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COST MANAGEMENT

COST MANAGEMENT. Don R. Hansen Maryanne M. Mowen. Chapter Nineteen. Activity Resource Usage Model and Relevant Costing: Tactical Decision Making. Learning Objectives. Describe and explain the tactical decision- making model. Define ad explain the concept of relevant costs and revenues.

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COST MANAGEMENT

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  1. COST MANAGEMENT Don R. Hansen Maryanne M. Mowen

  2. Chapter Nineteen Activity Resource Usage Model and Relevant Costing: Tactical Decision Making

  3. Learning Objectives • Describe and explain the tactical decision- making model. • Define ad explain the concept of relevant costs and revenues.

  4. Learning Objectives (continued) • Explain how the activity resource usage model is used in assessing relevancy. • Apply the tactical decision-making concepts in a variety of business situations.

  5. The Tactical Decision-Making Process Tactical decision makingconsists of choosing among alternatives with an immediate or limited end in view. Tactical cost analysis is the use of relevant cost data to identify the alternative that provides the greatest benefit to the organization.

  6. The Tactical Decision-Making Process (continued) • Recognize and define the problem. • Identify alternatives as possible solutions to the problem, and eliminate alternatives that are not feasible. • Identify the predicted costs and benefits associated with each feasible alternative. Eliminate the costs and benefits that are not relevant to the decision.

  7. The Tactical Decision-Making Process (continued) • Compare the relevant costs and benefits for each alternative, and relate each alternative to the overall strategic goals of the firm and other important qualitative factors. • Select the alternative with the greatest benefit which also supports the organization’s strategic objectives.

  8. Qualitative Factors How should qualitative factors be handled in the decision-making process? 1. They must be identified. 2. The decision maker should try to quantify them. 3. True qualitative factors should be taken into consideration in the final step of the decision-making process.

  9. Relevant Costs Defined • Costs that differ across alternatives • Costs that deal with future courses of action

  10. Irrelevant Cost Sunk costs are past costs. Example: The original cost of a building is a sunk cost when you are selling the building five years later.

  11. Activity Resource Usage Model and Assessing Relevancy Flexible Resources Resources Acquired as Needed a. Demand Changes b. Demand Constant Relevant Not Relevant

  12. Activity Resource Usage Model and Assessing Relevancy (continued) Committed Resources Acquired in Advance (Short Term) a. Demand Increase < Unused Capacity b. Demand Increase > Unused Capacity c. Demand Decrease (Permanent) 1. Activity Capacity Reduced 2. Activity Capacity Unchanged Not Relevant Relevant Relevant Not Relevant

  13. Some Types of Decisions Illustrated • Make or Buy • Keep or Drop • Special Order • Sell or Process Further Important: Short-term Perspective

  14. Activity and Cost Information Part Expected 34B Activity Activity Activity Units of ActivityCost DriverCost FormulaCapacityUsageUsagePurchase Using materials Units Y = $0.5X As needed 100,000 100,000 1 Using direct labor Units Y = $2X As needed 100,000 100,000 1 Providing Number of Y = $300,000 15 15 3 3 supervision lines Moving materials Number of Y = $250,000 250,000 240,000 40,000 25,000 moves + $0.60X Providing power Machine Y = $3X As needed 30,000 30,000 1 hours Inspecting Inspection Y = $280,000 16,000 14,000 2,000 2,000 products hours + $1.50X Setting Setup hours Y = $600,000 60,000 58,000 6,000 2,000 up equipment Providing space Square feet Y = $1,000,000 50,000 50,000 5,000 50,000 Equipment Units Y = $0.50X 120,000 100,000 100,000 15,000 depreciation

  15. Make-or-Buy Decisions • Assume the following cost data related to the decision to produce • 12,000 units of a product or buy from an external source: • Total Costs Unit Cost • Rental of equipment $15,000 $1.25 • Equip. depreciation 3,000 .25 • Direct materials 12,000 1.00 • Direct labor 24,000 2.00 • Variable overhead 9,000 .75 • Fixed overhead 36,000 3.00 • Total $99,000 $8.25 • ====== ==== Purchase price from an outside vendor is $5.50 per unit

  16. Make-or-Buy Decision (continued) Alternatives Differential Make Buy Cost to Make Rental of equip. $15,000 ---- $15,000 Direct materials 5,000 ---- 5,000 Direct labor 24,000 ---- 24,000 Variable overhead 9,000 ---- 9,000 Purchase cost $66,000 ($66,000) Relevant costs $53,000 $66,000 ($13,000) ====== ====== ====== Decision: Manufacture parts in-house

  17. Keep-or-Drop Decisions Assume the following: Regular Deluxe Total Sales units 400 200 600 Sales revenue $200,000 $150,000 $350,000 Less variable expenses: Variable cost of sales 96,000 60,000 156,000 Variable selling & admin. 10,000 7,500 17,500 Contribution margin $ 94,000 $ 82,500 $176,500 Less direct fixed expenses: Direct fixed costs 30,000 85,000 115,000 Product margin $ 64,000 $ (2,500) $ 61,500 Less common fixed costs ======= ======= 30,000 Net income $ 31,500 ======= Should the Deluxe product line be eliminated?

  18. Keep-or-Drop (continued) Differential Keep Drop Amount to Keep Sales $150,000 ---- $150,000 Variable expenses (67,500) ---- (67,500) Contribution margin $ 82,500 ---- $ 82,500 Direct fixed expenses (85,000) ---- (85,000) Relevant benefit/loss $ (2,500) ====== Decision: Drop the Deluxe product line but investigate alternative use of facilities. This analysis provides a benchmark for future decisions.

  19. Special-Order Decisions • Assume the following price quotation sheet for the XYX Company who • has received an offer buy at $38 per unit. • Direct materials $12 • Direct labor 14 • Variable overhead 4 • Variable selling and administrative 2 • Fixed manufacturing 20 • Total $52 • Markup--50% 26 • Target selling price $78 • === Important: XYZ Company has idle capacity and can produce the special order without affecting its current production.

  20. Special-Order Decisions (continued) Decision Rule: The “floor” for establishing a price for a special order is incremental cost(variable cost in this case). Incremental Costs: Direct materials $12 Sales price $38 Direct labor 14 Incremental costs 32 Variable overhead 4 Additional income $ 6 per unit Variable S & A 2 === Total $32 === Question: What impact is this decision likely to have on existing customers?

  21. Joint Products Joint products have common processes and costs of production up to a split-off point. The point of separation is called the split-off point.

  22. Decisions to Sell or Process Further Product A Separate Processing Joint Input Joint Costs Should the company process further? Product B Separate Processing Split-off point Joint products

  23. Decisions to Sell or Process Further (continued) Sell or process further decision: Products A B Sales value at split-off $240,000 $300,000 Sales value after additional processing 320,000 480,000 Allocated joint product costs 160,000 200,000 Cost of further processing 100,000 120,000 Incremental revenue from processing $ 80,000 $180,000 Cost of additional processing 100,000 120,000 Profit (loss) from further processing $(20,000) $ 60,000 Decision Sell at split-off Process further Joint costs are irrelevant

  24. End of Chapter 19

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