Cost Accounting, Chapter 11 11ch11

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Decision Making and

Relevant Information

Decision Making and

Relevant Information

Chapter

11

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Learning Objective 1

Use the five-step decision

process to make decisions.

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Information and the

Decision Process

Information and the

Decision Process

A decision model is a formal method for making a choice, often involving quantitative and qualitative analysis.

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Five-Step Decision Process

Gather Information

Make Predictions

Choose an Alternative

Implement the Decision Step 1. Step 2. Step 3. Step 4. Historical Costs Other Information Specific Predictions F ee d b ac k

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Learning Objective 2

Differentiate relevant

from irrelevant

costs and revenues in

decision situations.

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The Meaning of Relevance

Relevant costs and relevant revenues are expected future costs and revenues that differ among alternative courses of action.

Historical costs Sunk costs

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Learning Objective 3

Distinguish between quantitative

and qualitative factors in decisions.

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Quantitative and Qualitative

Relevant Information

Quantitative and Qualitative

Relevant Information

Quantitative factors

Financial Nonfinancial

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One-Time-Only

Special Order Example

One-Time-Only

Special Order Example

The Bismark Co. manufacturing plant has a

production capacity of 44,000 towels each month. Current monthly production is 30,000 towels. Costs can be classified as either variable or fixed

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One-Time-Only

Special Order Example

One-Time-Only

Special Order Example

Variable Fixed

Costs Costs

Per Unit Per Unit

Direct materials $6.50 $

-0-Direct labor .50 1.50

Manufacturing costs 1.50 3.50

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One-Time-Only

Special Order Example

One-Time-Only

Special Order Example

Total fixed direct manufacturing labor is $45,000. Total fixed overhead is $105,000.

Marketing costs per unit are $7 ($5 of which is variable).

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One-Time-Only

Special Order Example

One-Time-Only

Special Order Example

A hotel in San Juan has offered to buy 5,000 towels from Bismark Co. at $11.50/towel for a total of $57,500. No marketing costs will be incurred.

Variable ($8.50 + $5.00): $13.50

Fixed: 7.00

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One-Time-Only

Special Order Example

One-Time-Only

Special Order Example

$8.50 × 5,000 = $42,500 incremental costs What are the incremental revenues ?

What are the relevant costs of making the towels ?

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Learning Objective 4

Beware of two potential

problems in

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Two Potential Problems in

Relevant-Cost Analysis

Two Potential Problems in

Relevant-Cost Analysis

Incorrect general assumptions: All variable costs

are relevant. All fixed costs

are irrelevant. 1 2 Misleading unit-cost data: Include irrelevant costs. Use same unit costs at different

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Outsourcing versus Insourcing

Outsourcing is purchasing goods and services from outside vendors.

Insourcing is producing goods or providing services within the organization.

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Make-or-Buy Decisions Example

Bismark Co. also manufactures bath accessories. Management is considering producing a part it

needs (#2) or buying a part produced by Towson Co. for $0.55.

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Make-or-Buy Decisions Example

Bismark Co. has the following costs for 150,000 units of Part #2:

Direct materials $ 28,000

Direct labor 18,500

Mixed overhead 29,000

Variable overhead 15,000

Fixed overhead 30,000

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Make-or-Buy Decisions Example

Mixed overhead consists of material handling and setup costs.

Bismark Co. produces the 150,000 units in 100 batches of 1,500 units each.

Total material handling and setup costs equal fixed costs of $9,000 plus variable

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Make-or-Buy Decisions Example

What is the cost per unit for Part #2? $120,500 ÷ 150,000 units = $0.8033/unit Should Bismark Co. manufacture the part

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Make-or-Buy Decisions Example

Bismark Co. anticipates that next year the 150,000 units of Part #2 expected to be

sold will be manufactured in 150 batches of 1,000 units each.

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Make-or-Buy Decisions Example

Variable costs per batch are expected to decrease to $100.

Bismark Co. plans to continue to produce 150,000 next year at the same variable manufacturing costs per unit as this year.

Fixed costs are expected to remain the same as this year.

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Make-or-Buy Decisions Example

What is the variable manufacturing cost per unit?

$61,500 ÷ 150,000 = $0.41 per unit

Direct material $28,000

Direct labor 18,500

Variable overhead 15,000

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Make-or-Buy Decisions Example

Expected relevant cost to make Part #2:

Cost to buy: (150,000 × $0.55) $82,500

Manufacturing $61,500

Material handling and setups 15,000*

Total relevant cost to make $76,500

*150 × $100 = $15,000

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Make-or-Buy Decisions Example

Now assume that the $9,000 in fixed clerical salaries to support material handling and

setup will not be incurred if Part #2 is purchased from Towson Co..

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Make-or-Buy Decisions Example

Relevant cost to make:

Variable $76,500

Fixed 9,000

Total $85,500

Cost to buy: $82,500

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Learning Objective 5

Explain the opportunity-cost

concept and why it is

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Assume that if Bismark buys the part from Towson, it can use the facilities previously

used to manufacture Part #2 to produce Part #3 for Krysta Company.

The expected additional future operating income is $18,000.

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Bismark Co. has three options regarding Krysta: 1. Make Part #2 and do not make Part #3.

2. Buy Part #2 and do not make Part #3.

3. Buy the part and use the facilities to produce Part #3.

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Expected cost of obtaining 150,000 parts:

Buy Part #2 and do not make Part #3: $82,500 Buy Part #2 and make Part #3:

$82,500 – $18,000 = $64,500

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Opportunity cost is the contribution to income that is forgone (rejected) by not using a

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Assume that annual estimated Part #2 requirements for next year is 150,000.

Cost per purchase order is $40. Cost per unit when each purchase is

1,500 units = $0.55.

Cost per unit when each purchase is equal to or greater than 150,000 = $0.54.

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Average investment in inventory is either: (1,500 × .55) ÷ 2 = $412.50 or

(150,000 × $0.54) = $40,500

Annual interest rate for investment in government bonds is 6%.

$412.50 × .06 = $24.75 $40,500 × .06 = $2,430

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Option A: Make 100 purchases of 1,500 units: Purchase order costs: (100 × $40) $ 4,000.00

Purchase costs: (150,000 × $0.55) $82,500.00

Annual interest income: $ 24.75

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Opportunity Costs,

Outsourcing, and Constraints

Opportunity Costs,

Outsourcing, and Constraints

Option B: Make 1 purchase of 150,000 units: Purchase order costs: (1 × $40) $ 40

Purchase costs: (150,000 × $0.54) $81,000

Annual interest income: $ 2,430

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Learning Objective 6

Know how to choose which

products to produce when there

are capacity constraints.

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Product-Mix Decisions

Under Capacity Constraints

Product-Mix Decisions

Under Capacity Constraints

Per unit Product #2 Product #3

Sales price $2.11 $14.50

Variable expenses 0.41 13.90

Contribution margin $1.70 $ 0.60

Contribution margin ratio 81% 4% Bismark Co. has 3,000 machine-hours available.

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Product-Mix Decisions

Under Capacity Constraints

Product-Mix Decisions

Under Capacity Constraints

One unit of Prod. #2 requires 7 machine-hours. One unit of Prod. #3 requires 2 machine-hours.

What is the contribution of each product per machine-hour?

Product #2: $1.70 ÷ 7 = $0.24 Product #3: $0.60 ÷ 2 = $0.30

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Learning Objective 7

Discuss what managers

must consider when

adding or discontinuing

customers and segments.

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Profitability, Activity-Based

Costing, and Relevant Costs

Profitability, Activity-Based

Costing, and Relevant Costs

Mountain View Furniture supplies furniture to two local retailers – Stevens and Cohen.

The company has a monthly capacity of 3,000 machine-hours.

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Profitability, Activity-Based

Costing, and Relevant Costs

Profitability, Activity-Based

Costing, and Relevant Costs

Stevens Cohen

Revenues $200,000 $100,000

Variable costs 70,000 60,000

Fixed costs 100,000 50,000

Total operating costs $170,000 $110,000

Operating income $ 30,000 $(10,000)

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Profitability, Activity-Based

Costing, and Relevant Costs

Profitability, Activity-Based

Costing, and Relevant Costs

Total

Revenues $300,000

Variable costs 130,000

Fixed costs 150,000

Total operating costs $280,000

Operating income $ 20,000

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Profitability, Activity-Based

Costing, and Relevant Costs

Profitability, Activity-Based

Costing, and Relevant Costs

Should Mountain View Furniture drop the Cohen business, assuming that dropping Cohen would

decrease its total fixed costs by 10%? New fixed costs would be:

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Profitability, Activity-Based

Costing, and Relevant Costs

Profitability, Activity-Based

Costing, and Relevant Costs

Stevens Alone

Revenues $200,000

Variable costs 70,000 Fixed costs 135,000

Total operating costs $205,000 Operating income $ (5,000)

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Profitability, Activity-Based

Costing, and Relevant Costs

Profitability, Activity-Based

Costing, and Relevant Costs

Cohen’s business is providing a contribution margin of $40,000.

$40,000 decrease in contribution margin – $15,000 decrease in fixed costs

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Profitability, Activity-Based

Costing, and Relevant Costs

Profitability, Activity-Based

Costing, and Relevant Costs

Assume that if Mountain View Furniture drops Cohen’s business it can lease the excess capacity

to the Perez Corporation for $70,000. Fixed costs would not decrease.

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Learning Objective 8

Explain why the book value

of equipment is irrelevant in

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Equipment-Replacement

Decisions Example

Equipment-Replacement

Decisions Example

Existing Replacement Machine Machine

Original cost $80,000 $105,000

Useful life 4 years 4 years

Accumulated depreciation $50,000

Book value $30,000

Disposal price $14,000

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Equipment-Replacement

Decisions Example

Equipment-Replacement

Decisions Example

Ignoring the time value of money and income taxes, should the company

replace the existing machine?

The cost savings over a 4-year period will be $36,000 × 4 = $144,000.

Investment = $105,000 – $14,000 = $91,000 $144,000 – $91,000 = $53,000

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Learning Objective 9

Explain how conflicts can arise

between the decision model

used by a manager and the

performance evaluation model

used to evaluate the manager.

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Decisions and

Performance Evaluation

Decisions and

Performance Evaluation

What is the journal entry to sell the existing machine?

Cash 14,000

Accumulated Depreciation 50,000

Loss on Disposal 16,000

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Decisions and

Performance Evaluation

Decisions and

Performance Evaluation

In the real world would the manager replace the machine?

An important factor in replacement decisions is the manager’s perceptions of whether the

decision model is consistent with how the manager’s performance is judged.

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Decisions and

Performance Evaluation

Decisions and

Performance Evaluation

Top management faces a challenge – that is, making sure that the performance-evaluation

model of subordinate managers is consistent with the decision model.

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End of Chapter 11

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Equipment-Replacement

Decisions Example

Equipment-Replacement

Decisions Example

Ignoring the time value of money and income taxes, should the company

replace the existing machine?

The cost savings over a 4-year period will be $36,000 × 4 = $144,000.

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Learning Objective 9

Explain how conflicts can arise

between the decision model

used by a manager and the

performance evaluation model

used to evaluate the manager.

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Decisions and

Performance Evaluation

Decisions and

Performance Evaluation

What is the journal entry to sell the existing machine?

Cash 14,000

Accumulated Depreciation 50,000 Loss on Disposal 16,000

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Decisions and

Performance Evaluation

Decisions and

Performance Evaluation

In the real world would the manager

replace the machine?

An important factor in replacement decisions is the manager’s perceptions of whether the

decision model is consistent with how the manager’s performance is judged.

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Decisions and

Performance Evaluation

Decisions and

Performance Evaluation

Top management faces a challenge – that is, making sure that the performance-evaluation

model of subordinate managers is consistent with the decision model.

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