Bài giảng Financial & Managerial Accounting - Chapter 20: Incremental Analysis

Incremental AnalysisChapter20SpecialorderdecisionsProductmixdecisionsMakeor buydecisionsJointproductdecisionsProduct markets can change quickly due to competitor pricecuts, changing customer preferences, and introduction ofnew products by competitors.Managers must make short-run decisions, with a fixed setof resources, to react to the changing market place. The Challenge ofChanging MarketsWill you drive or fly to Florida for spring break?You have gathered the following information to help you with the decision.Motel cost is $80 per night.Meal cost is $20 per day.Your car insurance is $100 per month.Kennel cost for your dog is $5 per day.Round-trip cost of gasoline for your car is $200.Round-trip airfare and rental car for a week is $500.Driving requires two days, with an overnight stay, cutting your time in Florida by two days.The Concept ofRelevant Cost Information8 days @ $808 days @ $208 days @ $5The Concept ofRelevant Cost InformationCosts do not differ,so they are notrelevant to decision.Also, car insuranceis not relevant tothe decision as itis a past cost.The Concept ofRelevant Cost InformationTransportationcosts differ betweenthe two alternatives,so they are relevantto your decisionAre the extra twodays in Floridaworth the $300extra cost to fly?The Concept ofRelevant Cost Information Decision making involves five steps: Define the problem. Identify the alternatives. Collect information on alternatives. Eliminate irrelevant information. Make a decision with the remaining relevant information. Decision Making Information that varies among the possible courses of action being considered. — Incremental costs and revenues —Important cost concepts forbusiness decisions.Opportunity costs.Sunk costs.Out-of-pocket costs.12Relevant Informationin Business DecisionsThe benefit that could have been attained by pursuing an alternative course of action. Example: If you were notattending college, you couldbe earning $20,000 per year. Your opportunity cost ofattending college for oneyear includes the $20,000.Opportunity costs are not recorded in the accounting records, but are relevant to decisions because they are a real sacrifice.Opportunity Cost All costs incurred in the past that cannot be changed by any decision made now or in the future. Sunk costs should not be considered in decisions. Example: You bought an automobile that cost $10,000 two years ago. The $10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the $10,000 cost.Sunk Costs VersusOut-of-Pocket CostsCost = $10,000two years agoCost = $25,000todayThe dealer will trade for $20,000 plus your car.What amount is relevant to your decision, the $10,000 sunk cost of your car or the$20,000 out-of-pocket cash differential?Trade ?Sunk Costs VersusOut-of-Pocket Costs We will now examine several different types of managerial decisions.Incremental Analysis inCommon Business Decisions The decision to accept additional business should be based on incremental costs and incremental revenues. Incremental amounts are those that occur only if the company decides to accept the new business.Special Order DecisionsJamCo currently sells 100,000 units of its product. The company has revenue and costs as shown below:Special Order Decisions JamCo is approached by an overseascompany that offers to purchase10,000 units at $8.50 per unit.If JamCo accepts the offer, total factory overhead will increase by $5,000; total selling expenses will increase by $2,000; and total administrative expenses will increaseby $1,000. Should JamCoaccept the offer?Special Order DecisionsFirst let’s look at incorrect reasoningthat leads to an incorrect decision.Our cost is $9.00per unit. I can’t sell for $8.50 per unit. Special Order DecisionsThis analysis leads to the correct decision.Special Order Decisions10,000 new units × $8.50 selling price = $85,000Special Order Decisions10,000 new units × $3.50 = $35,000Special Order Decisions10,000 new units × $2.20 = $22,000Special Order DecisionsEven though the $8.50 selling price is less than thenormal $10 selling price, JamCo should accept theoffer because net income will increase by $20,000.Special Order DecisionsWe can also look at this decisionusing contribution margin.Special Order Decisions Managers often face the problem of deciding how scarce resources are going to be utilized. Usually, fixed costs are not affected by this particular decision, so management can focus on maximizing total contribution margin. Let’s look at the Kaser Company example.Production Constraint DecisionsKaser Company produces two products and selected data is shown below:Production Constraint Decisions Machine A1 is the scarce resource because there is excess capacity on other machines. Machine A1 is being used at 100% of its capacity.Machine A1 capacity is 2,400 minutes per week.Should Kaser focus its efforts on Product 1 or 2?Production Constraint DecisionsLet’s calculate the contribution margin per unit of the scarce resource, machine A1.Production Constraint DecisionsProduct 2 should be emphasized. It is the more valuable use of the scarce resource, machine A1, yielding a contribution margin of $30 per minute as opposed to $24 for Product 1.Production Constraint DecisionsLet’s calculate the contribution margin per unit of the scarce resource, machine A1.If there are no other considerations, the best plan would be to produce to meet current demand for Product 2 and then use any capacity that remains to make Product 1.Production Constraint DecisionsLet’s calculate the contribution margin per unit of the scarce resource, machine A1.Let’s see how this plan would work.Production Constraint DecisionsProduction Constraint DecisionsLet’s see how this plan would work.Production Constraint DecisionsLet’s see how this plan would work.According to the plan, we will produce 2,200 units of Product 2 and 1,300 of Product 1. Our contribution margin looks like this.The total contribution margin for Kaser is $64,200.Production Constraint DecisionsShould Icontinue to makethe part, or shouldI buy it?I suppose Ishould comparethe outside purchaseprice with the additionalcosts to manufacturethe part.What will I do with myidle facilities ifI buy the part?Make or Buy DecisionsIncremental costs also are important in the decision to make a product or buy it from a supplier.The cost to produce an item must include(1) direct materials, (2) direct labor and (3) incremental overhead.We should not use the predetermined overhead rate to determine product cost.Make or Buy Decisions Exitel makes computer chips used inone of its products. Unit costs, based on production of 20,000 chips per year, are:Make or Buy Decisions An outside supplier has offered to provide the 20,000 chips at a cost of $25 per chip. Fixed overhead costs will not be avoided if the chips are purchased. Exitel has no alternative use for the facilities. Should Exitel accept the offer?Make or Buy DecisionsMake or Buy DecisionsDifferential costs of making (costs avoided if bought from outside supplier)Exitel should not pay $25 per unit to an outside supplier to avoid the $15 per unit differential cost of making the part. Fixed costs are irrelevant to decision. If Exitel buys the chips from the outside supplier, the idle facilities could be leased to another company for $250,000 per year.Should Exitel buy the chips andlease the facilities?Make or Buy DecisionsMake or Buy DecisionsThe real question to answer is, “What is the best use of Exitel’s facilities?” The opportunity cost of facilities changes the decision. Costs incurred in manufacturing units of product that do not meet quality standards are sunk costs and cannot be recovered. As long as rebuild costs are recovered through sale of the product, and rebuilding does not interfere with normal production, we should rebuild.Sell, Scrap, or Rebuild Decisions OserCo has 10,000 defective units thatcost $1.00 each to make. The units can be scrapped now for $.40 each or rebuilt at an additional cost of $.80 per unit.If rebuilt, the units can be sold for the normal selling price of $1.50 each. Rebuilding the 10,000 defective units will prevent the production of 10,000 new units that would also sell for $1.50.Should OserCo scrap or rebuild?Sell, Scrap, or Rebuild Decisions10,000 units × $1.50 per unit10,000 units × $0.40 per unitSell, Scrap, or Rebuild Decisions10,000 units × $0.80 per unit10,000 units × ($1.50 - $1.00) per unitSell, Scrap, or Rebuild DecisionsOserCo should scrap the units now.If OserCo fails to include the opportunity cost,the rework option would show a return of $7,000,mistakenly making rebuild appear more favorable. Sell, Scrap, or Rebuild DecisionsProduct 2Joint CostsProduct 1Product 3Two or more products produced from acommon input are called joint products.The split-off point is the point in a process where joint products can be recognized as separate products.Joint costs arethe costs ofprocessing prior to the split-off point.Joint Product Decisions Businesses are often faced with the decision to sell partially completed products at the split-off point or to process them to completion.General rule: process further only if incremental revenues > incremental costs. Joint Product DecisionsAmes Co. produces two products, A and B, from this process.Should the products besold at split-off orprocessed further?CommonProductionProcessFinalSale$120,000Split-OffPointJointCost$100,000Revenue$70,000AdditionalProcessing$40,000ABAdditionalProcessing$20,000FinalSale$65,000Revenue$50,000Joint Product DecisionsDecision: Process product A, but sell product B at the split-off point. Note that the $100,000 joint cost is irrelevant to the processing decision. Product A incremental revenue = $120,000 - $70,000 Product B incremental revenue = $65,000 - $50,000 Joint Product DecisionsJoint costs are really common costs incurred to simultaneously produce a variety of end products.Joint costs are commonly allocated to end products on the basis of the relative sales value of each product or on some other basis.Joint Product Decisions Joint costs are not relevantin decisions regarding what to do witha product after the split-off point. As a general rule . . .It is always profitable to continue processing a joint product after the split-off point so long as the incremental revenue exceeds the incremental processing costs.Joint Product DecisionsHey dude,it’s party time!End of Chapter 20