ACCT 301 Cost management Level 6

Ch 4 Relevant Information for Decision Making ‫المعلومات الالزمه التخاذ القرار‬

Nonroutine Operating Decisions ‫الروتينية غير التشغيل قرارات‬
Routine operating decisions are those made on a regular schedule. Examples include:

Process for Making Nonroutine Operating Decisions

1. Identify the type of decision to be made.
2. Identify the relevant quantitative analysis technique (s).
3. Identify and analyze the qualitative factors.
4. Perform quantitative and/or qualitative analyses
5. Prioritize issues and arrive at a decision.

Identify the Type of Decision

1. Accept Special order
2. Add or drop product
3. Make or buy

Accept special order

Sunbelt Company produces 100,000 Smoothie blenders per month, which is 80% of plant capacity. Variable
manufacturing costs are $8 per unit. Fixed manufacturing costs are $400,000, or $4 per unit. The blenders are
normally sold directly to retailers at $20 each. Sunbelt has an offer from Kensington Co. (a foreign wholesaler)
to purchase an additional 2,000 blenders at $11 per unit. Acceptance of the offer would not affect normal sales
of the product, and the additional units can be manufactured without increasing plant capacity. What should
management do?
Answer
Current situation Special order Total
Revenue 100,000*20 2,000,000 22,000 2,022,000
(-) Variable costs 100,000*8 (800,000) (16,000) (816,000)
= Contribution margin 1,200,000 6,000 1,206,000
(-) Fixed costs (400,000) Zero (400,000)
= Net income 800,000 6,000 806,000
Accept special order because profit increase 6,000

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 ACCT 301 Cost management Level 6
Ch 4 Relevant Information for Decision Making ‫المعلومات الالزمه التخاذ القرار‬

Add or drop product

Denly Company has three products, A, B, and C. The following information is available:
Product A Product B Product C
Sales $60,000 $90,000 $24,000
Variable costs 36,000 48,000 15,000
Contribution margin 24,000 42,000 9,000
Fixed costs:
Avoidable 9,000 18,000 6,000
Unavoidable 6,000 9,000 5,400
Operating income $ 9,000 $15,000 $ (2,400)

149. Denly Company is thinking of dropping Product C because it is reporting a loss. Assuming Denly drops
Product C and does not replace it, operating income will:
a. increase by $2,400
b. increase by $3,000
c. decrease by $3,000
d. decrease by $5,400
Answer: c
$24,000 – $15,000 – $6,000 = $3,000. Product C contributes $3,000 toward corporate profits. Without
Product C, operating income would be $3,000 less than currently reported.

150. Assuming Product C is discontinued and the space formerly used to produce Product C is rented for $12,000
per year, operating income will:
a. increase by $6,600
b. increase by $9,000
c. increase by $12,000
d. increase by $14,400
Answer: b
$12,000 – $3,000 = $9,000

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 ACCT 301 Cost management Level 6
Ch 4 Relevant Information for Decision Making ‫المعلومات الالزمه التخاذ القرار‬
Make-or-buy decision
Baron Company incurs the following annual costs in producing 25,000 ignition switches for motor scooters.

Instead of making its own switches, Baron Company might purchase the ignition switches at a price of $8 per
unit and he will save 10,000 of fixed costs. “What should management do?”
Make Buy Net income Increase (Decrease)
Direct material 50,000 0 50,000
Direct labor 75,000 0 75,000
Variable manufacturing overhead 40,000 0 40,000
Fixed manufacturing overhead 60,000 50,000 10,000
Purchase price(25,000*8) 0 200,000 (200,000)
Total annual costs 225,000 250,000 (25,000)
Baron Company will incur $25,000 additional cost if switches are purchased. So, Making is
better than buying.

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 ACCT 301 Cost management Level 6
Ch 4 Relevant Information for Decision Making ‫المعلومات الالزمه التخاذ القرار‬
Constrained Resource ‫موارد محدوده‬
Managers often face constraints such as
• production capacity constraints such as machine hours or limits on availability of material inputs
• limits on the quantities of outputs that customers demand
• Managers need to determine which products should first be allocated the scarce resources.
• The general rule for constrained resource allocation decisions with only one constraint is:
• allocate scarce resources to products with the highest contribution margin per unit of the constrained resource,
• subject to qualitative considerations.

Norton’s Mufflers manufactures three different product lines, Model X, Model Y, and Model Z.
Considerable market demand exists for all models. The following per unit data apply:
Model X Model Y Model Z
Selling price $80 $90 $100
Direct materials 30 30 30
Direct labor ($10 per hour) 15 15 20
Variable support costs ($5 per machine-hour) 5 10 10
Fixed support costs 20 20 20
a. For each model, compute the contribution margin per unit.
b. For each model, compute the contribution margin per machine-hour.
c. If there is excess capacity, which model is the most profitable to produce? Why?
d. If there is a machine breakdown, which model is the most profitable to produce? Why?
e. How can Norton encourage her sales people to promote the more profitable model?
Answer:
a. The contribution margin per unit is $30 for Model X ($80 - $30 - $15 - $5),
$35 for Model Y ($90 - $30 - $15 - $10),
and $40 for Model Z ($100 - $30 - $20 - $10).
b. The contribution margin per machine-hour is
$30 for Model X ($30 contribution margin / 1.0 machine-hours per unit),
$17.50 for Model Y ($35 / 2.0), and
$20 for Model Z ($40 / 2.0).
c. When there is excess capacity, Model Z is the most profitable because it has the greatest contribution
margin per unit.
d. When there are machine-hour capacity constraints, Model X is the most profitable because it has the
greatest contribution margin per constrained resource.
e. To encourage sales persons to promote specific products, Norton may want to provide marketing
incentives such as higher sales commissions for products contributing the most to profits. Norton
may also want to educate salespeople about the effects of constrained resources.

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 ACCT 301 Cost management Level 6
Ch 4 Relevant Information for Decision Making ‫المعلومات الالزمه التخاذ القرار‬
Computer Products produces two keyboards, Regular and Special. Regular keyboards have a unit
contribution margin of $128, and Special keyboards have a unit contribution margin of $720.
The demand for Regulars exceeds Computer Product’s production capacity, which is limited
by available machine-hours and direct manufacturing labor-hours. The maximum demand
for Special keyboards is 80 per month. Management desires a product mix that will
maximize the contribution toward fixed costs and profits.

Direct manufacturing labor is limited to 1,600 hours a month and machine-hours are limited
to 1,200 a month. The Regular keyboards require 20 hours of labor and 8 machine-hours.
Special keyboards require 34 labor-hours and 20 machine-hours.

Let R represent Regular keyboards and S represent Special keyboards. The correct set of
equations for the keyboard production process is

a. Maximize: $128R + $720S

Constraints:
Labor-hours: 20R + 34S  1,600
Machine-hours: 8R + 20S  1,200
Special: S  80
S 0
Regular: R 0

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