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

The Challenge of Changing Markets Product markets can change quickly due to competitor price cuts, changing customer preferences, and introduction of new products by competitors. Managers must make short-run decisions, with a fixed set of resources, to react to the changing market place.

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Incremental AnalysisChapter 20Special order decisionsProduct mix decisionsMake or buy decisionsJoint product decisionsProduct markets can change quickly due to competitor price cuts, changing customer preferences, and introduction of new products by competitors.Managers must make short-run decisions, with a fixed set of resources, to react to the changing market place. The Challenge of Changing 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 of Relevant Cost Information8 days @ $808 days @ $208 days @ $5The Concept of Relevant Cost InformationCosts do not differ, so they are not relevant to decision.Also, car insurance is not relevant to the decision as it is a past cost.The Concept of Relevant Cost InformationTransportation costs differ between the two alternatives, so they are relevant to your decisionAre the extra two days in Florida worth the $300 extra cost to fly?The Concept of Relevant 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 for business decisions.Opportunity costs.Sunk costs.Out-of-pocket costs.12Relevant Information in Business DecisionsThe benefit that could have been attained by pursuing an alternative course of action. Example: If you were not attending college, you could be earning $20,000 per year. Your opportunity cost of attending college for one year 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 Versus Out-of-Pocket CostsCost = $10,000 two years agoCost = $25,000 todayThe 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 Versus Out-of-Pocket Costs We will now examine several different types of managerial decisions.Incremental Analysis in Common 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 overseas company that offers to purchase 10,000 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 increase by $1,000. Should JamCo accept the offer?Special Order DecisionsFirst let’s look at incorrect reasoning that leads to an incorrect decision.Our cost is $9.00 per 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 the offer because net income will increase by $20,000.Special Order DecisionsWe can also look at this decision using 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 I continue to make the part, or should I buy it?I suppose I should compare the outside purchase price with the additional costs to manufacture the part.What will I do with my idle facilities if I 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 in one 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 and lease 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 that cost $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 a common 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 are the costs of processing 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 be sold at split-off or processed 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 relevant in decisions regarding what to do with a 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
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