Professional Documents
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Making
Learning Objective 1
2
1
An
An avoidable
avoidable cost
cost can
can be
be eliminated,
eliminated, inin whole
whole or
or
in
in part,
part, by
by choosing
choosing one
one alternative
alternative over
over
another.
another. Avoidable
Avoidable costs
costs are
are relevant
relevant costs.
costs.
Unavoidable
Unavoidable costs
costs are
are irrelevant
irrelevant costs.
costs.
Two
Two broad
broad categories
categories of
of costs
costs are
are never
never
relevant
relevant in
in any
any decision.
decision. They
They include:
include:
Sunk
Sunk costs.
costs.
Future
Future costs
costs that
that do
do not
not differ
differ between
between the
the
alternatives.
alternatives.
Process
$45
$45 per
per month
month × 8 months $1.60 per gallon ÷ 32 MPG
$18,000
$18,000 cost
cost – $4,000 salvage value ÷÷ 55 years
years
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.
13-8
As you can see, the only costs that differ between the alternatives are
the direct labor costs savings and the increase in fixed rental costs.
Situation Differential
Current With New Costs and
Situation Machine Benefits
Sales (5,000 units @ $40 per unit) $ 200,000 $ 200,000 -
Less variable expenses:
Direct materials (5,000 units @ $14 per unit) 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 per unit) 10,000 10,000 -
Total variable expenses 120,000 105,000 -
Contribution margin 80,000 95,000 15,000
Less fixed expense:
Learning Objective 2
Prepare an analysis
showing whether a product
line or other business
segment should be
dropped or retained.
Adding/Dropping Segments
Let’s
Let’s see
see how
how relevant
relevant costs
costs should
should
be
be used
used in
in this
this type
type of
of decision.
decision.
Adding/Dropping Segments
Due
Due to
to the
the declining
declining popularity
popularity of
of digital
digital
watches,
watches, Lovell
Lovell Company’s
Company’s digital
digital
watch
watch line
line has
has not
not reported
reported aa profit
profit for
for
several
several years.
years. Lovell
Lovell is
is considering
considering
dropping
dropping this
this product
product line.
line.
DECISION RULE
Lovell
Lovell should
should drop
drop the
the digital
digital watch
watch segment only
ifif its
its profit
profit would
would increase.
increase. This
This would
would only
only
happen
happen ifif the
the fixed
fixed cost
cost savings exceed
exceed the
the lost
lost
contribution
contribution margin.
margin.
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales $ 500,000
Less: variable expenses
Variable manufacturing costs $ 120,000
Variable shipping costs 5,000
Commissions 75,000 200,000
Contribution margin $ 300,000
Less: fixed expenses
General factory overhead $ 60,000
Salary of line manager 90,000
Depreciation of equipment 50,000
Advertising - direct 100,000
Rent - factory space 70,000
General admin. expenses 30,000 400,000
Net operating loss $ (100,000)
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.
13-22
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales $ 500,000
Less: variable expenses
Investigation has revealed that total fixed general
Investigation has revealed that
Variable manufacuring costs $ 120,000
total fixed general
factory overhead
overhead and
factory costs
Variable shipping and general
general
5,000
administrative
administrative
Commissions expenses
expenses would not
not be
would75,000 be affected
affected ifif
200,000
the
the digital
Contribution watch
watch line
margin
digital line is
is dropped.
dropped. The The fixed
$ 300,000
fixed
Less: fixed expenses
general
general factory
factory overhead
overhead and general
General factory overhead $ 60,000general
and
administrative
administrative expenses
expenses assigned
Salary of line manager assigned to
90,000to this
this product
product
would
would be
Depreciation reallocated
be of equipment to
reallocated to other
other product
product lines.
50,000 lines.
Advertising - direct 100,000
Rent - factory space 70,000
General admin. expenses 30,000 400,000
Net operating loss $ (100,000)
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales $ 500,000
Less: variable expenses
The
The equipment
equipment
Variable used to
to manufacture
usedcosts
manufacturing manufacture
$ 120,000
Variable shipping costs 5,000
digital watches has no resale
digital watches has no resale
Commissions 75,000 200,000
value
value
Contribution or
or alternative
marginalternative use.
use. $ 300,000
Less: fixed expenses
General factory overhead $ 60,000
Salary of line manager 90,000
Depreciation of equipment 50,000
Should
Should Lovell
Lovell retain
retain or
or drop
drop
Advertising - direct 100,000
Rent - factory space the
the digital
digital watch
70,000 segment?
watch segment?
General admin. expenses 30,000 400,000
Net operating loss $ (100,000)
Contribution Margin
Solution
Contribution margin lost if digital
watches are dropped $ (300,000)
Less fixed costs that can be avoided
Salary of the line manager $ 90,000
Advertising - direct 100,000
Rent - factory space 70,000 260,000
Net disadvantage $ (40,000)
RRe
ettaai
inn
Let’s
Let’s look
look at
at this
this second
second approach.
approach.
Learning Objective 3
When
When aa company
company is is involved
involved in in more
more than
than one
one activity
activity
in
in the
the entire
entire value
value chain,
chain, itit is
is vertically
vertically integrated.
integrated.
A
A decision
decision to
to carry
carry out
out one
one of of the
the activities
activities in
in the
the
value
value chain
chain internally,
internally, rather
rather thanthan toto buy
buy externally
externally
from
from aa supplier
supplier isis called
called aa “make
“make or or buy”
buy” decision.
decision.
Smoother flow of
parts and materials
Better quality
control
Realize profits
Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of special equip. 3
Supervisor's salary 2
General factory overhead 10
Unit product cost $ 30
Should
Should we
we accept
accept the
the supplier’s
supplier’s offer?
offer?
The
The special
special equipment
equipment hashas no
no resale
resale
value
value and
and is
is aa sunk
sunk cost.
cost.
Not
Not avoidable;
avoidable; irrelevant.
irrelevant. IfIf the
the product
product is
is
dropped,
dropped, itit will
will be
be reallocated
reallocated toto other
other products.
products.
Opportunity Cost
An
An opportunity
opportunity cost
cost is
is the
the benefit
benefit that
that is
is foregone
foregone asas
aa result
result of
of pursuing
pursuing some
some course
course of of action.
action.
Opportunity
Opportunity costs
costs are
are not
not actual
actual dollar
dollar outlays
outlays and
and
are
are not
not recorded
recorded in in the
the formal
formal accounts
accounts of of an
an
organization.
organization.
How
How would
would this
this concept
concept potentially
potentially relate
relate to
to the
the
Essex
Essex Company?
Company?
Learning Objective 4
Prepare an analysis
showing whether a special
order should be accepted.
Special Orders
Jet,
Jet, Inc.
Inc. makes
makes aa single
single product
product whose
whose normal
normal selling
selling
price
price is
is $20
$20 per
per unit.
unit.
AA foreign
foreign distributor
distributor offers
offers to
to purchase
purchase 3,000
3,000 units
units for
for $10
$10
per
per unit.
unit.
This
This is
is aa one-time
one-time order
order that
that would
would not
not affect
affect the
the
company’s
company’s regular
regular business.
business.
Annual
Annual capacity
capacity isis 10,000
10,000 units,
units, but
but Jet,
Jet, Inc.
Inc. is
is currently
currently
producing
producing and and selling
selling only
only 5,000
5,000 units.
units.
Special Orders
$8 variable cost
Special Orders
Quick Check
Quick Check
Quick Check
Learning Objective 5
• When
When aa constraint
constraint exists,
exists, aa company
company should
should
select
select aa product
product mix
mix that
that maximizes
maximizes the the total
total
contribution
contribution margin
margin earned
earned since
since fixed
fixed costs
costs
usually
usually remain
remain unchanged.
unchanged.
• A
A company
company should
should not
not necessarily
necessarily promote
promote those
those
products
products that
that have
have the
the highest
highest unit
unit contribution
contribution
margin.
margin.
• Rather,
Rather, itit should
should promote
promote those
those products
products that that
earn
earn the
the highest
highest contribution
contribution margin
margin inin relation
relation to
to
the
the constraining
constraining resource.
resource.
Example
• Machine
Machine A1 A1 is
is the
the constrained
constrained resource
resource and
and
is
is being
being used
used atat 100%
100% of
of its
its capacity.
capacity.
• There
There is
is excess
excess capacity
capacity on
on all
all other
other
machines.
machines.
• Machine
Machine A1 A1 has
has aa capacity
capacity ofof 2,400
2,400 minutes
minutes
per
per week.
week.
Should
Should Ensign
Ensign focus
focus its
its efforts
efforts on
on
Product
Product 11 or
or Product
Product 2?2?
Quick Check
Product 1 Product 2
a. 1 unit 0.5 unit
b. 1 unit 2.0 units
c. 2 units 1.0 unit
d. 2 units 0.5 unit
Quick Check
Product 1 Product 2
a. 1 unit 0.5 unit
b. 1 unit 2.0 units
c. 2 units 1.0 unit
d. 2 units 0.5 unit
I was just checking to make sure
you are with us.
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.
13-60
Quick Check
Quick Check
IfIf there
there are
are no
no other
other considerations,
considerations, the
the best
best
plan
plan would
would be
be to
to produce
produce to
to meet
meet current
current
demand
demand for for Product
Product 22 and
and then
then use
use remaining
remaining
capacity
capacity to
to make
make Product
Product 1.
1.
Weekly
Weeklydemand
demand for
for Product
Product22 2,200
2,200 units
units
Time
Time required
required per
perunit
unit ×× 0.50
0.50 min.
min.
Total
Total time
time required
required to
to make
make
Product
Product22 1,100
1,100 min.
min.
Weekly
Weeklydemand
demand for
for Product
Product22 2,200
2,200 units
units
Time
Time required
required per
perunit
unit ×× 0.50
0.50 min.
min.
Total
Total time
time required
required to
to make
make
Product
Product22 1,100
1,100 min.
min.
Total
Total time
time available
available 2,400
2,400 min.
min.
Time
Time used
used to
to make
make Product
Product22 1,100
1,100 min.
min.
Time
Time available
available for
for Product
Product11 1,300
1,300 min.
min.
Weekly
Weeklydemand
demand for
for Product
Product22 2,200
2,200 units
units
Time
Time required
required per
perunit
unit ×× 0.50
0.50 min.
min.
Total
Total time
time required
required to
to make
make
Product
Product22 1,100
1,100 min.
min.
Total
Total time
time available
available 2,400
2,400 min.
min.
Time
Time used
used to
to make
make Product
Product22 1,100
1,100 min.
min.
Time
Time available
available for
for Product
Product11 1,300
1,300 min.
min.
Time
Time required
required per
perunit
unit ÷÷ 1.00
1.00 min.
min.
Production
Production of ofProduct
Product11 1,300
1,300 units
units
Product 1 Product 2
Production and sales (units) 1,300 2,200
Contribution margin per unit $ 24 $ 15
Total contribution margin $ 31,200 $ 33,000
Quick Check
Quick Check
Quick Check
Chairs Tables
Selling price per unit $80 $400
Variable cost per unit $30 $200
Board feet per unit 2 10
Monthly demand 600 100
Quick Check
Chairs Tables
Selling price $ 80 $ 400
Chairs Tables
Variable
Selling price per unit cost$80 $400 30 200
Variable cost Contribution
per unit $30
margin $200
$ 50 $ 200
Board feet perBoard
unit feet 2 10 2 10
Monthly demand 600 100
CM per board foot $ 25 $ 20
The company’s supplier of hardwood will only
be able to supply Production
2,000 board of chairs
feet this 600
month.
What plan would Board feet required
maximize profits? 1,200
Board feet remaining 800
a. 500 chairs and 100 tables
Board feet per table 10
b. 600 chairs andProduction
80 tablesof tables 80
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.
13-72
Quick Check
Quick Check
Managing Constraints
Learning Objective 6
Prepare an analysis
showing whether joint
products should be sold at
the split-off point or
processed further.
Joint Costs
Joint Products
Oil
Common
Joint
Production Gasoline
Input
Process
Chemicals
Split-Off
Point
Joint Products
Joint
Costs Oil
Separate Final
Processing Sale
Common
Joint Final
Production Gasoline
Input Sale
Process
Separate Final
Chemicals
Processing
Sale
Split-Off Separate
Point Product
Costs
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.
13-79
• Sawmill,
Sawmill, Inc.
Inc. cuts
cuts logs
logs from
from which
which unfinished
unfinished
lumber
lumber andand sawdust
sawdust are are the
the immediate
immediate jointjoint
products.
products.
• Unfinished
Unfinished lumber
lumber is is sold
sold “as
“as is”
is” or
or processed
processed
further
further into
into finished
finished lumber.
lumber.
• Sawdust
Sawdust can can also
also bebe sold
sold “as
“as is”
is” to
to gardening
gardening
wholesalers
wholesalers or or processed
processed further
further into
into “presto-
“presto-
logs.”
logs.”
Costs
End of Chapter 12