to pay to buy the componentAll avoidable costs we would incur to make the componentWatch out for fixed overhead per unit; it may or may not be avoidableSlide22

DM $

3DL 4 VOH 1 FOH 6 $ 14

Which costs are relevant?AN EXAMPLE…

Thomas Company makes bicycles. It has always made its own tires but has recently received a bid from Tiny Tires, Inc. to supply the tires for $12

each. Thomas’s tire costs are shown below. Of the fixed overhead, 40% is related to plant occupancy costs that will continue even if tires are purchased from Tiny. Should Thomas make or buy the 5,000 tires it needs?Slide23

Which costs are relevant?

DM $ 3 ✔DL 4 ✔VOH 1 ✔

FOH 6 ✔ But only $3.60 $ 14

DM $ 3 DL 4 VOH 1

FOH 6 $ 14

AN EXAMPLE…

Thomas Company makes bicycles. It has always made its own tires but has recently received a bid from Tiny Tires, Inc. to supply the tires for $12 each. Thomas’s tire costs are shown below. Of the fixed overhead, 40% is related to plant occupancy costs that will continue even if tires are purchased from Tiny. Should Thomas make or buy the 5,000 tires it needs?

So, the relevant cost to make a tire is only $11.60

$ 11.60Slide24

WHAT ABOUT OPPORTUNITY COSTS?

Opportunity costs of using our facilities may be relevantWhat alternative uses of the capacity exist?Can we generate additional income by using the freed up facilities in some way?Slide25

WHAT IF…

Suppose that if Thomas Company buys tires from Tiny, it could use the freed up manufacturing capacity to produce a new line of tricycles. The new tricycles are expected to generate $6,000 in net income. Should Thomas make or buy the 5,000 tires it needs?Make

Buy

$11.60 × 5,000 = $58,000

$58,000

$12 x 5,000 = $60,000

Less new income ($6,000)

$54,000Slide26

QUALITATIVE FACTORS TO CONSIDER…

Relative net advantage given uncertainty of estimates (costs, risks, etc.)Reliability and number of sources of supplyAbility to assure qualityFuture bargaining position with suppliersPerceptions regarding possible future price changesSlide27

RECAP OF OUTSOURCING DECISION

Decision: Do you make a component in house or buy it from an outsider?Factors: avoidable costs to make, purchase price, alternative uses of facilityQualitative issues: supplier reliability and quality, theft of intellectual property, transfer or technological riskWatch out: non-differential fixed costs

Decision Rule: If purchase price is less than avoidable costs, buy from outsideSlide28

ALLOCATING CONSTRAINED

RESOURCES

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Unit 8.5Slide29

CONSTRAINED RESOURCE ALLOCATION

Most businesses face some constraint in terms of available resourcesWe need a way to decide how to allocate those scarce resources across the businessFocus on the highest contribution margin per unit of scarce resourceSlide30

Banners

Kites

Sales Price

$ 12

$ 15

Variable Costs

$ 9

$ 14

CM/unit

$ 3

$ 1

Machine hours/unit

1 hour

0.25 hour

CM/machine hour

$ 3

$ 4

Banners

Kites

Sales Price

$ 12

$ 15

Variable Costs

$ 9

$ 14

CM/unit

$ 3

$ 1

AN EXAMPLE

(Exercise 8-14)

Wendy’s Windy Things manufactures kites and banners. This month Wendy has orders for 3,000 Valentine banners and Easter 1,200 kites. Wendy only has 1,000 sewing machine hours available. Slide31

WHAT SHOULD WENDY PRODUCE?

As many kites as she can sell1000 kites x .25 hours = 250 hoursHow many hours are left?1,000 – 250 = 750 hoursProduce as many banners as she can with remaining hoursX banners x 1 hour = 750 hoursX = 750 bannersSlide32

RECAP OF CONSTRAINED RESOURCE ALLOCATION DECISION

Decision: How should we allocate a scarce resource across all products?Factors: scarce resource, CM per unit of scarce resource, demand for productsQualitative factors: customer preferences for products, customer service issuesWatch out: CM per unit of product

Decision Rule: Make the product with the highest contribution margin per unit of scarce resourceSlide33

KEEPING OR ELIMINATING

OPERATIONS

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MAKING THE OPERATIONS DECISION

How do we know when to add or drop a portion of operations?Decision should be based on relevant costs of those operationsA lot of costs that a company incurs support the entire company, not a specific segment; these common costs are often allocated to segments and are the ones that cause the problemsSlide35

WHAT IS RELEVANT TO THE DECISION?

All direct costs associated with the segmentVariable costsDirect avoidable fixed costsCalculate the segment marginRevenues – Variable Costs – Avoidable Fixed Costs

Watch out for allocated common fixed costsSlide36

TOTALS

Dept. A

Dept. B

Dept. C

Sales

$ 65,000

$20,000

$15,000

$30,000

COGS

Variable

29,000

4,000

10,000

15,000

Direct Fixed

9,000

2,000

1,000

6,000

S, G, & A

Variable

9,000

2,000

4,000

3,000

Direct Fixed

4,000

1,000

2,000

1,000

Common FC

13,000

4,000

3,000

6,000

Net Income

$ 1,000

$ 7,000

$ (5,000)

$ (1,000)

AN EXAMPLE…

If we eliminate departments B and C, what revenues and costs will disappear?Slide37

AN EXAMPLE…

TOTALS

Dept. A

Dept. B

Dept. C

Sales

$ 65,000

$20,000

$15,000

$30,000

Variable

COGS

29,000

4,000

10,000

15,000

S, G, & A

9,000

2,000

4,000

3,000

Product CM

27,000

14,000

1,000

12,000

Avoidable FC

COGS

9,000

2,000

1,000

6,000

S, G, & A

4,000

1,000

2,000

1,000

Segment Margin

$ 14,000

$ 11,000

$ (2,000)

$ 5,000

Department C is contributing $5,000 in segment margin to cover common fixed costs. Do not drop this department.Slide38

RECAP OF PRODUCT LINE DECISION

Decision: Should we keep an existing segment that appears to have a net loss?Factors: contribution margin, segment margin, direct fixed costsQualitative issues: customer relations, preferencesWatch out: allocated common fixed costs

Decision Rule: If segment margin is positive, keep the segment