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Financial & Managerial Accounting 2002e. Belverd E. Needles, Jr. Marian Powers Susan Crosson - - - - - - - - - - - Multimedia Slides by: Harry Hooper Santa Fe Community College . Chapter 24 Short-Run Decision Analysis. LEARNING OBJECTIVES.

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financial managerial accounting 2002e
Financial & Managerial Accounting 2002e

Belverd E. Needles, Jr.

Marian Powers

Susan Crosson

- - - - - - - - - - -

Multimedia Slides by:

Harry Hooper

Santa Fe Community College

Copyright © Houghton Mifflin Company. All rights reserved.

chapter 24 short run decision analysis

Chapter 24Short-Run Decision Analysis

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learning objectives
LEARNING OBJECTIVES
  • Explain how managers make short-run decisions during the management cycle.
  • Define and explain incremental analysis and its related concepts.
  • Apply incremental analysis to outsourcing decisions.
  • Apply incremental analysis to special order decisions.
  • Apply incremental analysis to segment profitability decisions.

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learning objectives4
LEARNING OBJECTIVES
  • Apply incremental analysis to product mix decisions involving constrained resources.
  • Apply incremental analysis to sell or process-further decisions.
  • Apply incremental analysis to service organizations.

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information for short run decisions

Information forShort-Run Decisions

OBJECTIVE 1

Explain how managers make short-run decisions during the management cycle, and identify the steps in the management decision cycle.

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short run decisions
Short-Run Decisions
  • Short-run decision analysis is an important component of the management cycle.
  • In the planning stage, managers estimate costs and revenues for use in making short-run decision.

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the management cycle
The Management Cycle
  • In the executing stage, managers make and implement short-run decisions to improve the organization’s profitability and liquidity in the short run.
    • Managers use financial and nonfinancial information to decide to:
      • Accept a special order.
      • Keep or drop a segment.
      • Select the appropriate product mix.
      • Contract with outside suppliers.
      • Sell a product as is or process further.

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the management cycle8
The Management Cycle
  • In the reviewing stage, each decision is evaluated to determine if it produced the forecasted results.
  • The reporting stage takes place throughout the management cycle.

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short run decisions9
Short-Run Decisions
  • Both quantitative and qualitative factors influence short-run decisions.
  • Managers must assess the importance of qualitative information such as:
    • Product (or service) quality.
    • Timeliness.
    • Social issues.

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the management cycle10
The Management Cycle

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the management decision cycle
The Management Decision Cycle

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discussion
Discussion
  • What are some examples of ways that

managers use financial and nonfinancial information?

  • 1. Accept a special order.

2. Keep or drop a segment.

3. Select the appropriate product mix.

4. Contract with outside suppliers.

5. Sell a product as is or process further.

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the decision making process

The Decision-Making Process

OBJECTIVE 2

Define and explain incremental analysis

and its related concepts.

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incremental analysis for management decisions
Incremental Analysis for Management Decisions
  • The management decision cycle:
    • Begins with the determination of a problem or need.
    • Then alternative courses of action are identified.
    • The effects of each alternative are evaluated.

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incremental analysis
Incremental Analysis
  • Also called differential analysis.
  • Ignores revenues or costs that stay the same or that do not differ among alternatives. (Irrelevant revenue and costs.)
  • Ignores sunk costs, already incurred and not recoverable.

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relevant decision information
Relevant Decision Information
  • Any data related to future costs, revenues, or uses of resources that will differ among alternative courses of action are considered relevant decision information.

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incremental analysis17
Incremental Analysis
  • Step 1: Eliminate irrelevant revenues and costs.
  • Step 2: Prepare the analysis using only projected revenues and expenses that will differ.
  • Step 3: Consider other relevant issues, such as quality, reputation, etc.

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incremental analysis18
Incremental Analysis

Lennox Company

Incremental Analysis

Difference

in favor of

Grinder C

Grinder W

Grinder W

Increase in revenues

$ 16,200

$ 19,800

$ 3,600

Increase in operating costs

Direct labor

$ 2,200

$ 4,100

($ 1,900)

Variable manufacturing overhead

2,100

3,050

(950)

Total relevant operating costs

$ 4,300

$ 7,150

($ 2,850)

Resulting change in net income

$ 11,900

$ 12,650

$ 750

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special considerations in short run decision analysis
Special Considerations in Short-Run Decision Analysis
  • The effects of opportunity costs
  • The need to prepare special decision reports

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decision costs
Decision Costs
  • Opportunity costs are the benefits forgone when one alternative is selected over another.
  • Incremental analysis helps managers compare alternatives by focusing on the differences in their projected revenues and costs.
    • Such a report helps identify which alternative contributes the most to profits or incurs the lowest cost.

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traditional versus special decision reports
Traditional Versus Special Decision Reports
  • Frequently contribution format incremental analyses are used to support special decisions.
  • If qualitative factors are very important, special formats must be used to support quantitative analysis with qualitative information.

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discussion22
Discussion
  • What data should be omitted from the analyses and reports accountants present to management?
  • 1. Past data.

2. Data that are identical under all alternatives.

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outsourcing decisions

Outsourcing Decisions

OBJECTIVE 3

Apply incremental analysis to outsourcing decisions.

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outsourcing
Outsourcing
  • Outsourcing is the use of suppliers outside the organization to perform services or produce goods that could be performed or produced internally.
  • Outsourcing includes make-or-buy decisions, which are decisions about whether to make a part internally or buy it from an external supplier.

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outsourcing25
Outsourcing
  • Many organizations outsource functions that do not represent core competencies such as:
    • Payroll processing.
    • Selling and marketing.
    • Fleet management.
    • Training.
    • Custodial services.
    • Information management.

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incremental analysis outsourcing decision
Incremental Analysis: Outsourcing Decision

Kriegel Electronics Company

Outsourcing Decision

Incremental Analysis

Difference

Make

Buy

in favor

of Make

Direct materials

¸

´

$ 16,800

--------

($ 16,800)

(20,000

100

$84)

Direct labor

8,000

--------

(8,000)

¸

´

(20,000

20

$8)

Variable manufacturing overhead

4,000

--------

(4,000)

¸

´

(20,000

20

$4)

To purchase completed castings

---------

$ 30,000

30,000

´

(20,000

$1.50)

Totals

$ 28,800

$ 30,000

$ 1,200

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outsourcing benefits
Outsourcing Benefits
  • Loss of control.
  • Loss of expertise within the organization.
  • Growing dependence on suppliers.
  • Potential loss of critical information to competitors.

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outsourcing problems
Outsourcing Problems
  • Some of the problems associated with outsourcing include:
      • Loss of control.
      • Loss of expertise within the organization.
      • Growing dependence on suppliers.
      • Potential loss of critical information to competitors.

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hidden costs of outsourcing the production of parts for assembly operations

When manufacturers purchase parts from suppliers, they expect

quality parts to be delivered quickly for a reasonable price. The

hidden costs of maintaining an outsourcing relationship with a

supplier can include the following:

Costs of Quality for Parts Purchased from Suppliers

·

Cost of inspecting parts delivered to the company

·

Cost of labor and shipping to return defective parts to suppliers

·

Cost of training suppliers to follow quality methods

Costs of Late Deliveries from Suppliers

·

Cost of lost customer sales due to late parts deliveries from suppliers

·

Cost of carrying extra direct materials and finished goods inventory to

compensate for late parts deliveries from suppliers

·

Cost of back orders due to partial shipments

Hidden Costs of Outsourcing the Production of Parts for Assembly Operations

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hidden costs
Hidden Costs
  • Hidden costs of maintaining an outsourcing relationship with a supplier can include:
      • Costs of quality.
      • Costs of late deliveries.
      • To manage the hidden costs, companies may add clauses to their contracts with suppliers to specify penalties for poor quality or late deliveries.

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make or buy decisions
Make-or-Buy Decisions

To decide whether to make a product or to buy from an outside supplier, the following information is needed:

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special order decisions

Special Order Decisions

OBJECTIVE 4Apply incremental analysis to special order decisions.

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special order decisions33
Special Order Decisions
  • Special order decisions are decisions about whether to accept or reject special product orders at prices below the normal market prices.
  • A special order is a one-time, nonrecurring order.
  • Before accepting a special order, compliance with federal price discrimination laws should be checked.

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special order decisions34
Special Order Decisions
  • Two different approaches to special order decisions include:Compare the special order price to the relevant costs to produce, package, and ship the order.
    • Prepare a special order bid price by calculating a minimum selling price for the special order.

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incremental analysis special order decision jens sporting goods inc
Incremental Analysis: Special Order DecisionJens Sporting Goods, Inc.

* Assuming available existing production capacity, so no additional fixed costs are incurred.

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special orders qualitative factors
Special Orders: Qualitative Factors
  • These may include:
    • Impact on sales to regular customers
    • Potential of special order to lead into new sales areas
    • Customer’s ability to maintain an ongoing relationship

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fixed costs
Fixed Costs
  • Examples of relevant fixed costs include:
      • Purchase of additional machinery.
      • Increase in supervisory help.
      • Increase in insurance premiums.

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segment profitability decisions

Segment Profitability Decisions

OBJECTIVE 5

Apply incremental analysis to segment profitability decisions.

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segment profitability decisions39
Segment Profitability Decisions
  • Segment profitability decisions involve the review of segments of an organization, such as:
        • Product lines.
        • Services.
        • Sales territories.
        • Divisions.
        • Departments.

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segment margin

Segment’s sales revenue

Segment Margin
  • A segment margin is:

- direct variable costs

- fixed costs that will be

avoided if that segment

is dropped

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segment profitability decisions41
Segment Profitability Decisions
  • Often managers must decide whether to add or drop a segment.
      • If a segment has a negative segment margin, the segment may be dropped.
      • Common costs that will be incurred regardless of the decision are unavoidable costs.

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incremental analysis segment profitability decision
Incremental Analysis: Segment Profitability Decision

Lebo Corporation

Segment Profitability Decision

Incremental Analysis

Difference in

Favor of

Keep

Drop

Dropping

Division Y

Division Y

Division Y

Sales

$ 150,000

$ 135,000

($ 15,000)

Less variable costs

60,000

52,500

7,500

Contribution margin

$ 90,000

$ 82,500

($ 7,500)

Less direct fixed costs

72,000

55,500

16,500

Segment margin

$ 18,000

$ 27,000

$ 9,000

Less common fixed costs

12,000

12,000

0

Net income

$ 6,000

$ 15,000

$ 9,000

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product mix decisions

Product Mix Decisions

OBJECTIVE 6

Apply incremental analysis to product mix decisions involving constrained resources.

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product mix decisions44
Product Mix Decisions
  • Product mix decisions require the selection of the most profitable combination of product sales when a company makes more than one product using a common constrained resource.

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constrained resources
Constrained Resources
  • The constrained or limited resource may be:
          • Labor time.
          • Machine time.
          • Quantity of a raw material.

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decision analysis
Decision Analysis
  • The steps in the decision analysis include:
      • Calculation of the contribution margin per unit for each product line affected by the constrained resource.
      • Divide the contribution margin per unit by the quantity of the constrained resource required per unit.

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decision analysis47
Decision Analysis
  • Profit will be maximized in the short run by devoting limited resources to the product(s) with the highest contribution margin per unit of the constrained resource.

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incremental analysis product mix decision involving constrained resources
Incremental Analysis: Product Mix Decision Involving Constrained Resources

Grady Enterprises

Product Mix Decision: Ranking the Order of Production

Incremental Analysis

Rising

Star

Ghost

Master

Road

Warrior

Selling price per unit

$24.00

$18.00

$32.00

Less: Variable costs

Manufacturing

$12.50

$10.00

$18.75

Selling

6.50

5.00

6.25

Total unit variable costs

$19.00

$15.00

$25.00

Contribution margin per unit (A)

$ 5.00

$ 3.00

$ 7.00

Machine hours per unit (B)

2

1

2.5

Contribution margin per

$ 2.50

$ 3.00

$ 2.80

machine hour (A ÷ B)

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incremental analysis product mix decision

Incremental Analysis: Product Mix Decision

  • Constraints:
  • Maximum production capacity: 100,000 machine hours
  • Current maximum sales demand:
        • Rising star: 20,000 units
        • Ghost master: 30,000 units
        • Road Warrior: 18,000 units

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incremental analysis product mix decision50

Grady Enterprises

Number of Units to Make

Incremental Analysis: Product Mix Decision

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sell or process further decisions

Sell or Process-Further Decisions

OBJECTIVE 7

Apply incremental analysis to sell or process further decisions.

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sell or process further decisions52
Sell or Process-Further Decisions
  • A sell or process-further decision is a decision about whether to sell a joint product at the split-off point or sell it after further processing.
  • Joint products are two or more products made from a common material or process that cannot be identified as separate productions until the split-off point.

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split off points
Split-Off Points
  • At the split-off point, joint products become separate and identifiable.
  • At that point, a company may choose to sell the product as is or to process it into another form for sale to a different market.

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incremental analysis54
Incremental Analysis
  • The objective of the incremental analysis is to determine if the product’s selling price will increase more than the incremental costs of processing further.
  • Only the incremental costs and incremental revenues beyond the split-off are relevant.

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incremental analysis sell or process further decision
Incremental Analysis: Sell or Process-Further Decision

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discussion56
Discussion

Q. What are five operating decisions facing managers that can be made using incremental analysis?

A.Outsourcing decisions.

  • 2. Special order decisions.
  • 3. Segment profitability decisions.
  • 4. Product mix decisions.
  • 5. Sell or process-further decisions.

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short run decisions in service organizations

Short-Run Decisions in Service Organizations

OBJECTIVE 8

Apply incremental analysis to service organizations.

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short run decisions58
Short-Run Decisions
  • Typical short-run decisions in service organizations include whether to:
      • Outsource a service.
      • Accept a bid for a special order.
      • Drop an unprofitable service.
      • Provide one service before another because of limited labor hours.

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incremental analysis service mix decision involving constrained resources
Incremental Analysis:Service Mix Decision Involving Constrained Resources

Cyber Web Services

Service Mix Decision: Ranking the Order in Which the Services Are Provided

Basic

Custom

Web Pages

Web Pages

Service revenue per page

$200

$ 750

Less variable costs per page

77

600

Contribution margin per page (A)

$123

$ 150

Design hours per page (B)

1

12.5

Contribution margin per design

¸

hour (A

B)

$123

$ 12

Decision: Complete Basic Web Pages first.

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incremental analysis outsourcing for a service organization
Incremental Analysis: Outsourcing for a Service Organization

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ok let s review
OK, Let’s Review
  • Explain how managers make short-run decisions during the management cycle.
  • Define and explain incremental analysis and its related concepts.
  • Apply incremental analysis to outsourcing decisions.
  • Apply incremental analysis to special order decisions.
  • Apply incremental analysis to segment profitability decisions.

Copyright © Houghton Mifflin Company. All rights reserved.

incremental analysis special orders for a service organization
Incremental Analysis: Special Orders for a Service Organization

Decision: Reject the Spaced Order

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incremental analysis segment profitability for a service organization
Incremental Analysis: Segment Profitability for a Service Organization

Decision: Eliminate design segment or improve segment margin.

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discussion64
Discussion

Q. What are the typical short-run decisions in service organizations?

A. 1. Service outsourcing.

2. Accept a special order bid. 3. Drop an unprofitable service. 4. What service to provide.

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ok let s review65
OK, Let’s Review
  • Apply incremental analysis to product mix decisions involving constrained resources.
  • Apply incremental analysis to sell or process-further decisions.
  • Apply incremental analysis to service organizations.

Copyright © Houghton Mifflin Company. All rights reserved.