ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 18 Professor Jeff Yu. Review: Relevant Cost Analysis. A Two-Step Process: Step 1: Eliminate costs and benefits that DO NOT differ between alternatives.
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Fundamentals of Accounting II
Professor Jeff Yu
A Two-Step Process:
Two broad categories of costs are NEVER relevant in decision making: (1) Sunk costs; (2) Future costs that do not differ between alternatives.
Review: equipment replacement decision
Review: Decision to Add/Drop Segments
Review: Transfer Pricing decision
Review: Decision to Accept/Reject a Special Order
The basic make-or-buy question is whether a company should make its own parts to be used in its products or buy them from vendors.
Note: watch out for any relevant opportunity costs.
Essex manufactures part 4A that is currently used in one of its products. The unit cost to make this part is:
The equipment used to make part 4A has no resale value and no alternative use. General overhead is allocated regardless of Essex making or buying part 4A. The $30 total unit cost is based on 20,000 parts produced each year. An outside supplier has offered to provide the 20,000 parts at a cost of $25 per part. Should we accept the supplier’s offer?
Motor Company manufactures 10,000 units of Part M-l each year for use in its production. The following total costs were reported last year:
Valve Company has offered to sell Motor 10,000 units of Part M-l for $18 per unit. If Motor accepts the offer, some of the facilities presently used to manufacture Part M-l could be rented to a third party at an annual rental of $25,000. Additionally, $4 per unit of the fixed overhead applied to Part M-l would be eliminated.
Q: Should Motor Company accept Valve Company's offer, and why?
Optimal Use of Limited Resources
Let’s take a look at another decision faced by many firms:
We have a limited number of machine hours in which to produce our products. How much of each product should we produce?
Optimal Use of Limited Resources
A company has two products: a plain cellular phone and a fancier cellular phone with many special features:
Selling price $ 80 $ 120
VC per unit 64 84
CM per unit 16 36
CM ratio 20% 30%
Suppose annual demand for phones of both types is unlimited, and managers identified labor hours to be the limited resource: only 10,000 hours are available next year.If in one hour plant workers can make either three plain phones or one fancy phone, which phone should be produced to maximize the profit?
Two or more products produced from a common 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.
Joint costs are costs incurred up to the split-off point and are usually allocated to the end products proportionate to their sales value.
Costs incurred after the point of split-off are called Separate Product Costs.
Decision: Sell or Process Further?
Managers frequently face decisions of whether to sell joint products at split-off or to process some products further.
The decision to process further (beyond the split-off point) should be made based on each product’s incremental costs and incremental revenues ONLY!
Decision Rule: process further only when the incremental revenue from such processing exceeds the incremental processing cost incurred after the split-off point.
Joint costs are irrelevant to the decision. Why?
sales value $750 for
$600 per ton
Total joint cost:
$1,100 per ton
Instant cocoa mix
Q: Should the cocoa powder be sold now or processed into instant cocoa mix?