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TRANSCRIPT
1
Module 9
Relevant costs for decision
making and inventory
management
Lectures and handouts by:
Shirley Mauger, MBA, HB Comm, CGA
Management Accounting
Fundamentals
2
Module 9 - Table of Contents
9.1 Cost concepts for decision making
9.2 Adding and dropping product lines
9.3 The make or buy decision
9.4 Computer illustration 9.4-1: Relevant costs
9.5 Special orders
9.6 Utilization of a constrained resource
9.7 Joint product costs and the contribution approach
9.8 Economic order quantity (EOQ) and the reorder point
Review question: Relevant cost analysis
Review question: Retain or drop a department, make or buy
decision
Review question: Economic order quantity and safety stock
Review question: Multiple choice questions
1
2
3
N/A
3
4
5
6
7
8
9
10
Part Content
3
Part 1
Cost concepts for decision making
Topic 9.1
MA1 – MODULE 9
2
Part 1 – Cost concepts for decision making (Topic 9.1)
Identify sunk costs and explain why they are not relevant in decision making based on a general rule for distinguishing between relevant and irrelevant costs. (Level 1)
4
Decision
Making
Formulating long-
and short-term plans
(Planning)
Measuring
performance
(Controlling)
Implementing
plans (Directing
and Motivating)
Comparing actual
to planned
performance
(Controlling)
Garrison, Noreen, Chesley, Carroll, Managerial Accounting, 6th Canadian edition, 2004 p. 6
Part 1 – Cost concepts for decision making (Topic 9.1)
Short term decisions
• Adding and dropping product lines or segments
• Make or buy
• Special orders
• Utilization of a constrained resource
• Sell or process further
5P 563
Part 1 – Cost concepts for decision making (Topic 9.1)
Short term decisions
Relevant costs Irrelevant costs
A cost that differs between
alternatives.
A cost that can be ignored
in the analysis.
• Adding and dropping product lines or segments
• Make or buy
• Special orders
• Utilization of a constrained resource
• Sell or process further
6p 563-568
3
Part 1 – Cost concepts for decision making (Topic 9.1)
Sunk cost
Opportunity cost
Future costs that don’t differ between alternatives
Relevant Irrelevant
Different costs for different purposes
Whether a cost is relevant or irrelevant depends on
the circumstances.
Avoidable/differential cost
7p 563-568
Part 1 – Cost concepts for decision making (Topic 9.1)
Can be eliminated in whole or in part by
choosing one alternative over another.
• Department manager’s salary if the department is eliminated.
• Savings in direct materials cost because of the purchase of a
new machine.
Relevant IrrelevantAvoidable/differential cost
Sunk cost
Opportunity cost
Future costs that don’t differ between alternatives
8p 563-568
Part 1 – Cost concepts for decision making (Topic 9.1)
Any cost in the future that will occur no
matter which alternative is chosen
• Lease cost on the building which will continue to be
used whether or not the new equipment is installed.
• Maintenance cost of existing equipment that will be
kept whether or not the new product line is
manufactured.
Relevant Irrelevant
Sunk cost
Opportunity cost
Future costs that don’t differ between alternatives
Avoidable/differential cost
9p 563-568
4
Part 1 – Cost concepts for decision making (Topic 9.1)
Any cost that has already been incurred and
cannot be changed
• Money that a corporation spent last year to
investigate the site for a new office, expensed those
funds and now is deciding whether or not to go
forward with the project.
• Book value of old equipment that cannot be resold.
Relevant Irrelevant
Sunk cost
Opportunity cost
Future costs that don’t differ between alternatives
Avoidable/differential cost
10p 563-568
Part 1 – Cost concepts for decision making (Topic 9.1)
The potential benefit foregone when one
alternative is chosen over another
• Revenue lost because the retail outlet closes early on
the weekends.
• Potential loss of investment income due to stockpiling
inventory.
• Seldom recognized on financial reports.
Relevant Irrelevant
Sunk cost
Opportunity cost
Future costs that don’t differ between alternatives
Avoidable/differential cost
11p 563-568
12
Part 2
Adding and dropping product lines
Topic 9.2
MA1 – MODULE 9
5
Part 2 – Adding and dropping product lines (Topic 9.2)
Prepare an analysis showing whether a product line or other organizational segment should be dropped or retained. (Level 1)
Adding and dropping product lines
Two approaches to the cost analysis:
1. Compare all costs
2. Compare only differential costs
(those that differ between alternatives)
13p 569-572
Part 2 – Adding and dropping product lines (Topic 9.2)
First classify the costs: Relevant/
Irrelevant
Variable costs R
Depreciation on van I
Liability insurance R
Program administrators’ salary R
General administrative overhead I
14
Cumberland County Senior Services
Exercise 12-2, page 597
Stop the audio, turn to exercise 12-2, page 597
and the handout, page 1 then come back to listen
to the solution. p 569-572
Part 2 – Adding and dropping product lines (Topic 9.2)
Stop the audio, turn to exercise 12-2, page 597
and the handout, page 1 then come back to listen
to the solution.
First classify the costs: Relevant/
Irrelevant
Variable costs R
Depreciation on van I
Liability insurance R
Program administrators’ salary R
General administrative overhead I
Cumberland County Senior Services
Exercise 12-2, page 597
15p 569-572
6
Part 2 – Adding and dropping product lines (Topic 9.2)
Current
Total
House-keeping
Dropped Difference
Revenues $900,000 $660,000 $(240,000)
Less variable expenses 490,000 330,000 160,000
Contribution margin 410,000 330,000 (80,000)
Variable costs are avoidable
1. Compare all costs
16
Cumberland County Senior Services
Exercise 12-2, page 597
p 569-572
Part 2 – Adding and dropping product lines (Topic 9.2)
Current
Total
House-keeping
Dropped Difference
Revenues $900,000 $660,000 $(240,000)
Less variable expenses 490,000 330,000 160,000
Contribution margin 410,000 330,000 (80,000)
Less fixed expenses:
Depreciation 68,000 68,000 0
Liability insurance 42,000 27,000 15,000
Depreciation is based on the van which is a sunk cost.Liability insurance is an
avoidable cost.
1. Compare all costs
17
Cumberland County Senior Services
Exercise 12-2, page 597
p 569-572
Part 2 – Adding and dropping product lines (Topic 9.2)
Current
Total
House-keeping
Dropped Difference
Revenues $900,000 $660,000 $(240,000)
Less variable expenses 490,000 330,000 160,000
Contribution margin 410,000 330,000 (80,000)
Less fixed expenses:
Depreciation 68,000 68,000 0
Liability insurance 42,000 27,000 15,000
Program admin. salaries 115,000 78,000 37,000
General administrative
overhead 180,000 180,000 0
Total fixed expenses 405,000 353,000 52,000
Net operating income/loss $ 5,000 $(23,000) $ (28,000)
Cost of administrator’s salary is avoidable.
General administrative overhead is not avoidable.
1. Compare all costs
18
Cumberland County Senior Services
Exercise 12-2, page 597
p 569-572
7
Cumberland County Senior Services
Exercise 12-2, page 597
Part 2 – Adding and dropping product lines (Topic 9.2)
Current
Total
House-keeping
Dropped Difference
Revenues $900,000 $660,000 $(240,000)
Less variable expenses 490,000 330,000 160,000
Contribution margin 410,000 330,000 (80,000)
Less fixed expenses:
Depreciation 68,000 68,000 0
Liability insurance 42,000 27,000 15,000
Program admin. salaries 115,000 78,000 37,000
General administrative
overhead 180,000 180,000 0
Total fixed expenses 405,000 353,000 52,000
Net operating income/loss $ 5,000 $(23,000) $ (28,000)
If the housekeeping service is dropped, net income will be reduced by $28,000.
1. Compare all costs
19p 569-572
Cumberland County Senior Services
Exercise 12-2, page 597
Part 2 – Adding and dropping product lines (Topic 9.2)
Current
Total
House-keeping
Dropped Difference
Revenues $900,000 $660,000 $(240,000)
Less variable expenses 490,000 330,000 160,000
Contribution margin 410,000 330,000 (80,000)
Less fixed expenses:
Depreciation 68,000 68,000 0
Liability insurance 42,000 27,000 15,000
Program admin. salaries 115,000 78,000 37,000
General administrative
overhead 180,000 180,000 0
Total fixed expenses 405,000 353,000 52,000
Net operating income/loss $ 5,000 $(23,000) $ (28,000)
1. Compare all costs
Compare lost contribution margin to costs that can be avoided.
(Relevant costs)
20p 569-572
Cumberland County Senior Services
Exercise 12-2, page 597
Part 2 – Adding and dropping product lines (Topic 9.2)
2. Compare differential costs
Difference
Contribution margin lost if housekeeping is dropped (80,000)
Less fixed costs that can be avoided
Liability insurance 15,000
Program admin. salaries 37,000
Total traceable fixed expenses 52,000
Net annual cost increase $ (28,000)
Ignoring the irrelevant costs, will give the same answer.
21p 569-572
8
Part 2 – Adding and dropping product lines (Topic 9.2)
22
Segmented statements –
module 8
= Contribution margin
Sales
(Variable costs)
(Traceable fixed costs)
= Segment margin
Corporate wide income
Segment reporting format
= Net income
(Common costs)
Part 2 – Adding and dropping product lines (Topic 9.2)
Total
Home
Nursing
Meals on
Wheels
House-
keeping
Revenues $900,000 $260,000 $400,000 $240,000
Less variable expenses 490,000 120,000 210,000 160,000
Contribution margin 410,000 140,000 190,000 80,000
Deduct variable expenses.Housekeeping has a 33%
contribution margin. ($80,000/$240,000)
23
Cumberland County Senior Services
Exercise 12-2, page 597, req. 2
p 569-572
Part 2 – Adding and dropping product lines (Topic 9.2)
Deduct fixed costs that can be traced to the department.
Total
Home
Nursing
Meals on
Wheels
House-
keeping
Revenues $900,000 $260,000 $400,000 $240,000
Less variable expenses 490,000 120,000 210,000 160,000
Contribution margin 410,000 140,000 190,000 80,000
Less traceable fixed expenses:
Depreciation 68,000 8,000 40,000 20,000
Liability insurance 42,000 20,000 7,000 15,000
Program administrators’
salaries 115,000 40,000 38,000 37,000
Total traceable fixed
expenses 225,000 68,000 85,000 72,000
Program segment margins $185,000 $ 72,000 $105,000 $ 8,000
24
Cumberland County Senior Services
Exercise 12-2, page 597, req. 2
p 569-572
9
25
Part 2 – Adding and dropping product lines (Topic 9.2)
Total
Home
Nursing
Meals on
Wheels
House-
keeping
Revenues $900,000 $260,000 $400,000 $240,000
Less variable expenses 490,000 120,000 210,000 160,000
Contribution margin 410,000 140,000 190,000 80,000
Less traceable fixed expenses:
Depreciation 68,000 8,000 40,000 20,000
Liability insurance 42,000 20,000 7,000 15,000
Program administrators’
salaries 115,000 40,000 38,000 37,000
Total traceable fixed
expenses 225,000 68,000 85,000 72,000
Program segment margins 185,000 $ 72,000 $105,000 $ 8,000
General administrative
overhead 180,000
Net operating income/loss $ 5,000
Cumberland County Senior Services
Exercise 12-2, page 597, req. 2
p 569-572
Deduct common costs from the
corporate wide total.
Part 2 – Adding and dropping product lines (Topic 9.2)
Qualitative factors to consider:
• Is the line necessary to the sale of other products?
• Does the line serve as a ‘magnet’ to attract customers?
26p 569-572
27
Part 3
The make or buy decision
Special orders
Topics 9.3 & 9.5
MA1 – MODULE 9
10
Part 3 – The make or buy decision (Topic 9.3)
Explain what is meant by a make or buy decision and prepare a make or buy analysis. (Level 1)
• Vertical integration:
• When a company is involved in the production of
more than one or more steps in the production and
distribution of the product. (value chain)
• Make or buy decision:
• Decision as to whether a product should be made
internally or purchased from an outside supplier.
Product Customer
R&D Design Manufacturing Marketing Distribution Service
© McGraw-Hill Ryerson Limited., 2009
Common steps in an organization’s value chain.
28p 572-576
Part 3 – The make or buy decision (Topic 9.3)
• Advantages of integration:
• Less dependence on suppliers.
• Smoother flow of parts and materials.
• More control over quality.
• Disadvantages of integration
• Suppliers may be able to benefit from economies of
scale resulting in higher quality and lower cost.
• Contact with suppliers may be necessary if there is an
emergency and parts cannot be produced in-house.
Product Customer
R&D Design Manufacturing Marketing Distribution Service
© McGraw-Hill Ryerson Limited., 200429
p 572-576
Part 3 – The make or buy decision (Topic 9.3)
Stop the audio, turn to exercise 12-3, page 598
and the handout, page 2, then come back to
listen to the solution.
First classify the costs: Relevant/
Irrelevant
Direct materials R
Direct labour R
Variable manufacturing OH R
Fixed manufacturing OH salaries R
Fixed manufacturing OH equipment I
Fixed manufacturing OH common I
Cost of component from outside supplier R
Climate Control Inc.
Exercise 12-3, page 598 – requirement 1
30p 572-576
11
Part 3 – The make or buy decision (Topic 9.3)
Per unit Total-15,000 units
Make Buy Make Buy
Direct materials $6
Direct labour 8
Variable manufacturing OH 1
Fixed manufacturing salaries 2
Fixed manufacturing OH equipment --
Fixed manufacturing OH common --
TOTAL $17
Exclude irrelevant costs.
31
Climate Control Inc.
Exercise 12-3, page 598 – requirement 1
p 572-576
Part 3 – The make or buy decision (Topic 9.3)
Per unit Total-15,000 units
Make Buy Make Buy
Direct materials $6
Direct labour 8
Variable manufacturing OH 1
Fixed manufacturing salaries 2
Fixed manufacturing OH equipment --
Fixed manufacturing OH common --
Purchase price of components $20
TOTAL $17 $20
It will cost $3 per unit more to purchase the
thermostats.
32
Climate Control Inc.
Exercise 12-3, page 598 – requirement 1
p 572-576
Part 3 – The make or buy decision (Topic 9.3)
Per unit Total-15,000 units
Make Buy Make Buy
Direct materials $6 $ 90,000
Direct labour 8 120,000
Variable manufacturing OH 1 15,000
Fixed manufacturing salaries 2 30,000
Fixed manufacturing OH equipment --
Fixed manufacturing OH common --
Purchase price of components $20 $300,000
TOTAL $17 $20$255,000 $300,000
A total difference of $45,000.
33
Climate Control Inc.
Exercise 12-3, page 598 – requirement 1
p 572-576
12
Part 3 – The make or buy decision (Topic 9.3)
First classify the costs: Relevant/
Irrelevant
Opportunity cost: segment margin
foregone on a new product line R
34
Climate Control Inc.
Exercise 12-3, page 598 – requirement 2
p 572-576
Part 3 – The make or buy decision (Topic 9.3)
Total-15,000 units
Make Buy
Cost of making the part 255,000
Purchase price of components $300,000
Segment margin foregone 65,000
TOTAL $320,000 $300,000
A difference of $20,000 in favor of buying the new thermostat and
implementing the new product line.
35
Climate Control Inc.
Exercise 12-3, page 598 – requirement 2
p 572-576
Part 3 – Special orders (Topic 9.5)
Prepare an analysis showing whether a special order should be accepted. (Level 1)
Special order
• One-time order that is not considered part of the
company’s normal ongoing business.
• Only incremental costs are considered.
• Should not affect normal sales.
• Idle capacity should be available.
36p 577-578
13
Stop the audio, turn to exercise 12-4, page 598,
and the handout, page 3 then come back to listen
to the solution.
First classify the costs: Relevant/
Irrelevant
Materials R
Direct labour R
Fixed manufacturing OH I
Variable manufacturing OH R
Additional materials (for filigree) R
Cost of special tool R
Miyamoto Jewellers
Exercise 12-4, page 598
Part 3 – Special orders (Topic 9.5)
37p 577-578
First classify the costs: Relevant/
Irrelevant
Materials R
Direct labour R
Fixed manufacturing OH I
Variable manufacturing OH R
Additional materials (for filigree) R
Cost of special tool R
Miyamoto Jewellers
Exercise 12-4, page 598
Part 3 – Special orders (Topic 9.5)
38p 577-578
Per bracelet 10 bracelets
Incremental revenue ($349.95 x 10) $349.95 $3,499.50
Incremental cost
Variable costs:
Total variable cost
Fixed costs:
Total incremental cost
Incremental operating income
Part 3 – Special orders (Topic 9.5)
39
Miyamoto Jewellers
Exercise 12-4, page 598
p 577-578
14
Per bracelet 10 bracelets
Incremental revenue ($349.95 x 10) $349.95 $3,499.50
Incremental cost
Variable costs:
Materials 143.00 1,430,00
Direct labour 86.00 860.00
Variable manufacturing OH 7.00 70.00
Additional materials (for filigree) 6.00 60.00
Total variable cost $242.00 $2,420.00
Fixed costs:
Total incremental cost
Incremental operating income
Part 3 – Special orders (Topic 9.5)
40
Miyamoto Jewellers
Exercise 12-4, page 598
p 577-578
Per bracelet 10 bracelets
Incremental revenue ($349.95 x 10) $349.95 $3,499.50
Incremental cost
Variable costs:
Materials 143.00 1,430,00
Direct labour 86.00 860.00
Variable manufacturing OH 7.00 70.00
Additional materials (for filigree) 6.00 60.00
Total variable cost $242.00 $2,420.00
Fixed costs:
Fixed manufacturing OH -
Cost of special tool 465.00
Total incremental cost $2,885.00
Incremental operating income $ 614.50
Part 3 – Special orders (Topic 9.5)The special order adds $614,50 to the company’s net operating income and
should be accepted.
41
Miyamoto Jewellers
Exercise 12-4, page 598
p 577-578
42
Part 4
Utilization of a constrained resource
Topic 9.6
MA1 – MODULE 9
15
Part 4 – Utilization of a constrained resource (Topic 9.6)
Determine the most profitable utilization of scarce resources. (Level 1)
Constraint
• A limitation under which a company must operate that
restricts its ability to satisfy demand.
• i.e. – a machine already operating 24/7 cannot
produce any more units.
• When this constraint is narrowly focused it’s called a
bottleneck.
• How can a company maximize its profits under these
conditions?
• Focus on maximizing total contribution margin.
43p 581-584
Product
A B C
Selling price $60 $90 $80
Less variable costs:
Direct materials 27 14 40
Direct labour 12 32 16
Variable manufacturing OH 3 8 4
Total variable cost 42 54 60
Contribution margin $18 $36 $20
Stop the audio, turn to exercise 12-5, page 598
and the handout, page 4, then come back to
listen to the solution.
Banner Company
Exercise 12-5 page 598 – requirement 1
Part 4 – Utilization of a constrained resource (Topic 9.6)
Maximize contribution margin when there is a constraint on direct labour: 3,000 hours at $8 per hour
44p 581-584
Part 4 – Utilization of a constrained resource (Topic 9.6)
Product
A B C
Selling price $60 $90 $80
Less variable costs:
Direct materials 27 14 40
Direct labour 12 32 16
Variable manufacturing OH 3 8 4
Total variable cost 42 54 60
Contribution margin $18 $36 $20
Amount of direct labour hours required 1.5 4.0 2.0
Direct labour cost per unit/$8Product A: $12/$8=1.5 hoursProduct B: $32/$8=4.0 hoursProduct C: $16$/8=2.0 hours
45
Banner Company
Exercise 12-5 page 598 – requirement 1
p 581-584
16
Part 4 – Utilization of a constrained resource (Topic 9.6)
Product
A B C
Selling price $60 $90 $80
Less variable costs:
Direct materials 27 14 40
Direct labour 12 32 16
Variable manufacturing OH 3 8 4
Total variable cost 42 54 60
Contribution margin $18 $36 $20
Amount of direct labour hours required 1.5 4.0 2.0
Contribution margin per direct labour hour $12 $9 $10
Contribution margin per direct labour hourProduct A: $18/1.5= $12/hourProduct B: $36/4.0= $9/hourProduct C: $20/2.0= $10/hour
46
Banner Company
Exercise 12-5 page 598 – requirement 1
p 581-584
Part 4 – Utilization of a constrained resource (Topic 9.6)
Product
A B C
Selling price $60 $90 $80
Less variable costs:
Direct materials 27 14 40
Direct labour 12 32 16
Variable manufacturing OH 3 8 4
Total variable cost 42 54 60
Contribution margin $18 $36 $20
Contribution margin ratio 30% 40% 25%
Amount of direct labour hours required 1.5 4.0 2.0
Contribution margin per direct labour hour $12 $9 $10
Times 3,000 direct labour hours available 3,000 3,000 3,000
Total contribution margin $36,000 $27,000 $30,000
Focus production on product A.
47
Banner Company
Exercise 12-5 page 598 – requirement 2
p 581-584
Part 4 – Utilization of a constrained resource (Topic 9.6)
How much would you be willing to pay to relax a constraint?
Not more than the additional contribution margin will generate.
Utilizing constraints
• Focus on the constraint by relaxing (or elevating) it.
• Add more hours by paying overtime.
• Add another machine.
• Subcontract bottleneck processing.
• Move shift workers from a non-bottleneck process.
• Perform business process reengineering or total
quality management techniques on the bottleneck
process.
• Reduce defective units.
48p 581-584
17
Part 4 – Utilization of a constrained resource (Topic 9.6)
Product
A B C
Contribution margin $18 $36 $20
Amount of direct labour hours required 1.5 4 2
Contribution margin per direct labour hour $12 $9 $10
Times 3,000 direct labour hours available 3,000 3,000 3,000
Total contribution margin $36,000 $27,000 $30,000
Up to how much should the company be willing to pay per hour in overtime wages if 3,000 additional hours are made available?
49
Banner Company
Exercise 12-5 page 598 – requirement 3
p 581-584
Part 4 – Utilization of a constrained resource (Topic 9.6)
Product
A B C
Contribution margin $18 $36 $20
Amount of direct labour hours required 1.5 4 2
Contribution margin per direct labour hour $12 $9 $10
Times 3,000 direct labour hours available 3,000 3,000 3,000
Total contribution margin $36,000 $27,000 $30,000
Contribution margin per direct labour hour $12
Current direct labour rate 8
Maximum overtime rate: $20
They would be willing to pay an additional $12 per hour or $20 in total in overtime pay to produce Product A.
50
Banner Company
Exercise 12-5 page 598 – requirement 3
p 581-584
Part 4 – Utilization of a constrained resource (Topic 9.6)
Product
A B C
Contribution margin $18 $36 $20
Amount of direct labour hours required 1.5 4 2
Contribution margin per direct labour hour $12 $9 $10
Times 3,000 direct labour hours available 3,000 3,000 3,000
Total contribution margin $36,000 $27,000 $30,000
Contribution margin per direct labour hour $12 $9 $10
Current direct labour rate 8 8 8
Maximum overtime rate: $20 $17 $18
They would be willing to spend up to $17 in overtime pay for product B and up to $18 in overtime for product C.
51
Banner Company
Exercise 12-5 page 598 – requirement 3
p 581-584
18
52
Part 5
Joint product costs and the contribution
approach
Topic 9.7
MA1 – MODULE 9
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)Prepare an analysis showing whether joint products should be sold at the split-off point or processed further. (Level 1)
Raw
milk Purchasing
and
separating
Joint product
costs
Split-off
pointJoint
products
Skim
Cream
53p 579-581
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)Prepare an analysis showing whether joint products should be sold at the split-off point or processed further. (Level 1)
How are the costs of the raw
milk and the further processing
allocated to cream and liquid
milk?
1. Based on relative sales
value.
2. Based on physical measure.
Raw
milk
Joint product
costs
Split-off
pointJoint
products
Skim
$22,000
30,000
litres
Cream
$28,000
10,000
litresPurchasing
and
separating
$30,000
Sales value
Stop the audio, turn to the
handout, page 5, then come
back to listen to the solution.
54p 579-581
19
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)Prepare an analysis showing whether joint products should be sold at the split-off point or processed further. (Level 1)
Based on relative sales value Cream Skim Total
Sales value $28,000 $22,000 $50,000
% of total 56% 44% 100%
Allocate $30,000 processing costs $16,800 $13,200 $30,000
Contribution margin $11,200 $8,800 $20,000
55p 579-581
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)Prepare an analysis showing whether joint products should be sold at the split-off point or processed further. (Level 1)
Based on relative sales value Cream Skim Total
Sales value $28,000 $22,000 $50,000
% of total 56% 44% 100%
Allocate $30,000 processing costs $16,800 $13,200 $30,000
Contribution margin $11,200 $8,800 $20,000
Based on physical measure
Litres 10,000 30,000 40,000
% of total 25% 75% 100%
Allocate $30,000 processing costs $7,500 $22,500 $30,000
Contribution margin $20,500 ($500) $20,000
56p 579-581
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)Prepare an analysis showing whether joint products should be sold at the split-off point or processed further. (Level 1)
Raw
milk Purchasing
and
separating
Manu-
facture
ice
cream
Pasteurize
homo-
genize
and bottle
Packaged
skim milk
Ice
cream
Joint product
costs Separate product costs
Split-off
pointJoint
products
Skim
Cream
57p 579-581
20
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)Prepare an analysis showing whether joint products should be sold at the split-off point or processed further. (Level 1)
Raw
milk Purchasing
and
separating
Manu-
facture
ice
cream
Pasteurize
homo-
genize
and bottle
Packaged
skim milk
Ice
cream
Joint
products
Skim
Cream
Sell or process further decision.
58p 579-581
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Input
Stop the audio, turn to exercise 12-6 page 599,
and the handout, page 6, then come back to
listen to the solution.
Solex Company
Exercise 12-6, page 599
59p 579-581
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Input
X
$50,000
Processing
$100,000Y
$90,000
Z
$60,000
Split-off
pointJoint
products
Joint product
costs
60
Solex Company
Exercise 12-6, page 599
p 579-581
21
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Input
Additional
processing
$35,000
New
product X
$80,000X
$50,000
Additional
processing
$40,000
Processing
$100,000Y
$90,000
Z
$60,000
New
product Y
$150,000
New
product Z
$75,000
Additional
processing
$12,000
Joint product
costs
Split-off
pointJoint
products
Separate
product costs
61
Solex Company
Exercise 12-6, page 599
p 579-581
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Input
Additional
processing
$35,000
New
product X
$80,000X
$50,000
Additional
processing
$40,000
Processing
$100,000Y
$90,000
Z
$60,000
New
product Y
$150,000
New
product Z
$75,000
Additional
processing
$12,000
Joint product
costs
Split-off
pointJoint
products
Separate
product costs
62
Solex Company
Exercise 12-6, page 599
p 579-581
Classify the costs: Relevant/
Irrelevant
Joint processing costs I
Further processing costs R
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
63
Solex Company
Exercise 12-6, page 599
p 579-581
22
Product
X Y Z
Sales value after further processing $80,000 $150,000 $75,000
Sales value at split-off point 50,000 90,000 60,000
Incremental revenue 30,000 60,000 15,000
Cost of further processing
Incremental profit/loss
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
64
Solex Company
Exercise 12-6, page 599
p 579-581
Product
X Y Z
Sales value after further processing $80,000 $150,000 $75,000
Sales value at split-off point 50,000 90,000 60,000
Incremental revenue 30,000 60,000 15,000
Cost of further processing 35,000 40,000 12,000
Incremental profit/loss ($5,000) $20,000 $3,000
Sell product X at split-off and process product Y and Z further.
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
65
Solex Company
Exercise 12-6, page 599
p 579-581
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Input
X
ProcessingY
Z
By-products:Joint product with a
relatively low sales value.
(wood chips, molasses)
Joint product
costs
Split-off
point
Joint
products
W
66
23
67
Part 6
Economic order quantity (EOQ) and the reorder
point
Topic 9.8
MA1 – MODULE 9
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)Compute the optimum inventory level and order size. (Level 1)
Inventory Costs
• Ordering cost
• Clerical costs
• Transportation costs
• Carrying cost
• Storage space costs
• Handling costs
• Property taxes
• Insurance
• Obsolescence losses
• Interest on capital invested in inventory
68Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)Compute the optimum inventory level and order size. (Level 1)
Inventory Costs
• Ordering cost
• Clerical costs
• Transportation costs
• Carrying cost
• Storage space costs
• Handling costs
• Property taxes
• Insurance
• Obsolescence losses
• Interest on capital invested in inventory
• Costs of not carrying sufficient inventory (stock outs)
• Customer ill will
• Quantity discounts forgone
• Erratic production
• Inefficiency of production runs
• Added transportation charges
• Lost sales 69Reading 9-1
24
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)Compute the optimum inventory level and order size. (Level 1)
Inventory Control
• ABC analysis
• Break inventory items into three categories based on
value. Control is focused on ‘A’ items which have the
highest value and are usually the smallest in number.
• Economic order quantity
• Determining an order size that minimizes costs of
ordering and carrying inventory.
70Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity
Annual carrying cost: C
Total cost
Annual ordering cost: P
Exhibit 13-9, Reading 9-1, CGA lesson notes, module 971
Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity
EOQ – Total cost is minimized
(reading 9-1 page 2)
Exhibit 13-9, Reading 9-1, CGA lesson notes, module 972
Reading 9-1
25
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity formula
E = order size in units
Q = annual quantity used
in units
P = cost of placing an order
C = annual cost of carrying
one unit in stock
73Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity formula
E = ?
Q = 3,000
P = $10
C = $.80
74Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Total annual cost
E = order size in units
Q = annual quantity used in
units
P = cost of placing an order
C = annual cost of carrying
one unit in stock
T = P(Q/E)+C(E/2)
Order cost Carrying cost
75Reading 9-1
26
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Total annual cost
T = P(Q/E)+C(E/2)
Order cost Carrying cost
T = P(Q/E) + C(E/2)=$10(3,000/274) + $.80*(274/2)= $109 + $110 = $219
76Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity formula for production
O = optimal production lot
size
Q = annual production
quantity
P = setup costs for each run
C = annual cost of carrying
one unit in stock
O
77Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about rising
costs and wants to determine the economic order quantity.
After doing some research, the manager has determined the
following costs:
• Cost to place an order $25
• Cost to carry one Deluxe-2M in inventory
for 1 year $2
What is the EOQ for the Deluxe-2M?
Stop the audio, turn to the handout, page 7,
then come back to listen to the solution.78
Reading 9-1
27
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
What is the EOQ for the Deluxe-2M?
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about rising
costs and wants to determine the economic order quantity.
After doing some research, the manager has determined the
following costs:
• Cost to place an order $25
• Cost to carry one Deluxe-2M in inventory
for 1 year $2
= 775 units
per order
79Reading 9-1Handout, page 7
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
What is the total annual cost for Deluxe-2M?
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about rising
costs and wants to determine the economic order quantity.
After doing some research, the manager has determined the
following costs:
• Cost to place an order $25
• Cost to carry one Deluxe-2M in inventory
for 1 year $2
T = P ( Q / E) + C( E / 2)
T=25(24,000/775) + 2(775/2)
T = $1,549 per year
80Reading 9-1Handout, page 7
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
What will happen to EOQ if ordering costs increase to $35 per order?
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about rising
costs and wants to determine the economic order quantity.
After doing some research, the manager has determined the
following costs:
• Cost to place an order $35
• Cost to carry one Deluxe-2M in inventory
for 1 year $2
= 917 units
per order
81Reading 9-1Handout, page 7
28
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
What will happen to EOQ if carrying costs increase to $2.50 per unit?
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about rising
costs and wants to determine the economic order quantity.
After doing some research, the manager has determined the
following costs:
• Cost to place an order $25
• Cost to carry one Deluxe-2M in inventory
for 1 year $2.50
= 693 units
per order
82Reading 9-1Handout, page 7
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
As order costs increase, EOQ increases. The manager will want to order larger quantities
resulting in fewer orders
As carrying costs increase, EOQ decreases. The manager will want to order smaller quantities, resulting in less storage and
handling.
Summary of requirements
Order
cost
Annual
carrying
cost/unit
EOQ
Original costs $25 $2.00 775
Increased order costs $35 $2.00 917
Increased carrying costs $25 $2.50 693
83Reading 9-1
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
JIT focuses on reducing the order cost
(P).
84Reading 9-1
29
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Reorder point• Time when an order is placed to replenish stock.
Lead time• Time between order and receipt of stock.
Safety stock• Additional units kept on hand to satisfy maximum demand that can be reasonably expected during the lead time.
= (lead time x average demand) + safety stock
85Reading 9-2
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Safety
stock
Time (weeks)
Inve
nto
ry(u
nits) Average
usage
EOQ
Adapted from Exhibit 13-10, Reading 9-2, CGA lesson notes, module 9
86Reading 9-2
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Safety
stock
Time (weeks)
Inve
nto
ry(u
nits) Average
usage
Maximum
expected
usage
EOQ
Adapted from Exhibit 13-10, Reading 9-2, CGA lesson notes, module 9
87Reading 9-2
30
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Safety
stock
Time (weeks)
Inve
nto
ry(u
nits)
Reorder
point
Average
usage
Maximum
expected
usage
Lead
time
EOQ
Adapted from Exhibit 13-10, Reading 9-2, CGA lesson notes, module 9
88Reading 9-2
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Aegean distributors, sells building materials throughout western Canada. The following information relates to a line of metal doors carried by the company:
Economic order quantity 650 unitsLead time 4 weeksAverage weekly usage 65 units
What is the reorder point? (assuming no safety stock)
= (lead time x average demand) + safety stock= ( 4 weeks x 65 ) + 0= 260 + 0 = 260 units
Stop the audio, turn to the handout, page 8,
then come back to listen to the solution.89
Reading 9-2
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Aegean distributors, sells building materials throughout western Canada. The following information relates to a line of metal doors carried by the company (Handout, page 8):
Economic order quantity 650 unitsLead time 4 weeksAverage weekly usage 65 unitsMaximum weekly usage 78 units
What is the reorder point? (with safety stock)
Safety stock is additional stock required to satisfy maximum demand during the lead time.
Maximum weekly usage 78 unitsAverage weekly usage 65 unitsSafety stock 13 unitsLead time x 4 weeksSafety stock 52 units
90Reading 9-2
31
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Aegean distributors, sells building materials throughout western Canada. The following information relates to a line of metal doors carried by the company:
Economic order quantity 650 unitsLead time 4 weeksAverage weekly usage 65 unitsMaximum weekly usage 78 units
What is the reorder point? (with safety stock)
= (lead time x average demand) + safety stock= ( 4 weeks x 65 ) + 52= 260 + 52 = 312 units
91Reading 9-2Handout, page 8
92
Part 7
Review question:
Relevant cost analysis
(download the additional questions handout:
ma1_mod9_handout1.pdf)
MA1 – MODULE 9
93
Problem 12-24 pages 607-608Handout pages 9 and 10
1. Would the increased fixed expenses be justified?
2. Compute the per unit break-even price on this order.
3. What unit cost figure is relevant for setting a minimum selling price?
4. What would be the impact on profits of closing the plant for the two-month period?
5. Compute the unit cost figure that is relevant for comparison to the quoted price.
Part 7 – Review question: Relevant cost analysis
Stop the audio, read and attempt the
question in the textbook then come back to
listen to the solution.
32
94
Problem 12-24 pages 607-608Handout pages 9 and 10
1. Would the increased fixed expenses be justified?
2. Compute the per unit break-even price on this order.
3. What unit cost figure is relevant for setting a minimum selling price?
4. What would be the impact on profits of closing the plant for the two-month period?
5. Compute the unit cost figure that is relevant for comparison to the quoted price.
Part 7 – Review question: Relevant cost analysis
95
Problem 12-24 pages 607-608Handout pages 9 and 10
1. Would the increased fixed expenses be justified?
2. Compute the per unit break-even price on this order.
3. What unit cost figure is relevant for setting a minimum selling price?
4. What would be the impact on profits of closing the plant for the two-month period?
5. Compute the unit cost figure that is relevant for comparison to the quoted price.
Part 7 – Review question: Relevant cost analysis
96
Part 8
Review questions:
Retain or drop a department
Make or buy decision
Special order/make or buy(download the additional questions handout:
ma1_mod9_handout1.pdf)
MA1 – MODULE 9
33
97
Past CGA exam questionHandout page 11
Prepare an analysis to determine whether the shoe department should be dropped, and make a recommendation.
Part 8 – Review question: Retain or drop a department;
make or buy decision; special order
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
98
Past CGA exam questionHandout page 12
State whether Green’s should make or buy the game boards from the competitor.
Part 8 – Review question: Retain or drop a department;
make or buy decision; special order
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
99
Past CGA exam questionHandout pages 13 - 14
a. Should the government agency contract be accepted?
b. Should the contractor’s offer be accepted?
Part 8 – Review question: Retain or drop a department;
make or buy decision; special order
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
34
100
Part 9
Review question:
EOQ and safety stock
(download the additional questions handout:
ma1_mod9_handout1.pdf)
MA1 – MODULE 9
101
Handout questionHandout pages 15 - 16
1. Compute the EOQ.
2. At 18% risk of a stock out what would be the safety stock? The reorder point?
3. At 6% risk of a stock out what would be the safety stock? The reorder point?
Part 9 – Review question: EOQ and safety stock
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
102
Handout questionHandout pages 15 - 16
4. At a 6% stock out risk what would be the total cost of ordering and carrying inventory for one year?
5. a) Using a JIT purchasing policy compute the new EOQ.
b) How frequently would the company be placing an order?
Part 9 – Review question: EOQ and safety stock
35
103
Part 10
Review questions:
Multiple Choice Questions
(download the additional questions handout:
ma1_mod9_handout1.pdf)
MA1 – MODULE 9
104
Multiple choice questionsHandout pages 17 thru 19
Now working on page 17
Q1 What is the affect of the decision on EOQ?
Q2 If the division were discontinued how much would IPM’s income increase?
Q3 What is the EOQ for Popcorn Co?
Q4 Which would not be relevant to the closure decision?
Part 10 – Review questions: Multiple choice
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
105
Multiple choice questionsHandout pages 17 thru 19
Now working on page 18
Q5 What type of cost is machine amortization?
Q6 Which is not a relevant cost?
Q7 Which is the appropriate decision and related cost?
Part 10 – Review questions: Multiple choice