bmac 5203 - handouts - new - part 1

8/12/2019 BMAC 5203 - Handouts - New - Part 1

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BMAC 5203

ACCOUNTING FOR BUSINESS

DECISION MAKING

Lecturer

Nguyen Phong Nguyen

Lecturer in Accounting-University of Economics HCMC

MA. University of EconomicsHCMC

MBus (Accounting). MonashUniversity (Australia)

DBA. University of Western Sydney(Australia)


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Study Program

1. Managerial accounting and basic cost concepts2. Activity-based costing3. CVP analysis4. Relevant costs for decision making5. Profit planning6. Flexible budgets and performance analysis7. Standard costs and operating performance measures

8. Performance evaluation and decentralization9. Other contemporary issues in managerial accounting[no lecture, self-reading]

Lecture 1Part A:

Introduction to ManagerialAccounting and Ethics


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Learning Objectives

1. Explain the meaning and objectives of

managerial accounting.

2. Explain the differences between managerial

accounting and financial accounting.

3. Explain the IMA Ethical Principles.

Why do managers need

accounting information?


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Comparison of Financial and

Managerial Accounting (continued)

The key point isflexibility

the accounting system should be able to supply

different information for different purposes.

Managerial Accounting

and Ethical Conduct [self reading]

The objective of profit maximization shouldbe constrained by the requirement that profits

be achieved through legal and ethical means.Ethical behavior involves choosing actions

that are right, proper, and just.


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IMA Ethical Principles

Competencemaintain an appropriate level ofprofessional expertise by continually developingknowledge and skills;

Confidentialityrefrain using confidentialinformation for unethical or illegal advantage;

Integrityabstain from engaging in or supporting anyactivity that might discredit the profession; and

Credibilitycommunicate information fairly and

objectively.

Lecture 1Part B:

Basic Cost Concepts


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Learning Objectives

1. Define cost

2. Understand three types of manufacturing costs.

3. Distinguish between product costs and period costs

4. Apply cost estimation methods to separate mixedcosts into fixed and variable elements.

What is cost?

Costis the amount of cash or cash equivalent

sacrificed for goods and/or services that are

expected to bring a current or future benefit tothe organization.


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The Product

DirectMaterials DirectLabor ManufacturingOverhead

Manufacturing Costs

Direct Materials

Raw materials that become an integralpart of the product and that can be

conveniently traced directly to it.

Example: A radio installed in an automobile


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Direct Labor

Those labor costs that can be easily tracedto individual units of product.

Example: Wages paid to automobile assembly workers

Manufacturing costs that cannotbe traced directlyto specific units produced.

Manufacturing Overhead

Examples: Indirect materials and indirect labor

Wages paid to employeeswho are not directly

involved in productionwork.

Examples: maintenanceworkers, janitors and

security guards.

Materials used to supportthe production process.

Examples: lubricants andcleaning supplies used in theautomobile assembly plant.


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Nonmanufacturing Costs

Selling

Costs

Costs necessary to

secure the order anddeliver the product.

Administrative

Costs

All executive,

organizational, andclerical costs.

Product Costs Versus Period Costs

Product costs include

direct materials, directlabor, and manufacturing

overhead.

Period costsinclude all

selling costs andadministrative costs.

Inventory Cost of Good Sold

BalanceSheet

IncomeStatement

Sale

Expense

IncomeStatement


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Manufacturing Cost Flows

Finished

Goods

Cost of

GoodsSold

Selling and

Administrative

Period CostsSelling andAdministrative

ManufacturingOverhead

Work in

Process

Direct Labor

Balance SheetCosts Inventories

IncomeStatement

ExpensesMaterial Purchases Raw Materials

Cost Classifications for Predicting

Cost Behavior

How a cost will react to changesin the level of activity within

the relevant range.Totalvariable costschange

when activity changes.

Total fixed costsremainunchanged when activitychanges.


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RelevantRange

A straight lineclosely

approximates acurvilinear variablecost line within the

relevant range.

Activity

TotalCost

EconomistsCurvilinear Cost

Function

The Linearity Assumption and the

Relevant Range

Accountants Straight-Line

Approximation (constant unitvariable cost)

Fixed Monthly

Utility Charge

Variable

Cost per KW

Activity (Kilowatt Hours)

TotalUtilityCost

X

Y

A mixed cost contains both variable and fixed elements.

Consider the example of utility cost.

Mixed Costs (also called semivariable costs)


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Mixed Costs

The total mixed cost line can be expressed

as an equation: Y= a+ bX

Where: Y = The total mixed cost.

a = The total fixed cost (the

vertical intercept of the line).

b = The variable cost per unit of

activity (the slope of the line).

X = The level of activity.

Fixed Monthly

Utility Charge

Variable

Cost per KW

Activity (Kilowatt Hours)

TotalU

tilityCost

X

Y

Plot the data points on a graph(Total Cost Yvs. Activity X).

0 1 2 3 4

*

MaintenanceCost

1,0

00sofDollars

10

20

0

***

**

**

*

*

Patient-days in 1,000s

X

Y

The Scattergraph Method


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The Scattergraph MethodDraw a line through the data points with about anequal numbers of points above and below the line.

0 1 2 3 4

*

MaintenanceCost

1,0

00sofDollars

10

20

0

***

**

**

*

*


X

Y

The Scattergraph Method

Use one data point to estimate the total level of activityand the total cost.

Intercept = Fixed cost: $10,000

0 1 2 3 4

*

MaintenanceCost

1,0

00sofDollars

10

20

0

***

**

**

*

*


X

Y

Patient days = 800

Total maintenance cost = $11,000


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Assigning Costs to Cost Objects

Direct costs

Costs that can beeasily and convenientlytraced to a unit ofproduct or other costobject.

Examples: directmaterial and directlabor

Indirect costs

Costs that cannot beeasily and convenientlytraced to a unit ofproduct or other costobject.

Example:manufacturingoverhead

McGraw-Hill/Irwin

Every decision involves a choice between

at least two alternatives.

Only those costs and benefits that differ

between alternatives are relevant in a

decision. All other costs and benefits can

and should be ignored.

Cost Classifications for Decision Making


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Differential Cost and Revenue

Costs and revenues that differ amongalternatives.

Example: You have a job paying $1,500 per month in yourhometown. You have a job offer in a neighboring city that

pays $2,000 per month. The commuting cost to the city is$300 per month.

Differential revenue is:

$2,000$1,500 = $500

Differential cost is:

$300

Opportunity Cost

The potential benefit that is givenup when one alternative is selected

over another.

Example: If you were not attending college,you could be earning $15,000 per year.Your opportunity cost of attending collegefor one year is $15,000.


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Sunk Costs

Sunk costs have already been incurred and cannot bechanged now or in the future. These costs should be

ignored when making decisions.

Example:You bought an automobile that cost $10,000two years ago. The $10,000 cost is sunk becausewhether you drive it, park it, trade it, or sell it, you

cannot change the $10,000 cost.

Homework

Exercises 2-2; 2-3; 2-6; 2-7; 2-13; 3-2; 3-3;3-7; 3-8; 3-10

Problem 3-12


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Product Cost Assignment under Traditional

Overhead Costing Approach

Direct materials

Direct labors Product A

PRIME COSTS

ManufacturingOverhead

(plantwide costs)Product B

Allocating based ona pre-determined

overhead rate

Tracing

Tracing

COST OBJECTS

How Costs are Treated UnderActivityBased Costing

Traditional cost systems usually rely on volumemeasures such as direct labor hours and/or machine

hours to allocate all overhead costs to products.

ABC definesfive levels of activity

that largely do not relateto the volume of units

produced.


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Activity Based Costing

The costing system that first trace costs to

activities (activity cost pools) and then to cost

objects.

The underlying assumption is that

Activities consume resources, and

Cost objects, in turn, consume activities

ABC is a two-stage process

Steps in Activity Based Costing

First stage cost allocation

1. Define activities, activity cost pools, and

activities measures.2. Assign overhead costs to activities cost poolsSecond stage cost allocation

3. Calculate activity rates

4. Assign overhead costs to cost objects usingactivity rates and activity measures


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First Stage Cost Allocation - Example

Exercise 7-6 - Define activities, activity cost pools, and activitiesmeasures

ActivityLevel of

activity

Examples of

measures

a. Direct labor workers assemble a product. Unit

b. Products are designed by engineers. Product

c. Equipment is set up. Batch

d. Machines are used to shape and cut materials. Unit

e. Monthly bills are sent out to regular customers. Customerf. Materials are moved from the receiving dock

to production lines.Batch

g. All completed units are inspected for defects. Unit

First Stage Cost Allocation - Example

Exercise 7-2 -Assign overhead costs to activities cost pools

TravelPickup and

delivery

Customer

serviceOther Totals

Driver and guard wages 360,000 252,000 72,000 36,000 720,000

Vehicle operating expense 196,000 14,000 70,000 280,000

Vehicle depreciation 72,000 18,000 30,000 120,000

Customer representativesalaries and expenses

- 144,000 16,000 160,000

Office expenses 6,000 9,000 15,000 30,000

Administrative expenses 16,000 192,000 112,000 320,000

Total cost 628,000 306,000 417,000 279,000 1,630,000


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Second Stage Cost Allocation - Example

Exercise 7-3 - Calculate activity rates

Activity cost pool

Estimated

overhead

cost ($)

Expected activity Activity rate ($)

Caring for lawn 72,000 150,000 square feet oflawn

0.48 per square footof lawn

Caring for gardenbedslowmaintenance

26,400 20,000 square feet of lowmaintenance beds(LMB)

1.32 per square footof LMB

Caring for gardenbedshighmaintenance

41,400 15,000 square feet of highmaintenance beds(HMB)

2.76 per square footof HMB

Travel to jobs 3,250 12,500 miles 0.26 per mile

Customer billingand service

8,750 25 customers 350 per customer


Exercise 7-4 -Assign overhead costs to cost objects using activityrates and activity measures

Product - K425

Activity Cost Pool Activity Rate ($) Expected activity ABC costSupporting direct labor 6 per DLH 80 direct DLHs 480

Machine processing 4 per machine-hour 100 machine-hours 400

Machine setups 50 per setup 1 setup 50

Production orders 90 per order 1 order 90

Shipments 14 per shipment 1 shipment 14

Product sustaining 840 per product 1 product 840

Total 1,874


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Exercise 7-4 -Assign overhead costs to cost objects using activityrates and activity measures

ProductM67

Activity Cost Pool Activity Rate ($) Expected activity ABC cost

Supporting direct labor 6 per DLH 500 direct DLHs 3,000

Machine processing 4 per machine-hour 1,500 machine-hours 6,000

Machine setups 50 per setup 4 setup 200

Production orders 90 per order 4 order 360

Shipments 14 per shipment 10 shipment 140

Product sustaining 840 per product 1 product 840

Total 10,540

ABC Limitations

Substantial resourcesrequired to implement

and maintain.

Resistance tounfamiliar numbers

and reports.

Desire to fullyallocate all costs

to products.

Potentialmisinterpretation ofunfamiliar numbers.

Does not conform toGAAP. Two costing

systems may be needed.


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Homework

Exercises 7-7; 7-8; 7-9; 7-10; 7-11; 7-12; 7-

13; 7-14

Problem 7-18

Lecture 3:Cost-Volume-Profit (CVP)

Analysis


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Learning Objectives

1. Understand the basics of CVP analysis

2. Determine the break-even point, the amount

of sales required for a target profit, the margin

of safety, and the degree of operating leverage.

3. .

4. Understand the underlying assumptions and

limitations of the CVP analysis tool.

Basics of Cost-Volume-Profit Analysis

Contribution Margin (CM) is the amount remaining from sales

revenue after variable expenses have been deducted.

Sales (500 bicycles) 250,000$

Less: Variable expenses 150,000

Contribution margin 100,000

Less: Fixed expenses 80,000

Net operating income 20,000$

Racing Bicycle Company

Contribution Income Statement

For the Month of June

The contribution income statement is helpful to managers in

judging the impact on profits of changes in selling price, cost, or

volume. The emphasis is on cost behavior.


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Basics of Cost-Volume-Profit Analysis

CM is used first to cover fixed expenses. Any remaining

CM contributes to net operating income.

Sales (500 bicycles) 250,000$

Less: Variable expenses 150,000







Total Per Unit

Sales (500 bicycles) 250,000$ 500$

Less: Variable expenses 150,000 300

Contribution margin 100,000 200$






The Contribution Approach

Sales, variable expenses, and contribution margin can also beexpressed on a per unit basis. If Racing sells an additional

bicycle, $200 additional CM will be generated to coverfixed expenses and profit.


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Total Per Unit

Sales (500 bicycles) 250,000$ 500$

Less: Variable expenses 150,000 300Contribution margin 100,000 200$







Each month, RBC must generate at least

$80,000 in total contribution margin to break-even (whichis the level of sales at which profit is zero).

Total Per Unit

Sales (400bicycles) 200,000$ 500$


Contribution margin 80,000 200$


Net operating income -$

Racing Bicycle CompanyContribution Income Statement



If RBC sells 400 unitsin a month, it will be

operating at the break-even point.


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Total Per Unit

Sales (401bicycles) 200,500$ 500$


Contribution margin 80,200 200$Less: Fixed expenses 80,000

Net operating income 200$





If RBC sells one more bike (401 bikes), net

operating income will increase by $200.


We do not need to prepare an income statement to estimateprofits at a particular sales volume. Simply multiply the

number of units sold above break-even by the contribution

margin per unit.

If Racing sells 430bikes, its net

operating incomewill be $6,000.


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CVP Relationships in Equation Form

This equation can also be used to show the $200 profit RBCearns if it sells 401 bikes.

Profit = (SalesVariable expenses)Fixed expenses

Profit = (P QV Q)Fixed expenses

Profit = ($500 401$300 401)$80,000$200 = ($500 401$300 401)$80,000

Unit CM = Selling price per unitVariable expenses per unit

It is often useful to express the simple profit equation in terms ofthe unit contribution margin (Unit CM) as follows:

Profit = (P QV Q)Fixed expensesProfit = (PV) QFixed expensesProfit = Unit CM QFixed expenses

Unit CM = PV

CVP Relationships in Equation Form


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Contribution Margin Ratio (CM Ratio)

Total Per Unit CM Ratio

Sales (500 bicycles) 250,000$ 500$ 100%

Less: Variable expenses 150,000 300 60%

Contribution margin 100,000 200$ 40%

Less: Fixed expenses 80,000Net operating income 20,000$




$100,000 $250,000 = 40%

The CM ratio is calculated by dividing the total contribution

margin by total sales.


The contribution margin ratio at Racing Bicycle is:

The CM ratio can also be calculated by dividingthe contribution margin per unit by the selling

price per unit.

CM per unitSP per unit

CM Ratio = = 40%$200$500

=


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400 Units 500 Units

Sales 200,000$ 250,000$

Less: variable expenses 120,000 150,000

Contribution margin 80,000 100,000

Less: fixed expenses 80,000 80,000

Net operating income -$ 20,000$


A $50,000 increase in sales revenue results in a $20,000increase in CM. ($50,000 40% = $20,000)

If Racing Bicycle increases sales by $50,000, contributionmargin will increase by $20,000 ($50,000 40%).

Here is the proof:

The Variable Expense Ratio

The variable expense ratio is the ratio of variable expenses tosales. It can be computed by dividing the total variable expenses bythe total sales, or in a single product analysis, it can be computedby dividing the variable expenses per unit by the unit selling price.


Sales (500 bicycles) 250,000$ 500$ 100%

Less: Variable expenses 150,000 300 60%

Contribution margin 100,000 200$ 40%







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A shortcut solution using incrementalanalysis

Increase in CM (40 units X $200) 8,000$

Increase in advertising expenses 10,000

Decrease in net operating income (2,000)$

Changes in Fixed Costs and Sales Volume

Change in Variable Costs and Sales Volume

What is the profit impact if Racing Bicycle can

use higher quality raw materials, thus increasingvariable costs per unit by $10, to generate an

increase in unit sales from 500 to 580?


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500 units 580 units

Sales 250,000$ 290,000$

Less: Variable expenses 150,000 179,800


Less: Fixed expenses 80,000 80,000

Net operating income 20,000$ 30,200$

580 units $310 variable cost/unit = $179,800

Sales increaseby $40,000, and net operating

income increasesby $10,200.

Change in Variable Costs and Sales Volume

Change in Fixed Cost, Sales Price

and Volume

What is the profit impact if RBC: (1) cuts its

selling price $20 per unit, (2) increases its

advertising budget by $15,000 per month, and (3)increases sales from 500 to 650 units per month?


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Sales increaseby $62,000, fixed costs increase by $15,000, and

net operating income increasesby $2,000.

Change in Fixed Cost, Sales Price and Volume

500 units 650 units

Sales 250,000$ 312,000$





650 units $480 = $312,000

Change in Variable Cost, Fixed Cost

and Sales Volume

What is the profit impact if RBC: (1) pays a $15 salescommission per bike sold instead of paying

salespersons flat salaries that currently total $6,000 permonth, and (2) increases unit sales from 500 to 575

bikes?


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Sales increaseby $37,500, fixed expenses decreaseby $6,000.

Net operating income increasesby $12,375.

500 units 575 units

Sales 250,000$ 287,500$





575 units $315 = $181,125

Change in Variable Cost, Fixed Cost

and Sales Volume

Change in Regular Sales Price

If RBC has an opportunity to sell 150 bikes toa wholesaler without disturbing sales to other

customers or fixed expenses, what price wouldit quote to the wholesaler if it wants to

increase monthly profits by $3,000?


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Change in Regular Sales Price

3,000$ 150 bikes = 20$ per bike

Variable cost per bike = 300 per bike

Selling price required = 320$ per bike

150 bikes $320 per bike = 48,000$

Total variable costs = 45,000

Increase in net operating income = 3,000$

Target Profit Analysis

Suppose Racing Bicycle management wants

to know how many bikes must be sold toearn a target profit of $100,000.


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Target Profit Analysis in Terms of Unit Sales

Suppose Racing Bicycle Company wants to know

how many bikes must be sold to earn a profit of

$100,000.

Target profit + Fixed expenses

CMper unit=

Unit sales to attain

the target profit

Unit sales = 900

$100,000 + $80,000$200Unit sales =

Target Profit Analysis in Terms of Dollar Sales

We can calculate the dollar sales needed to attain atarget profit (net operating profit) of $100,000 at

Racing Bicycle.

Target profit + Fixed expenses

CM ratio=

Dollar sales to attain

the target profit

Dollar sales = $450,000

$100,000 + $80,00040%

Dollar sales =


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Break-even Analysis

The equation and formula methods can be used to

determine the unit sales and dollar sales needed to achieve

a target profit of zero. Lets us the RBC information to

complete the break-even analysis.


Sales (500 bicycles) 250,000$ 500$ 100%

Less: Variable expenses 150,000 300 60%Contribution margin 100,000 200$ 40%






Break-even in Unit Sales

Lets apply this formula to determine the break-

even point.

Unit sales = 400

$80,000$200

Unit sales =

Fixed expenses

CMper unit=

Unit sales to

break even


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Break-even in Dollar Sales:

Formula MethodNow, lets use the formula method to calculate the dollar

sales at the break-even point.

Dollar sales = $200,000

$80,00040%Dollar sales =

Fixed expenses

CM ratio=

Dollar sales to

break even

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

0 100 200 300 400 500 600

Sales

Total expenses

Fixed expenses

Preparing the CVP Graph

Break-even point

(400 units or $200,000 in sales)

UnitsLoss Area

Profit Area


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The Margin of Safety in Dollars

The margin of safety in dollars is the excess of

budgeted (or actual) sales over the break-even

volume of sales.

Margin of safety in dollars = Total sales - Break-even sales

Lets look at Racing Bicycle Company and

determine the margin of safety.

The Margin of Safety in Dollars

If we assume that RBC has actual sales of $250,000, giventhat we have already determined the break-even sales tobe $200,000, the margin of safety is $50,000 as shown.

Break-even

sales

400 units

Actual sales

500 units

Sales 200,000$ 250,000$



Less: fixed expenses 80,000 80,000



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The Margin of Safety Percentage

RBCs margin of safety can be expressed as

20%of sales. ($50,000 $250,000)

Break-even

sales

400 units

Actual sales

500 units

Sales 200,000$ 250,000$


Contribution margin 80,000 100,000Less: fixed expenses 80,000 80,000


The Margin of Safety

The margin of safety can be expressed in terms of thenumber of units sold. The margin of safety at RBC is

$50,000, and each bike sells for $500; hence, RBCsmargin of safety is 100 bikes.

Margin ofSafety in units

= = 100 bikes$50,000

$500


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Operating Leverage

Operating leverage is a measure of how sensitive net operatingincome is to percentage changes in sales. It is a measure, atany given level of sales, of how a percentage change in sales

volume will affect profits.

** Profit Before Tax is a commonly used alternative to Net Operating Income

in the degree of operating leverage calculation

**IncomeOperatingNet

MarginonContributiLeverageOperatingofDegreeDOL

Operating Leverage

Actual sales

500 Bikes

Sales 250,000$Less: variable expenses 150,000


Less: fixed expenses 80,000

Net income 20,000$

$100,000

$20,000 = 5

Degree of

Operating

Leverage=

To illustrate, lets revisit the contribution income

statement for RBC.


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Operating Leverage

With an operating leverage of 5, if RBC increases its

sales by 10%, net operating income would increase

by 50%.

Percent increase in sales 10%

Degree of operating leverage 5

Percent increase in profits 50%

Heres the verification!

Operating Leverage

Actual sales

(500)

Increased

sales (550)

Sales 250,000$ 275,000$

Less variable expenses 150,000 165,000


Less fixed expenses 80,000 80,000


10% increase in sales from

$250,000 to $275,000 . . .

. . . results in a 50% increase in

income from $20,000 to $30,000.


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What does higher value of Operating

Leverage mean?

High Operating Leverage ratiosignals the existence of high fixed costs.

increases risk of making loss in adverse market conditions.

increases opportunity to make profit when higher demandexists.

has lower margin of safety percentage (MoS%)

MoS%1DOL

The Concept of Sales Mix

Sales mix is the relative proportion in which acompanys products are sold.

Different products have different selling prices, cost

structures, and contribution margins.When a company sells more than one product, break-

even analysis becomes more complex as the followingexample illustrates.

Lets assume Racing Bicycle Company sells bikes andcarts and that the sales mix between the two products

remains the same.


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Key Assumptions of CVP Analysis

Selling price is constant.

Costs are linear and can be accurately divided intovariable (constant per unit) and fixed (constant in total)elements.

In multiproduct companies, the sales mix is constant.

In manufacturing companies, inventories do not

change (units produced = units sold).

Homework

Exercises 4-12; 4-13; 4;15; 4-16; 4-18

Problems 4-19; 4-22; 4-23; 4-27; 4-28


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Lecture 4:

Relevant Costs for Decision

Making

Learning Objectives

1. Understand the concepts of relevant costs andbenefits.

2. Identify and apply relevant costs and benefits, in avariety of business decisions

a. Make or buy.

b. Drop or retain a business segment.

c. Accept or reject a special order.

d. Determine the most profitable use of a constrained resources.

e. Sell or process further.


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Cost Concepts for Decision Making

A relevant costis a cost that differs between

alternatives.

Is sunk cost a relevant cost?


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Is opportunity cost a relevant cost?

Relevant Cost Analysis: A Two-Step Process

Eliminate costs and benefits that do not differ

between alternatives.

Use the remaining costs and benefits that differbetween alternatives in making the decision. The

costs that remain are the differential, or avoidable,

costs.

Step 1

Step 2


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Adding/Dropping Segments

Due to the declining popularity of digital

watches, Lovell Companys digital watch

line has not reported a profit for several

years. Lovell is considering discontinuing

this product line.

Adding/Dropping SegmentsSegment 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 ex penses

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 30,000 400,000Net operating loss (100,000)$


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The Make or Buy Decision

When a company is involved in more than oneactivity in the entire value chain, it is verticallyintegrated. A decision to carry out one of the

activities in the value chain internally, rather thanto buy externally from a supplier is called a

make or buy decision.

The Make or Buy Decision: An Example

Essex Company manufactures part 4A that is used inone of its products.

The unit product cost of this part is:

Direct materials $ 9

Direct labor 5

Variable overhead 1

Depreciation of special equip. 3

Supervisor's salary 2

General factory overhead 10Unit product cost 30$


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The special equipment used to manufacture part 4A has noresale value.

The total amount of general factory overhead, which isallocated on the basis of direct labor hours, would beunaffected by this decision.

The $30 unit product cost is based on 20,000 partsproduced each year.

An outside supplier has offered to provide the 20,000 partsat a cost of $25 per part.

Should we accept the suppliers offer?


The avoidable costsassociated with making part 4A include direct

materials, direct labor, variable overhead, and the supervisors salary.

Cost

Per

Unit Cost of 20,000 Units

Make Buy

Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) 9$ 180,000

Direct labor 5 100,000

Variable overhead 1 20,000

Depreciation of equip. 3 -

Supervisor's salary 2 40,000

General factory overhead 10 -Total cost 30$ 340,000$ 500,000$


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Cost

Per


Make Buy









The depreciation of the special equipment represents a sunk cost.The equipment has no resale value, thus its cost and associated

depreciation are irrelevant to the decision.

Cost

Per


Make Buy









Not avoidable; irrelevant. If the product is dropped, it

will be reallocated to other products.


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Should we make or buy part 4A?Given that the total avoidable costsare less than the cost of buying the part, Essex should continue to

make the part.

Cost

Per


Make Buy







General factory overhead 10 -

Total cost 30$ 340,000$ 500,000$

Opportunity Cost

Anopportunity cost is the benefit that is foregone as a

result of pursuing some course of action.

Opportunity costs are not actual cash outlays and are

not recorded in the formal accounts of anorganization.

How would this concept potentially relate to the Essex

Company?


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Key Terms and Concepts

A special order is a one-time order

that is not considered part of the

companys normal ongoing

business.

When analyzing a special order,

only the incremental costs and

benefits are relevant.

Since the existing fixedmanufacturing overhead costs

would not be affected by the

order, they are not relevant.

Special Orders

Jet Corporation. makes a single product whose normal

selling price is $20 per unit.

A foreign distributor offers to purchase 3,000 units for $10

per unit.This is a one-time order that would not affect the

companys regular business.

Annual capacity is 10,000 units, but Jet Corporation is

currently producing and selling only 5,000 units.

Should Jet accept the offer?


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Special Orders

Jet Corporation


Revenue (5,000 $20) 100,000$

Variable costs:

Direct materials 20,000$

Direct labor 5,000

Manufacturing overhead 10,000

Marketing costs 5,000

Total variable costs 40,000


Fixed costs:

Manufacturing overhead 28,000$

Marketing costs 20,000

Total fixed costs 48,000Net operating income 12,000$

$8 variable cost

Special Orders

If Jet accepts the special order, the incremental revenuewill exceed the incremental costs. In other words, netoperating income will increase by $6,000. This suggests

that Jet should accept the order.

Increase in revenue (3,000 $10) 30,000$

Increase in costs (3,000 $8 variable cost) 24,000Increase in net income 6,000$

Note: This answer assumes that the fixed costs areunavoidableand that variable marketing costs must be

incurred on the special order.


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Utilization of a Constrained Resource

When a limited resource of

some type restricts the

companys ability to satisfy

demand, the company is said to

have a constraint.

The machine or process

that is limiting overalloutput is called the

bottleneckit is the

constraint.

Fixed costs are usually unaffected in these situations,so the product mix that maximizes the companys total

contribution margin should ordinarily be selected.

A company should not necessarily promote thoseproducts that have the highest unit contribution

margins.

Rather, total contribution margin will be maximized bypromoting those products or accepting those orders

that provide the highest contribution margin in relation

to the constraining resource.



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Utilization of a Constrained Resource:

An ExampleEnsign Company produces two products and selected data

are shown below:

Product

1 2

Selling price per unit $ 60 $ 50

Less variable expenses per unit 36 35

Contribution margin per unit 24$ 15$

Current demand per week (units) 2,000 2,200

Contribution margin ratio 40% 30%

Processing time required

on machine A1 per unit 1.00 min. 0.50 min.

Machine A1 is the constrained resource and isbeing used at 100% of its capacity.

There is excess capacity on all other machines.

Machine A1 has a capacity of 2,400 minutes perweek.

Should Ensign focus its efforts on Product1 or Product 2?

Utilization of a Constrained Resource:

An Example


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The key is the contribution margin per unit of theconstrained resource.

Ensign should emphasize Product 2because it generates

a contribution margin of $30 per minute of the

constrained resource relative to $24 per minute for

Product 1.

Product

1 2

Contribution margin per unit $ 24 $ 15

Time re quired to produce one unit 1.00 min. 0.50 min.

Contribution margin per minute 24$ 30$


Ensign can maximize its contribution margin by

first producing Product 2to meet customer demand

and then using any remaining capacity to produce

Product 1. The calculations would be performed as

follows.

The key is the contribution margin per unit of the

constrained resource.Product

1 2Contribution margin per unit $ 24 $ 15

Time re quired to produce one unit 1.00 min. 0.50 min.

Contribution margin per minute 24$ 30$


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According to the plan, we will produce 2,200 units of

Product 2 and 1,300 of Product 1. The

contribution margin looks like this.

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$

The total contribution margin for Ensign is $64,200.

In some industries, a number of end products

are produced from a single raw material input.

Two or more products produced from acommon input are called joint products.

The point in the manufacturing process where

each joint product can be recognized as a

separate product is called the split-off point.

Sell or Process Further


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SeparateProcessing

Separate

Processing

Final

Sale

Final

Sale

FinalSale

Separate

Product

Costs

JointInput

CommonProduction

Process

Split-Off

Point

Oil

Gasoline

Chemicals

Joint costs

are incurredup to the

split-off point


Sell or Process Further: An Example

Sawmill, Inc. cuts logs from which unfinished lumberand sawdust are the immediate joint products.

Unfinished lumber is sold as is or processed furtherinto finished lumber.

Sawdust can also be sold as is to gardening

wholesalers or processed further into presto-logs.


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Data about Sawmills joint products includes:

Per Log

Lumber Sawdust

Sales value at the split-off point 140$ 40$

Sales value after further processing 270 50

Allocated joint product costs 176 24

Cost of further processing 50 20


The lumber should be processedfurther and the sawdust should be

sold at the split-off point.

Analysis of Sell or Process Further

Per Log

Lumber Sawdust

Sales value after further processing 270$ 50$

Sales value at the split-off point 140 40

Incremental revenue 130 10

Cost of further processing 50 20Profit (loss) from further processing 80$ (10)$


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Homework

Exercises 14-2; 14-3; 14-4; 14-5; 14-6; 14-7; 14-9; 14-11; 14-12; 14-13; 14-14; 14-15; 14-17

bmac 5203 - handouts - new - part 1

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