1 / 55

Introduction to Management Accounting

Introduction to Management Accounting. Introduction to Management Accounting. Chapter 6. Relevant Information for Decision Making with a Focus on Operational Decisions. Learning Objective 1. Opportunity, Outlay, and Differential Costs. Differential cost is the difference in

aimee
Download Presentation

Introduction to Management Accounting

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Introduction to Management Accounting

  2. Introduction to Management Accounting Chapter 6 Relevant Information for Decision Making with a Focus on Operational Decisions

  3. Learning Objective 1 Opportunity, Outlay, and Differential Costs Differentialcost is the difference in total cost between two alternatives. Differential revenue is the difference in total revenue between two alternatives. Incremental cost are additional costs or reduced benefits generated by the proposed alternative. Incremental benefits are the additional revenues or reduced costs generated by the proposed alternative.

  4. Opportunity, Outlay, and Differential Costs An incremental analysis is an analysis of the additional costs and benefits of a proposed alternative. An opportunitycost is the maximum available contribution to profit forgone (or passed up) by using limited resources for a particular purpose. An outlaycost requires a cash disbursement.

  5. Opportunity, Outlay, and Differential Costs Nantucket Nectars has a machine for which it paid $100,000 and it is sitting idle. • Nantucket Nectars has three alternatives: • Increase production of Peach juice • Sell the machine • 3. Produce a new drink Papaya Mango

  6. Revenue $500,000 Costs: Outlay Costs 400,000 Financial benefit before opportunity costs $100,000 Opportunity cost of machine 60,000 Net financial benefit $ 40,000 Opportunity Cost Peach Juice Contribution margin is $60,000. 1 Sell machine for $50,000. 2 Produce Papaya Mango juice with projected sales of $500,000. 3

  7. Learning Objective 2 Make-or-Buy Decisions Managers often must decide whether to produce a product or service within the firm or purchase it from an outside supplier.

  8. Direct material $ 60,000 $.06 Direct labor 20,000 .02 Variable factory overhead 40,000 .04 Fixed factory overhead 80,000 .08 Total costs $200,000 $.20 Make or Buy Decisions Nantucket Nectars Company’s Cost of Making 12-ounce Bottles

  9. Make-or-Buy Example Another manufacturer offers to sell Nantucket the bottles for $.18. If the company buys the bottles, $50,000 of fixed overhead would be eliminated. Should Nantucket make or buy the bottles?

  10. Buy Make Total Per Bottle Total Per Bottle Purchase cost $180,000 $.18 Direct material $ 60,000 $.06 Direct labor 20,000 .02 Variable overhead 40,000 .04 Fixed OH avoided by not making 50,000 .05 0 0 Total relevant costs $170,000 $.17 $180,000 $.18 Difference in favor of making $ 10,000 $.01 Relevant Cost Comparison

  11. Make or Buy and the Use of Facilities Suppose Nantucket can use the released facilities in other manufacturing activities to produce a contribution to profits of $55,000, or can rent them out for $25,000. What are the alternatives?

  12. Make or Buy and the Use of Facilities (000) Make Buy and leave facilities idle Buy and rent out facilities Buy and use facilities for other products Rent revenue $ — $ — $ 25 $ — Contribution from other products — — — 55 Variable cost of bottles (170) (180) (180) (180) Net relevant costs $(170) $(180) $(155) $(125)

  13. Avoidable and Unavoidable Costs Learning Objective 3 Avoidable costs are costs that will not continue if an ongoing operation is changed or deleted. Unavoidable costs are costs that continue even if an operation is halted. Common costs are costs of facilities and services that are shared by users.

  14. Department Store Example Consider a discount department store that has three major departments: Groceries General merchandise Drugs

  15. Department Store Example Departments Groceries Drugs Total General Mdse. Sales $1,900 $1,000 $800 $100 Variable expenses 1,420 800 560 60 Contribution margin $ 480 (25%) $ 200 (20%) $240 (30%) $ 40 (40%) Fixed expenses: Avoidable $ 265 $ 150 $100 $ 15 Unavoidable 18060 100 20 Total fixed expenses $ 445 $ 210 $200 $ 35 Operating income $ 35$ (10) $ 40 $ 5 ($000)

  16. Department Store Example Assume that the only alternatives to be considered are dropping or continuing the grocery department, which has consistently shown an operating loss. Assume further that the total assets invested would be unaffected by the decision. The vacated space would be idle and the unavoidable costs would continue.

  17. Department Store Example Store as a Whole ($000) Total Before Change Effect of Dropping Groceries Total After Change Sales $1,900 $1,000 $900 Variable expenses 1,420 800 620 Contribution margin $ 480 $ 200 $280 Avoidable fixed expenses 265 150 115 Profit contribution to common space and other unavoidable costs $ 215 $ 50 $165 Unavoidable expenses 180 0 180 Operating income $ 35 $ 50 $ (15)

  18. Department Store Example Assume that the store could use the space made available by the dropping of groceries to expand the general merchandise department. This will increase sales by $50,000, generate a 30% contribution-margin, and have avoidable fixed costs of $70,000. $80,000 – $50,000 = $30,000

  19. Department Store Example Store as a Whole ($000) Total Before Change Drop Groceries Expand General Merchandise Total After Change Sales $1,900 $1,000 $500 $1,400 Variable expenses 1,420 800350 970 Contribution margin $ 480 $ 200 $150 $ 430 Avoidable fixed expenses 265 150 70 185 Profit contribution to common space and other unavoidable costs $ 215 $ 50 $80 $245 Unavoidable expenses 180 0 0 180 Operating income $ 35 $ 50 $80 $ 65

  20. Optimal Use of Limited Resources Learning Objective 4 A limiting factor or scarce resource restricts or constrains the production or sale of a product or service. Assume that the capacity of the facility is determined by machine time, and the maximum capacity is 10,000 machine hours. The facility can produce 10 pairs of Air Court Shoes or 5 pairs of Air Max shoes per hour.

  21. Optimal Use of Limited Resources Air Court Air Max Selling price per pair $80 $120 Variable costs per pair 60 84 Contribution margin per pair $20 $ 36 Contribution margin ratio 25% 30%

  22. Optimal Use of Limited Resources Which is more profitable? If the limiting factor is demand, that is, pairs of shoes, the more profitable product is Air Max. Why?

  23. Optimal Use of Limited Resources Air Max is the product with the higher contribution per unit. The sale of a pair of Air Court shoes adds $20 to profit. The sale of a pair of Air Max shoes adds $36 to profit.

  24. Optimal Use of Limited Resources Suppose that demand for either shoe would fill the plant’s capacity. Now, capacity is the limiting factor. Which is more profitable? If the limiting factor is capacity, the more profitable product is Air Court. Why?

  25. Optimal Use of Limited Resources Air Court $20 contribution margin per pair × 10,000 hours = $2,000,000 contribution Air Max: $36 contribution margin per pair × 10,000 hours = $1,800,000 contribution

  26. Optimal Use of Limited Resources In retails stores, the limiting factor is often floor space. The focus is on products taking up less space or on using the space for shorter periods of time. Retail stores seek faster inventory turnover (the number of times the average inventory is sold per year).

  27. Retail Price $4.00 $3.50 Costs of Merchandise and other variable costs 3.00 3.00 Contribution to profit per unit $1.00 (25%) $ .50 (14%) Units sold per year 10,000 22,000 Total contribution to profit, assuming the same space allotment in both stores $10,000 11,000 Optimal Use of Limited Resources Faster inventory turnover makes the same product a more profitable use of space in a discount store. Regular Department Store Discount Department Store

  28. Learning Objective 5 Joint Product Costs Joint products have relatively significant sales values. They are not separately identifiable as individual products until their split-off point. The split-off point is that juncture of manufacturing where the joint products become individually identifiable.

  29. Joint Product Costs Separable costs are any costs beyond the split-off point. Joint costs are the costs of manufacturing joint products before the split-off point. Should Dow sell the products at the split-off point or process them further?

  30. Joint Product Costs Suppose Dow Chemical Company produces two chemical products, X and Y, as a result of a particular joint process. The joint processing cost is $100,000. Both products are sold to the petroleum industry to be used as ingredients of gasoline.

  31. Joint-processing cost is $100,000 Split-off point Joint Product Costs 1 million liters of X at a selling price of $.09 = $90,000 500,000 liters of Y at a selling price of $.06 = $30,000 Total sales value at split-off is $120,000

  32. Illustration of Sell or Process Further Suppose the 500,000 liters of Y can be processed further and sold to the plastics industry as product YA. The additional processing cost would be $.08 per liter for manufacturing and distribution, a total of $40,000. The net sales price of YA would be $.16 per liter, a total of $80,000.

  33. Illustration of Sell or Process Further Sell at Split-off as Y Process Further and Sell as YA Difference Revenues $30,000 $80,000 $50,000 Separable costs beyond split-off @ $.08 – 40,000 40,000 Income effects $30,000 $40,000 $10,000

  34. Learning Objective 6 Equipment Replacement The book value of equipment is not a relevant consideration in deciding whether to replace the equipment. Why? Because it is a past, not a future cost.

  35. Book Value of Old Equipment Depreciation is the periodic allocation of the cost of equipment. The equipment’s book value (or net bookvalue) is the original cost less accumulated depreciation.

  36. Book Value of Old Equipment Suppose a $10,000 machine with a 10-year life span has depreciation of $1,000 per year. What is the book value at the end of 6 years? Original cost $10,000 Accumulated depreciation (6 × $1,000) 6,000 Book value $ 4,000

  37. Old Machine Replacement Machine Original cost $10,000 $8,000 Useful life in years 10 4 Current age in years 6 0 Useful life remaining in years 4 4 Accumulated depreciation $ 6,000 0 Book value $ 4,000 N/A Disposal value (in cash) now $ 2,500 N/A Disposal value in 4 years 0 0 Annual cash operating costs $ 5,000 $3,000 Keep or Replace the Old Machine?

  38. Relevance of Equipment Data A sunk cost is a cost already incurred and is irrelevant to the decision-making process. 4 commonly encountered items: • Book value of old equipment • Disposal value of old equipment • Gain or loss on disposal • Cost of new equipment

  39. Relevance of Equipment Data The book value of old equipment is irrelevant because it is a past (historical) cost. Therefore, depreciation on old equipment is irrelevant.

  40. Disposal Value of Old Equipment The disposal value of old equipment is relevant because it is an expected future inflow that usually differs among alternatives.

  41. Gain or Loss on Disposal This is the difference between book value and disposal value. It is a meaningless combination of irrelevant (book value) and relevant items (disposal value). It is best to think of each separately.

  42. Cost of New Equipment The cost of new equipment is relevant because it is an expected future outflow that will differ among alternatives.

  43. Four Years Together Keep Replace Difference Cash operating costs $20,000 $12,000 $8,000 Old equipment (book value): Depreciation, or 4,000 – – Lump-sum write-off – 4,000 – Disposal value – (2,500) 2,500 New machine acquisition cost – 8,000 (8,000) Total costs $24,000 $21,500 $2,500 Cost Comparison

  44. Learning Objective 7 Irrelevant or Misspecified Costs The ability to recognize irrelevant costs is important to decision makers. Cost of obsolete inventory Book value of old equipment

  45. Irrelevant or Misspecified Costs Suppose General Dynamics has 100 obsolete aircraft parts in its inventory. The original manufacturing cost of these parts was $100,000. General Dynamics can remachine the parts for $30,000 and then sell them for $50,000, or scrap them for $5,000.

  46. Expected future revenue $ 50,000 $ 5,000 $45,000 Expected future costs 30,000 0 30,000 Relevant excess of revenue over costs $ 20,000 $ 5,000 $15,000 Accumulated historical inventory cost* 100,000 100,000 0 Net loss on project $(80,000) $ (95,000) $15,000 * Irrelevant because it is unaffected by the decision. Irrelevant or Misspecified Costs Remachine Scrap Difference

  47. Irrelevant or Misspecified Costs There are two major ways to go wrong when using unit costs in decision making: • including irrelevant costs • comparing unit costs not computed • on the same volume basis

  48. Irrelevant or Misspecified Costs Assume that a new $100,000 machine with a five-year life can produce 100,000 units a year at a variable cost of $1 per unit, as opposed to a variable cost per unit of $1.50 with an old machine. Is the new machine a worthwhile acquisition?

  49. Irrelevant or Misspecified Costs New Machine Old Machine Units 100,000 100,000 Variable cost $150,000 $100,000 Straight-line depreciation 0 20,000 Total relevant costs $ 45,000 $120,000 Unit relevant costs $ 1.50 $ 1.20

  50. Irrelevant or Misspecified Costs It appears that the new machine will reduce costs by $.30 per unit. However, if the expected volume is only 30,000 units per year, the unit costs change in favor of the old machine.

More Related