ACCT 301 Saudi Electronic University Cost Accounting Paper

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Business Finance

ACCT 301

Saudi electronic university

ACT

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Q1 Give example of company using ABC costing and explain the process used in this company to assign costs in an ABC system? (Week 7: Chapter 7, ABC costing)

Answer:

Q 2 Give examples of questions managers could ask to help them identify relevant qualitative factors that will be used before making decision? (Week 9: Chapter 4, Relevant information for decision making)

Answer:

Q 3 Kadhim Co. manufactures product B which is a part of its main product. Kadhim Co makes 50,000 units of product B per year. The production costs are detailed below. An outside supplier has offered to supply 50,000 units of product B per year at $ 2.45 each. Fixed production cost of $ 40,000 associated with the product B are unavoidable. Should Kadhim Co make or buy the product B?

The production cost per unit for manufacturing a unit of product B are:

Direct Materials

0.85

Direct Labor

0.65

Variable Manufacturing Overhead

0.40

(Week 9: Chapter 4, Relevant information for decision making)


Chapters attached below.

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Cost Management Measuring, Monitoring, and Motivating Performance Chapter 7 Activity-Based Costing and Management © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 7: Activity-Based Costing and Management Learning objectives • Q1: What is activity-based costing (ABC)? • Q2: What are activities and how are they identified? • Q3: What process is used to assign costs in an ABC system? • Q4: What is activity-based management? • Q5: What are GPK and RCA? • Q6: How does information from ABC, GPK, and RCA affect managers’ incentives and decisions? © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Activity-Based Costing (ABC) • ABC is a method of cost system refinement. • Indirect costs are divided into “sub-pools” of costs of activities. • Activity costs are then allocated to the final cost objects using a cost allocation base (more commonly called cost drivers in ABC). • Activities are measurable, making it more likely that cost drivers can be found so that a final cost object will absorb indirect costs in proportion to its use of the activity. © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Traditional Costing vs. ABC Traditional costing systems: Indirect Costs Indirect costs are grouped into one (or a small number) of cost pools; a cost allocation base assigns costs to the individual products © John Wiley & Sons, 2011 Product A Direct Costs Product B Direct Costs Product C Direct Costs The individual products are the final cost objects. Direct costs are traced to the individual products. Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q1: Traditional Costing Systems © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q1: Traditional Costing vs. ABC Activity-based costing systems: Activity 1 Indirect Costs Activity 2 Product A Direct Costs Product B Direct Costs Product C Direct Costs Activity 3 Indirect costs are assigned (traced & allocated) to various pools of activity costs. © John Wiley & Sons, 2011 Activity costs are allocated to products Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e The individual products are the final cost objects & direct costs are traced to the individual products. Slide # 6 Q1: ABC Costing Systems © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 7 Q2: What are Activities and How are They Identified? The ABC cost hierarchy includes the following activities: • organization-sustaining – associated with overall organization • facility-sustaining – associated with single manufacturing plant or service facility • customer-sustaining – associated with a single customer • product-sustaining – associated with product lien or single product • batch-level – associated with each batch of product • unit-level – associated with each unit produced © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2: ABC Cost Hierarchy Example Some of the costs incurred by the Dewey Chargem law firm are listed below. This firm specializes in immigration issues and family law. For each cost, identify whether the cost most likely relates to a(n) (1) organiz-ationsustaining, (2) facility-sustaining, (3) customer-sustaining, (4) productsustaining, (5) batch-level, or (6) unit-level activity and explain your choice. Cost Cost Hierarchy Level Bookkeeping software Salary for partner in charge of family law Office supplies Subscription to family law update journal Telephone charges for local calls Long distance telephone charges Window washing service Salary of receptionist © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 9 Q3: What Process is Used to Assign Costs in an ABC system? 1. Identify the relevant cost object. 2. Identify activities and group homogeneous activities. 3. Assign costs to the activity cost pools. 4. Choose a cost driver for each activity cost pool. 5. Calculate an allocation rate for each activity cost pool. 6. Allocate activity costs to the final cost object. © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 10 Q3: How Are Cost Drivers Selected for Activities? • For each activity, determine its place in the ABC cost hierarchy. • Look for drivers that have a good cause-and-effect relationship with the activities’ costs. • Use a reasonable driver when there is no cause-and-effect relationship. © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q3: ABC in Manufacturing Example Alphabet Co. makes products A & B. Product A is a low-volume specialty item and B is a high-volume item. Estimated factory- wide overhead is $800,000, and the number of DL hours for the year is estimated to be 50,000 hours. DL costs are $10/hour. Each product uses 2 DL hours. Compute the traditional cost of each product if Products A & B use $25 and $10 in direct materials, respectively. First, compute the estimated overhead rate: Estimated overhead rate = $800,000/50,000 hours = $16/hour. Direct materials Direct labor (2hrs @ $10) Overhead (2 hrs @ $16) © John Wiley & Sons, 2011 Product A $25 20 32 $77 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Product B $10 20 32 $62 Slide # 12 Q3: ABC in Manufacturing Example Alphabet Co. is implementing an ABC system. It estimated the costs and activity levels for the upcoming year shown below. Estimated Estimated Activity Levels Costs Prod. A Prod. B Total Cost Driver Machine set-ups $200,000 3,000 2,000 5,000 # set-ups Inspections 140,000 500 300 800 # inspections Materials handling 80,000 400 400 800 # mat'l requistions Machining dep't 320,000 12,000 28,000 40,000 # machine hours Quality control dep't 60,000 600 150 750 # tests $800,000 First, compute the estimated overhead rate for each activity: © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 13 Q3: ABC in Manufacturing Example Estimated Costs Estimated Activity Overhead Rate $40 Machine set-ups $200,000 5,000 set-ups $40/setup /setup $175 Inspections 140,000 800 inspections $175/inspection /inspection Materials handling 80,000 800 mat'l requistions $100 $100/requisition /requisition $8 Machining dep't 320,000 40,000 machine hours $8/mach /machhrhr $80 Quality control dep't 60,000 750 tests $80/test /test $800,000 © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q3: ABC in Manufacturing Example Alphabet recently completed a batch of 100 As and a batch of 100 Bs. Direct material and labor costs were as budgeted. Information about each batch’s use of the cost drivers is given below. Compute the overhead allocated to each unit of A and B. 100 As 100 Bs Machine set-ups 60 10 Inspections 10 2 Overhead allocated: 100 As 100 Bs Materials handling 4 2 Machine set-ups $2,400 $400 Machining dep't 240 120 Inspections 1,750 350 Quality control dep't 3 1 Materials handling 400 200 Machining dep't 1,920 960 Quality control dep't 240 80 Overhead for batch $6,710 $1,990 Overhead per unit © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e $67.10 $19.90 Slide # 15 Q3: ABC in Manufacturing Example Compute the total cost of each product and compare it to the costs computed under traditional costing. Prod A Prod B Direct material $25.00 $10.00 Direct labor 20.00 20.00 Overhead 67.10 19.90 $112.10 $49.90 Total Traditional costing assigned $77 to a unit of Product A and $62 to a unit of Product B. • The only difference between the two costing systems is that Product A is assigned more overhead costs under ABC. • The additional overhead assigned to Product A reflects Product A’s consumption of resources. © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 16 Q4: Activity-Based Management (ABM) • ABM is the process of using ABC information to evaluate opportunities for improvements in an organization. • Examples include managing & monitoring • • • • • customer profitability product and process design environmental costs quality constrained resources © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q4: ABM & Customer Profitability • Activities can be defined so that different costs of servicing customers are accumulated. • Examples include • analyzing the types of bank transactions used by various categories of customers • comparing the costs of servicing insurance contracts sold to married versus single individuals • comparing the costs of different distribution channels © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q4: ABM & Product/Process Improvements • Activities can be defined so that the costs of stages of production or of a business process are accumulated. • Examples include • determining the costs of non-value-added activities so the most costly can be reduced or eliminated • changing the steps in the accounts payable function to reduce the number of personnel • determining the most costly stages of product development so that the time to market is reduced © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 19 Q4: ABM & Environmental Costs • Activities can be defined so that types of environmental costs are accumulated. • Examples include • capturing the costs of contingent liabilities for waste disposal site remediation • comparing the cost of recycling packaging to the cost of disposal • computing the costs of treating different kinds of emissions © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 20 Q4: ABM & Quality Costs • Activities can be defined so that categories of costs of managing quality are accumulated. • Common categories of quality costs are • costs of prevention activities • costs of appraisal activities • costs of production activities • costs of postsales activities © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q5: What are GPK and RCA? • Costing approaches similar to ABC because they involve multiple pools and multiple drivers • GPK can be described as marginal planning and cost accounting – Each cost is traced to a cost center (smaller than a department) which performs a single repetitive activity, and is the responsibility of one manager) – Output measures tracks the volume of resource use – Costs are segregated into proportional (change with volume in resource use) and fixed – Practical capacity is used for estimated allocation rate volumes © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 22 Q5: Capacity Definitions • Theoretical capacity – maximum assuming continuous, uninterrupted operations 365 days/year • Practical capacity – typical operating conditions • Budgeted capacity – expected volume for the upcoming time period • Idle/excess capacity – difference between activity capacity used and one of the above measures of capacity © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 23 Q5: What are GPK and RCA? • Resource Consumption Accounting (RCA) • Builds on GPK and ABC principles • Each cost is assigned to a resource cost pool – Labor and machinery are often placed in different cost pools since they are different types of resources – RCA involves a significantly larger number of cost pools than traditional accounting – Like GPK, segregates proportional and fixed costs – Utilizes theoretical rather than practical capacity for allocating fixed costs • More likely to focus manager attention on reducing idle and nonproductive resource time © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 24 Q5: Benefits/Drawbacks to GPK/RCA • Benefits – Generates multi-level internal income statements useful for short terms decisions because it focuses on marginal cost – Increases cause & effect awareness among managers – Categorizes costs (and generates profit margin) at the product, product group, division, and company level – Avoids arbitrary allocations of fixed costs • Drawbacks – Can be costly to implement – Can result in a large number of variances to analyze © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 25 Q5: Comparison of ABC, GPK, and RCA ABC Character of cost accounting system GPK RCA Full costing Marginal costing Full and marginal costing Location of data Database separate from general ledger Comprehensive accounting system Comprehensive accounting system Primary decision relevance Mid- to long-term Short-term Short-, Mid-, and Long term Activities Cost Centers Resources and/or activities Activity –Based Resource Output related Resource output or activity related Actual, budgeted, or practical capacity Budgeted or practical capacity Theoretical capacity Allocation of overhead based on Cost Drivers Fixed cost allocation rate denominator © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 26 Q6: Decision Making with ABC, GPK, and RCA • Benefits • more accurate and relevant product cost information • employees focus attention on activities • measurement of the costs of activities and business processes • identify non-value-added activities and reduce costs • Costs • systems can be difficult to design and maintain • more information must be captured • decision makers may not use the information appropriately © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 27 Q6: Uncertainties in ABC and ABM Implementation • Judgment is required when determining activities. • Judgment is required when selecting cost drivers. • Denominator levels for cost drivers are estimates. • ABC information includes unitized fixed costs, so decision makers must use ABC information correctly. © John Wiley & Sons, 2011 Chapter 7: Activity-Based Costing and Management Eldenburg & Wolcott’s Cost Management, 2e Slide # 28 Cost Management Measuring, Monitoring, and Motivating Performance Chapter 4 Relevant Information for Decision Making © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 1 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Learning objectives • • • • • • Q1: What is the process for identifying and using relevant information in decision making? Q2: How is relevant quantitative and qualitative information used in special order decisions? Q3: How is relevant quantitative and qualitative information used in keep or drop decisions? Q4: How is relevant quantitative and qualitative information used in outsourcing (make or buy) decisions? Q5: How is relevant quantitative and qualitative information used in product emphasis and constrained resource decisions? Q6: What factors affect the quality of operating decisions? © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 2 Q1: Nonroutine Operating Decisions • Routine operating decisions are those made on a regular schedule. Examples include: • annual budgets and resource allocation decisions • monthly production planning • weekly work scheduling issues • Nonroutine operating decisions are not made on a regular schedule. Examples include: • • • • accept or reject a customer’s special order keep or drop business segments insource or outsource a business activity constrained (scarce) resource allocation issues © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 3 Q1: Nonroutine Operating Decisions © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 4 Q1: 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. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 5 Q1: Identify the Type of Decision • • Special order decisions • determine the pricing • accept or reject a customer’s proposal for order quantity and pricing • identify if there is sufficient available capacity Keep or drop business segment decisions • • examples of business segments include product lines, divisions, services, geographic regions, or other distinct segments of the business eliminating segments with operating losses will not always improve profits © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 6 Q1: Identify the Type of Decision • • • Outsourcing decisions • make or buy production components • perform business activities “in-house” or pay another business to perform the activity Constrained resource allocation decisions • determine which products (or business segments) should receive allocations of scarce resources • examples include allocating scarce machine hours or limited supplies of materials to products Other decisions may use similar analyses © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 7 Q1: Identify and Apply the Relevant Quantitative Analysis Technique(s) • • Regression, CVP, and linear programming are examples of quantitative analysis techniques. Analysis techniques require input data. • Data for some input variables will be known and for other input variables estimates will be required. • Many nonroutine decisions have a general decision rule to apply to the data. • The results of the general rule need to be interpreted. • The quality of the information used must be considered when interpreting the results of the general rule. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 8 Q2-Q5 : Identify and Analyze Qualitative Factors • Qualitative information cannot easily be valued in dollars. • • • can be difficult to identify can be every bit as important as the quantitative information Examples of qualitative information that may be relevant in some nonroutine decisions include: • quality of inputs available from a supplier • effects of decision on regular customers • effects of decision on employee morale • effects of production on the environment or the community © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 9 Q1: Consider All Information and Make a Decision • Before making a decision: • Consider all quantitative and qualitative information. • Judgment is required when interpreting the effects of qualitative information. • Consider the quality of the information. • Judgment is also required when user lower-quality information. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 10 Q2: Special Order Decisions • • A new customer (or an existing customer) may sometimes request a special order with a lower selling price per unit. The general rule for special order decisions is: • • accept the order if incremental revenues exceed incremental costs, subject to qualitative considerations. Price >= • Relevant Variable Costs + Relevant Fixed Costs + Opportunity Cost If the special order replaces a portion of normal operations, then the opportunity cost of accepting the order must be included in incremental costs. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 11 Q2: Special Order Decisions RobotBits, Inc. makes sensory input devices for robot manufacturers. The normal selling price is $38.00 per unit. RobotBits was approached by a large robot manufacturer, U.S. Robots, Inc. USR wants to buy 8,000 units at $24, and USR will pay the shipping costs. The per-unit costs traceable to the product (based on normal capacity of 94,000 units) are listed below. Which costs are relevant to this decision? yes$6.20 Relevant? Direct materials yes 8.00 Relevant? Direct labor Variable mfg. overhead yes 5.80 Relevant? no 3.50 Relevant? Fixed mfg. overhead yes Shipping/handling no 2.50 Relevant? Fixed administrative costs no 0.88 Relevant? no 0.36 Relevant? Fixed selling costs $27.24 © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e $20.00 Slide # 12 Q2: Special Order Decisions Suppose that the capacity of RobotBits is 107,000 units and projected sales to regular customers this year total 94,000 units. Does the quantitative analysis suggest that the company should accept the special order? First determine if there is sufficient idle capacity to accept this order without disrupting normal operations: Projected sales to regular customers Special order 94,000 units 8,000 units 102,000 units RobotBits still has 5,000 units of idle capacity if the order is accepted. Compare incremental revenue to incremental cost: Incremental profit if accept special order = ($24 selling price - $20 relevant costs) x 8,000 units = $32,000 © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 13 Q2: Qualitative Factors in Special Order Decisions What qualitative issues, in general, might RobotBits consider before finalizing its decision? • Will USR expect the same selling price per unit on future orders? • Will other regular customers be upset if they discover the lower selling price to one of their competitors? • Will employee productivity change with the increase in production? • Given the increase in production, will the incremental costs remain as predicted for this special order? • Are materials available from its supplier to meet the increase in production? © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 14 Q2: Special Order Decisions and Capacity Issues Suppose instead that the capacity of RobotBits is 100,000 units and projected sales to regular customers this year totals 94,000 units. Should the company accept the special order? Here the company does not have enough idle capacity to accept the order: Projected sales to regular customers Special order 94,000 units 8,000 units 102,000 units If USR will not agree to a reduction of the order to 6,000 units, then the offer can only be accepted by denying sales of 2,000 units to regular customers. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 15 Q2: Special Order Decisions and Capacity Issues Suppose instead that the capacity of RobotBits is 100,000 units and projected sales to regular customers this year total 94,000 units. Does the quantitative analysis suggest that the company should accept the special order? Direct materials Direct labor Variable mfg. overhead Fixed mfg. overhead Shipping/handling Fixed administrative costs Fixed selling costs $6.20 8.00 5.80 3.50 2.50 0.88 0.36 $27.24 Variable cost/unit for regular sales = $22.50. CM/unit on regular sales = $38.00 - $22.50 = $15.50. The opportunity cost of accepting this order is the lost contribution margin on 2,000 units of regular sales. Incremental profit if accept special order = $32,000 incremental profit under idle capacity – opportunity cost = $32,000 - $15.50 x 2,000 = $1,000 © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 16 Q2: Qualitative Factors in Special Order Decisions What additional qualitative issues, in this case of a capacity constraint, might RobotBits consider before finalizing its decision? • What will be the effect on the regular customer(s) that do not receive their order(s) of 2,000 units? • What is the effect on the company’s reputation of leaving orders from regular customers of 2,000 units unfilled? • Will any of the projected costs change if the company operates at 100% capacity? • Are there any methods to increase capacity? What effects do these methods have on employees and on the community? • Notice that the small incremental profit of $1,000 will probably be outweighed by the qualitative considerations. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 17 Q3: Keep or Drop Decisions • Managers must determine whether to keep or eliminate business segments that appear to be unprofitable. • The general rule for keep or drop decisions is: • • keep the business segment if its contribution margin covers its avoidable fixed costs, subject to qualitative considerations. Drop if: Contribution < Relevant Margin Fixed Costs • + Opportunity Cost If the business segment’s elimination will affect continuing operations, the opportunity costs of its discontinuation must be included in the analysis. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q3: Keep or Drop Decisions Starz, Inc. has 3 divisions. The Gibson and Quaid Divisions have recently been operating at a loss. Management is considering the elimination of these divisions. Divisional income statements (in 1000s of dollars) are given below. According to the quantitative analysis, should Starz eliminate Gibson or Quaid or both? Revenues Variable costs Contribution margin Traceable fixed costs Division operating income Unallocated fixed costs Operating income Gibson Quaid Russell $390 $433 $837 247 335 472 143 98 365 166 114 175 ($23) ($16) $190 Breakdown of traceable fixed costs: Avoidable $154 Unavoidable 12 $166 © John Wiley & Sons, 2011 $96 18 $114 Total $1,660 1,054 606 455 151 81 $70 $139 36 $175 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 19 Q3: Keep or Drop Decisions Revenues Variable costs Contribution margin Traceable fixed costs Division operating income Unallocated fixed costs Operating income Gibson Quaid Russell $390 $433 $837 247 335 472 143 98 365 166 114 175 ($23) ($16) $190 Breakdown of traceable fixed costs: Avoidable $154 Unavoidable 12 $166 $96 18 $114 Total $1,660 1,054 606 455 151 81 $70 $139 36 $175 Contribution margin Avoidable fixed costs Effect on profit if keep Use the general rule to determine if Gibson and/or Quaid should be eliminated. Gibson Quaid $143 $98 154 96 ($11) $2 The general rule shows that we should keep Quaid and drop Gibson. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 20 Q3: Keep or Drop Decisions Revenues Variable costs Contribution margin Traceable fixed costs Division operating income Unallocated fixed costs Operating income Gibson Quaid Russell $390 $433 $837 247 335 472 143 98 365 166 114 175 ($23) ($16) $190 Breakdown of traceable fixed costs: Avoidable $154 Unavoidable 12 $166 $96 18 $114 Total $1,660 1,054 606 455 151 81 $70 $139 36 $175 Revenues Using the general rule is easier than recasting the income statements: Gibson Quaid Russell Total $390 $433 $837 $1,270 Variable costs 247 335 472 807 Contribution margin 143 98 365 $463 Traceable fixed costs 166 114 175 289 ($23) ($16) $190 $174 Division operating income Unallocated fixed costs 81 Gibson's unavoidable fixed costs 12 Operating income Quaid & Russell only $81 Profits increase by $11 when Gibson is eliminated. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 21 Q3: Keep or Drop Decisions Suppose that the Gibson & Quaid Divisions use the same supplier for a particular production input. If the Gibson Division is dropped, the decrease in purchases from this supplier means that Quaid will no longer receive volume discounts on this input. This will increase the costs of production for Quaid by $14,000 per year. In this scenario, should Starz still eliminate the Gibson Division? Effect on profit if drop Gibson before considering impact on Quaid's production costs Opportunity cost of eliminating Gibson Revised effect on profit if drop Gibson $11 (14) ($3) Profits decrease by $3 when Gibson is eliminated. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 22 Q3: Qualitative Factors in Keep or Drop Decisions What qualitative issues should Starz consider before finalizing its decision? • What will be the effect on the customers of Gibson if it is eliminated? What is the effect on the company’s reputation? • What will be the effect on the employees of Gibson? Can any of them be reassigned to other divisions? • What will be the effect on the community where Gibson is located if the decision is made to drop Gibson? • What will be the effect on the morale of the employees of the remaining divisions? © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 23 • Q4: Insource or Outsource (Make or Buy) Decisions Managers often must determine whether to • • • make or buy a production input keep a business activity in house or outsource the activity The general rule for make or buy decisions is: • • choose the alternative with the lowest relevant (incremental cost), subject to qualitative considerations If the decision will affect other aspects of operations, these costs (or lost revenues) must be included in the analysis. Outsource if: Cost to Outsource < Cost to Insource Where: © John Wiley & Sons, 2011 Cost to Relevant Relevant Opportunity Insource = FC + VC + Cost Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 24 Q4: Make or Buy Decisions Graham Co. currently of our main product manufactures a part called a gasker used in the manufacture of its main product. Graham makes and uses 60,000 gaskers per year. The production costs are detailed below. An outside supplier has offered to supply Graham 60,000 gaskers per year at $1.55 each. Fixed production costs of $30,000 associated with the gaskers are unavoidable. Should Graham make or buy the gaskers? The production costs per unit for manufacturing a gasker are: yes $0.65 Relevant? Direct materials yes 0.45 Relevant? Direct labor Variable manufacturing overhead yes 0.40 Relevant? no 0.50 Relevant? Fixed manufacturing overhead* $2.00 *$30,000/60,000 units = $0.50/unit $1.50 Advantage of “make” over “buy” = [$1.55 - $1.50] x 60,000 = $3,000 © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 25 Q4: Qualitative Factors in Make or Buy Decisions The quantitative analysis indicates that Graham should continue to make the component. What qualitative issues should Graham consider before finalizing its decision? • Is the quality of the manufactured component superior to the quality of the purchased component? • Will purchasing the component result in more timely availability of the component? • Would a relationship with the potential supplier benefit the company in any way? • Are there any worker productivity issues that affect this decision? © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 26 Q3: Make or Buy Decisions Suppose the potential supplier of the gasker offers Graham a discount for a different sub-unit required to manufacture Graham’s main product if Graham purchases 60,000 gaskers annually. This discount is expected to save Graham $15,000 per year. Should Graham consider purchasing the gaskers? Advantage of “make” over “buy” before considering discount (slide 23) Discount Advantage of “buy” over “make” $3,000 15,000 $12,000 Profits increase by $12,000 when the gasker is purchased instead of manufactured. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 27 Q5: Constrained Resource (Product Emphasis) Decisions • 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. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 28 Q5: Constrained Resource Decisions (Two Products; One Scarce Resource) Urban’s Umbrellas makes two types of patio umbrellas, regular and deluxe. Suppose there is unlimited customer demand for each product. The selling prices and variable costs of each product are listed below. Selling price per unit Variable cost per unit Contribution margin per unit Contribution margin ratio Required machine hours/unit Regular $40 20 $20 Deluxe $110 44 $ 66 50% 60% 0.4 2.0 Urban has only 160,000 machine hours available per year. Write Urban’s machine hour constraint as an inequality. 0.4R + 2D  160,000 machine hours © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 29 Q5: Constrained Resource Decisions (Two Products; One Scarce Resource) Suppose that Urban decides to make all Regular umbrellas. What is the total contribution margin? Recall that the CM/unit for R is $20. The machine hour constraint is: 0.4R + 2D  160,000 machine hours If D=0, this constraint becomes 0.4R  160,000 machine hours, or R  400,000 units Total contribution margin = $20*400,000 = $8 million Suppose that Urban decides to make all Deluxe umbrellas. What is the total contribution margin? Recall that the CM/unit for D is $66. If R=0, this constraint becomes 2D  160,000 machine hours, or D  80,000 units Total contribution margin = $66*80,000 = $5.28 million © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 30 Q5: Constrained Resource Decisions (Two Products; One Scarce Resource) If the choice is between all Ds or all Rs, then clearly making all Rs is better. But how do we know that some combination of Rs and Ds won’t yield an even higher contribution margin? make all Ds; get $5.28 million make all Rs; get $8 million In a one constraint problem, a combination of Rs and Ds will yield a contribution margin between $5.28 and $8 million. Therefore, Urban will only make one product, and clearly R is the best choice. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 31 Q5: Constrained Resource Decisions (Two Products; One Scarce Resource) The general rule for constrained resource decisions with one scarce resource is to first make only the product with the highest contribution margin per unit of the constrained resource. In Urban’s case, the sole scarce resource was machine hours, so Urban should make only the product with the highest contribution margin per machine hour. R: CM/mach hr = $20/0.4mach hrs = $50/mach hr D: CM/mach hr = $66/2mach hrs = $33/mach hr Notice that the total contribution margin from making all Rs is $50/mach hr x 160,000 machine hours to be used producing Rs = $8 million. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 32 Q5: Constrained Resource Decisions (Multiple Scarce Resources) • Usually managers face more than one constraint. • Multiple constraints are easiest to analyze using a quantitative analysis technique known as linear programming. • A problem formulated as a linear programming problem contains • an algebraic expression of the company’s goal, known as the objective function • • for example “maximize total contribution margin” or “minimize total costs” a list of the constraints written as inequalities © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 33 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) Suppose Urban also need 2 and 6 hours of direct labor per unit of R and D, respectively. There are only 120,000 direct labor hours available per year. Formulate this as a linear programming problem. Max 20R + 66D R,D subject to: 0.4R+2D  160,000 mach hr constraint 2R+6D  120,000 DL hr constraint nonnegativity constraints R0 (can’t make a negative D0 amount of R or D) objective function R, D are the choice variables constraints © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 34 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) Draw a graph showing the possible production plans for Urban. Every R, D ordered pair To determine this, graph the is a production plan. constraints as inequalities. But which ones are feasible, 0.4R+2D  160,000 mach hr constraint given the constraints? When D=0, R=400,000 D When R=0, D=80,000 2R+6D  120,000 DL hr constraint When D=0, R=60,000 When R=0, D=20,000 80,000 20,000 R 60,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 35 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) There are not enough machine hours or enough direct labor hours to produce this production plan. There are enough machine hours, but not enough direct labor hours, to produce this production plan. This production plan is feasible; there are enough machine hours and enough direct labor hours for this plan. D 80,000 The feasible set is the area where all the production constraints are satisfied. 20,000 R 60,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 36 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) The graph helped us realize an important aspect of this problem – we thought there were 2 constrained resources but in fact there is only one. For every feasible production plan, Urban will never run out of machine hours. D The machine hour constraint is non-binding, or slack, but the direct labor hour constraint is binding. 80,000 We are back to a one-scarceresource problem. 20,000 R 60,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 37 Q5: Constrained Resource Decisions (Two Products; One Scarce Resource) Here direct labor hours is the sole scarce resource. We can use the general rule for one-constraint problems. R: CM/DL hr = $20/2DL hrs = $10/DL hr D: CM/DL hr = $66/6DL hrs = $11/DL hr D Urban should make all deluxe umbrellas. 80,000 Optimal plan is R=0, D=20,000. Total contribution margin = $66 x 20,000 = $1,320,000 20,000 R 60,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 38 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) Suppose Urban has been able to train a new workforce and now there are 600,000 direct labor hours available per year. Formulate this as a linear programming problem, graph it, and find the feasible set. Max 20R + 66D R,D subject to: 0.4R+2D  160,000 mach hr constraint 2R+6D  600,000 DL hr constraint R0 D0 The formulation of the problem is the same as before; the only change is that the right hand side (RHS) of the DL hour constraint is larger. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 39 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) The machine hour constraint is the same as before. 0.4R+2D  160,000 mach hr constraint D 100,000 2R+6D  600,000 DL hr constraint When D=0, R=300,000 When R=0, D=100,000 80,000 R 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 40 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) There are not enough machine hours or enough direct labor hours for this production plan. There are enough direct labor hours, but not enough machine hours, for this production plan. There are enough machine hours, but not enough direct labor hours, for this production plan. D 100,000 This production plan is feasible; there are enough machine hours and enough direct labor hours for this plan. 80,000 The feasible set is the area where all the production constraints are satisfied. R 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 41 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) How do we know which of the feasible plans is optimal? We can’t use the general rule for one-constraint problems. We can graph the total contribution margin line, because its slope will help us determine the optimal production plan. D 100,000 80,000 The objective “maximize total contribution margin” means that we . . . this would be the choose a production plan so that the optimal production plan. contribution margin is a large as possible, without leaving the feasible set. If the slope of the total contribution margin line is lower (in absolute value terms) than the slope of the machine hour constraint, then. . . R 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 42 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) What if the slope of the total contribution margin line is higher (in absolute value terms) than the slope of the direct labor hour constraint? If the total CM line had this steep slope, . . D 100,000 . . then this would be the optimal production plan. 80,000 R 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 43 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) What if the slope of the total contribution margin line is between the slopes of the two constraints? If the total CM line had this slope, . . D 100,000 . . then this would be the optimal production plan. 80,000 R 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 44 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) The last 3 slides showed that the optimal production plan is always at a corner of the feasible set. This gives us an easy way to solve 2 product, 2 or more scarce resource problems. D 100,000 R=0, D=80,000 The total contribution margin here is 0 x $20 + 80,000 x $66 = $5,280,000. R=?, D=? Find the intersection of the 2 constraints. 80,000 R=300,000, D=0 The total contribution margin here is 300,000 x $20 + 0 x $66 = $6,000,000. R 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 45 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) To find the intersection of the 2 constraints, use substitution or subtract one constraint from the other. multiply each side by 5 Total CM = $5,280,000. D 100,000 80,000 0.4R+2D = 160,000 2R+10D = 800,000 2R+6D = 600,000 2R+6D = 600,000 subtract 0R+4D = 200,000 D = 50,000 Total CM = $20 x 150,000 + 2R+6(50,000) = 600,000 $66 x 50,000 = $6,300,000. 2R = 300,000 R = 150,000 Total CM = $6,000,000. R 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 46 Q5: Constrained Resource Decisions (Two Products; Two Scarce Resources) By checking the total contribution margin at each corner of the feasible set (ignoring the origin), we can see that the optimal production plan is R=150,000, D=50,000. Total CM = $5,280,000. D 100,000 80,000 Knowing how to graph and solve 2 product, 2 scarce resource problems is good for understanding the nature of a linear programming problem (but difficult in more complex problems). Total CM = $6,300,000. 50,000 Total CM = $6,000,000. R 150,000 300,000 © John Wiley & Sons, 2011 400,000 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 47 Q5: Qualitative Factors in Scarce Resource Allocation Decisions The quantitative analysis indicates that Urban should produce 150,000 regular umbrellas and 50,000 deluxe umbrellas. What qualitative issues should Urban consider before finalizing its decision? • The assumption that customer demand is unlimited is unlikely; can this be investigated further? • Are there any long-term strategic implications of minimizing production of the deluxe umbrellas? • What would be the effects of attempting to relax the machine hour or DL hour constraints? • Are there any worker productivity issues that affect this decision? © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 48 Q5: Constrained Resource Decisions (Multiple Products; Multiple Constraints) • Problems with multiple products, one scarce resource, and one constraint on customer demand for each product are easy to solve. • The general rule is to make the product with the highest contribution margin per unit of the scarce resource: – until its customer demand is satisfied – then move to the product with the next highest contribution margin per unit of the scarce resource, etc. • Problems with multiple products and multiple scarce resources are too cumbersome to solve by hand – Excel solver is a useful tool here. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 49 Q5: Constrained Resource Decisions (Two Products; One Scarce Resource) Urban’s Umbrellas makes two types of patio umbrellas, regular and deluxe. Suppose customer demand for regular umbrellas is 300,000 units and for deluxe umbrellas customer demand is limited to 60,000. Urban has only 160,000 machine hours available per year. What is his optimal production plan? How much would he pay (above his normal costs) for an extra machine hour? Selling price per unit Variable cost per unit Contribution margin per unit Regular $40 20 $20 Deluxe $110 44 $ 66 Required machine hours/unit 0.4 2.0 CM/machine hour $50 $33 Urban should first concentrate on making Rs. He can make enough to satisfy customer demand for Rs: 300,000 Rs x 0.4 mach hr/R = 120,000 mach hrs. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 50 Q5: Constrained Resource Decisions (Two Products; One Scarce Resource) Selling price per unit Variable cost per unit Contribution margin per unit Regular $40 20 $20 Deluxe $110 44 $ 66 Required machine hours/unit 0.4 2.0 CM/machine hour $50 $33 The 40,000 remaining hours will make 20,000 Ds. The optimal plan is 300,000 Rs and 20,000 Ds. The CM/mach hr shows how much Urban would be willing to pay, above his normal costs, for an additional machine hour. Here Urban will be producing Ds when he runs out of machine hours so he’d be willing to pay up to $33 for an additional machine hour. If customer demand for Rs exceeded 400,000 units, Urban would be willing to pay up to an additional $50 for a machine hour. If customer demand for Rs and Ds could be satisfied with the 160,000 available machine hours, then Urban would not be willing to pay anything to acquire an additional machine hour. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 51 Q5: Constrained Resource Decisions Using Excel Solver To obtain the solver dialog box, choose “Solver” from the Tools pull-down menu. The “target cell” will contain the maximized value for the objective (or “target”) function. Choose “max” for the types of problems in this chapter. Add constraint formulas by clicking “add”. © John Wiley & Sons, 2011 Choose one cell for each choice variable (product). It’s helpful to “name” these cells. Click “solve” to obtain the next dialog box. Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 52 Q5: Constrained Resource Decisions Using Excel Solver Cell B2 was named “Regular” and cell C2 was named Deluxe. =20*Regular + 66*Deluxe =0.4*Regular+ 2*Deluxe =2*Regular+ 6*Deluxe =Regular (cell B2) =Deluxe (cell C2) Then click “solve” and choose all 3 reports. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 53 Q5: Excel Solver Answer Report Microsoft Excel 9.0 Answer Report Refer to the problem on Slide #50. Target Cell (Max) Original Cell Name Value 0 $B$3 Regular The total contribution margin for the optimal plan was $6.3 million. Final Value 6,300,000 The optimal production plan was 150,000 Rs and 50,000 Ds. Adjustable Cells Original Cell Name Value 0 $B$2 Regular 0 $C$2 Deluxe Final Value 150,000 50000 The machine and DL hour constraints are binding – the plan uses all available machine and DL hours. Constraints Cell Value Formula Status 600,000 $B$9=$C$11 Binding 50,000 $B$10 R>0 Not 150,000 $B$10>=$C$10 Binding 150,000 Cell Name $B$9 DL hr © John Wiley & Sons, 2011 Slack The nonnegativity constraints for R and D are not binding; the slack is 50,000 and 150,000 units respectively. Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 54 Q5: Excel Solver Sensitivity Report Microsoft Excel 9.0 Sensitivity Report Refer to the problem on Slide #50. Adjustable Cells Final Reduced Objective Allowable Allowable Cell Name Value Cost Coefficient Increase Decrease $B$2 Regular 150,000 0 20 2 6.8 $C$2 Deluxe 50000 0 66 34 6 Constraints Final Shadow Constraint Allowable Allowable Cell Name Value Price R.H. Side Increase Decrease $B$9 DL hr 600,000 9 600000 200000 120000 $B$8 mach hr 160,000 8 160000 40000 40000 $B$11 D>0 50,000 0 0 50000 1E+30 $B$10 R>0 150,000 0 0 150000 1E+30 This shows how much the slope of the total CM line can change before the optimal production plan will change. The CM per unit for Regular can drop to $13.20 or increase to $22 (all else equal) before the optimal plan will change. The CM per unit for Deluxe can drop to $60 or increase to $100 (all else equal) before the optimal plan will change. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 55 Q5: Excel Solver Sensitivity Report Microsoft Excel 9.0 Sensitivity Report Refer to the problem on Slide #50. Adjustable Cells Final Reduced Objective Allowable Allowable Cell Name Value Cost Coefficient Increase Decrease $B$2 Regular 150,000 0 20 2 6.8 $C$2 Deluxe 50000 0 66 34 6 Constraints Final Shadow Constraint Allowable Allowable Cell Name Value Price R.H. Side Increase Decrease $B$9 DL hr 600,000 8.50 600000 200000 120000 $B$8 mach hr 160,000 7.50 160000 40000 40000 $B$11 D>0 50,000 0.00 0 50000 1E+30 $B$10 R>0 150,000 0.00 0 150000 1E+30 This shows how much the RHS of each constraint can change before the shadow price will change. The available DL hours could decrease to 480,000 or increase to 800,000 (all else equal) before the shadow price for DL would change. The available machine hours could decrease to 120,000 or increase to 200,000 (all else equal) before the shadow price for machine hours would change. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 56 Q5: Excel Solver Sensitivity Report Microsoft Excel 9.0 Sensitivity Report Refer to the problem on Slide #50. Adjustable Cells Final Reduced Objective Allowable Allowable Cell Name Value Cost Coefficient Increase Decrease $B$2 Regular 150,000 0 20 2 6.8 $C$2 Deluxe 50000 0 66 34 6 Constraints Final Shadow Constraint Allowable Allowable Cell Name Value Price R.H. Side Increase Decrease $B$9 DL hr 600,000 8.50 600000 200000 120000 $B$8 mach hr 160,000 7.50 160000 40000 40000 $B$11 D>0 50,000 0.00 0 50000 1E+30 $B$10 R>0 150,000 0.00 0 150000 1E+30 The shadow price shows how much a one unit increase in the RHS of a constraint will improve the total contribution margin. Urban would be willing to pay up to $8.50 to obtain one more DL hour and up to $7.50 to obtain one more machine hour. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 57 Q7: Impacts to Quality of Nonroutine Operating Decisions • The quality of the information used in nonroutine operating decisions must be assessed. • There may be more information quality issues (and more uncertainty) in nonroutine decisions because of the irregularity of the decisions. • Three aspects of the quality of information available can affect decision quality. • Business risk (changes in economic condition, consumer demand, regulation, competitors, etc.) • Information timeliness • Assumptions in the quantitative and qualitative analyses © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 58 Q7: Impacts to Quality of Nonroutine Operating Decisions • Short term decision must align to company’s overall strategic plans • Must watch for decision maker bias – Predisposition for specific outcome – Preference for one type of analysis without considering other options • Opportunity costs are often overlooked • Performing sensitivity analysis can help assess and minimize business risk • Established control system incentives (performance bonuses, etc.) can encourage sub-obtimal decision making © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 59
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Question one
The activity-based costing system can be considered to be a method of accounting enabling an
individual to find the total budget or cost of activities needed to make a product. The ABS system
usually assigns costs to every activity going into production for example workers trying out a
product
Process
1. Identify the activities needed to create a product
2. Separate every ac...


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I was struggling with this subject, and this helped me a ton!

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