Bài giảng Managerial Accounting - Chapter 9: Incremental Analysis

John Wiley & Sons, Inc.Prepared byKarleen Nordquist..The College of St. Benedict... and St. John’s University...with contributions byMarianne Bradford..The University of Tennessee...Gregory K. Lowry.Macon Technical Institute..Managerial Accounting Weygandt, Kieso, & KimmelChapter 9Incremental AnalysisAfter studying this chapter, you should be able to:1 Identify the steps in management’s decision-making process.2 Describe the concept of incremental analysis.3 Identify the relevant costs in accepting an order at a special price.4 Indicate the relevant costs in a make-or-buy decision.5 Give the decision rule in deciding whether to sell or process materials further.Chapter 9Incremental AnalysisAfter studying this chapter, you should be able to:6 Identify the factors to be considered in retaining or replacing equipment.7 Explain the factors that are relevant in deciding whether to eliminate an unprofitable segment.8 Explain the term “sales mix” and its effects in determining break-even sales.9 Determine sales mix when a company has limited resources.Chapter 9Incremental AnalysisPreview of Chapter 9Decision-Making ProcessIncremental Analysis ApproachHow Incremental Analysis WorksTypes of Incremental AnalysisAccept an Order at a Special PriceMake or BuySell or Process FurtherRetain or Replace EquipmentEliminate an Unprofitable SegmentINCREMENTAL ANALYSISPreview of Chapter 9Sales MixBreak-even SalesLimited ResourcesOther ConsiderationsQualitative FactorsIncremental Analysis and ABCINCREMENTAL ANALYSISIdentify the steps in management’s decision-making process.Study Objective 1Management’s Decision-Making ProcessManagement’s decision-making process frequently involves the following steps:1 Identify the problem and assign responsibility.2 Determine and evaluate possible courses of action.3 Make a decision.4 Review results of the decision.Management’s Decision-Making ProcessIn making decisions, management ordinarily considers both financial and nonfinancial information.Although nonfinancial information can be as important as, and in some cases more important than, financial information, the following discussion will primarily be limited to financial information that is relevant to decisions since that is the kind of information accounting usually provides (primarily in steps 2 and 4).Describe the concept of incremental analysis.Study Objective 2Incremental AnalysisBusiness decisions involve a choice among alternative courses of action. The process used to identify the financial data that change under alternative courses of action is called incremental analysis.In some cases, both costs and revenues will change under alternative choices. In other cases only costs or revenues will vary.It is important to recognize that variable costs may not change under the alternatives, andfixed costs may change.Incremental AnalysisIncremental analysis involves not only identifying relevant revenues and costs, but also determining the probable effects of decisions on future earnings.Data for incremental analysis often involves estimates and uncertainty.Gathering data may involve market analysts, engineers, and accountants.How Incremental Analysis WorksThe basic approach in incremental analysis is illustrated in the following illustration: Alternative Alternative Net Income A B Increase (Decrease)Revenues $125,000 $110,000 $(15,000) Costs 100,000 80,000 20,000 Net income $ 25,000 $ 30,000 $ 5,000 Illustration 9-2In this illustration, alternative B is being compared with alternative A. The net income column shows the differences between the alternatives. Alternative B will produce $5,000 more net income than alternative A.Key Cost Concepts in Incremental AnalysisIn incremental analysis, the only factors to be considered are those costs and revenues that differ across alternatives. Those factors are called relevant. Costs and revenues that do not differ across alternatives can be ignored when trying to chose between alternatives.Three important cost concepts used in incremental analysis follow:Key Cost Concepts in Incremental AnalysisOften in choosing one course of action, the company must give up the opportunity to benefit from some other course of action. This lost benefit is referred to as opportunity cost.Costs that have already been incurred and will not be changed or avoided by any future decision are referred to as sunk costs. Sunk costs are not relevant costs.Types of Incremental AnalysisA number of different types of decisions involve incremental analysis. The more common types of decisions are whether to:Accept an order at a special price.Make or buy component parts or finished products.Sell products or process them further.Retain or replace equipment.Eliminate an unprofitable business segment.Identify the relevant costs in accepting an order at a special price.Study Objective 3Accept an Order at a Special PriceSometimes a company may have an opportunity to obtain additional business if it is willing to make major price concessions to a specific customer.An order at a special price should be accepted when the incremental revenue from the order exceeds the incremental costs.It is assumed that sales in other markets will not be affected by the special order. If other sales were affected, the lost sales would have to be considered in making the decision.If the units can be produced within existing plant capacity, generally only variable costs will be affected.To illustrate, assume that Sunbelt Companyproduces 100,000 automatic blenders per month, which is 80% of plant capacity.Variable manufacturing costs are $8 perunit, and fixed manufacturing costs are$400,000, or $4 per unit. The blenders arenormally sold to retailers at $20 each. Question:Sunbelt has an offer from Mexico Co. to purchase an additional 2,000 blenders at $11 per unit. Acceptance of this offer would not affect normal sales of the product, and the additional units can be manufactured without increasing plant capacity. Accept an Order at a Special PriceAccept an Order at a Special Price: Incremental AnalysisIf management makes its decision on the basis of total cost per unit of $12 ($8 + $4), the order would be rejected, because costs ($12) would exceed revenues ($11) by $1 per unit. However, since the units can be produced within existing plant capacity, the special order will not increase fixed costs. The relevant data for the decision, therefore, are the variable manufacturing costs per unit of $8 and the expected revenue of $11 per unit. Reject Accept Net Income Order Order Increase (Decrease)Revenues $ -0- $22,000 $ 22,000 Costs -0- 16,000 (16,000) Net income $ -0- $ 6,000 $ 6,000 Illustration 9-4Decision:Sunbelt will increase its net income by $6,000 when accepting this special order.Indicate the relevant costs in a make-or-buy decision.Study Objective 4Make or BuyWhen a manufacturer assembles component parts in producing a finished product, management must decide whether to make or buy the components.This is often referred to as an outsourcing decision.If there is an opportunity to use the productive capacity for another purpose, opportunity costs should be considered. The decision to make or buy components should be made on the basis of incremental analysis. Assume that Baron Co. incurs the following annual costs in producing 25,000 ignition switches for motor scooters.Question:Should Baron make or buy the ignition switches?Make or BuyAlternatively, Baron may purchase the ignition switches from Ignition, Inc., at a price of $8 per unit. Direct materials $ 50,000Direct labor 75,000Variable manufacturing overhead 40,000Fixed manufacturing overhead 60,000Total manufacturing costs $225,000Total cost per unit ($225,000  25,000) $9.00Make or Buy:Incremental AnalysisAt first glance, it appears that management should buy the switches for $8 instead of make for $9. However, a review of operations indicates that if the switches are purchased all of Baron’s variable costs, but only $10,000 of its fixed manufacturing costs, will be eliminated. Thus, $50,000 of fixed costs will remain. The incremental costs are: Net Income  Make Buy Increase (Decrease) Direct materials $ 50,000 $ - 0 - $ 50,000 Direct labor 75,000 - 0 - 75,000 Variable manufacturing costs 40,000 - 0 - 40,000 Fixed manufacturing costs 60,000 50,000 10,000 Purchase price -0- 200,000 (200,000) Total annual cost $225,000 $250,000 $ (25,000) Illustration 9-6Decision:Barton Company will incur $25,000 of additional costs by buying the switches. Therefore, Barton should continue to make the switches.Make or Buy with Opportunity Cost: Incremental AnalysisAssume that through buying the switches, Baron Co. can use the released productive capacity to generate additional income of $28,000. This lost income is an additional cost of continuing to make the switches in the make-or-buy decision. This opportunity cost is added to the “Make” column, for comparison. Net Income  Make Buy Increase (Decrease) Total annual cost $225,000 $250,000 $(25,000) Opportunity cost 28,000 - 0 - 28,000 Total cost $225,000 $250,000 $ 3,000 Illustration 9-7Decision:It is now advantageous to buy the switches. Barton will save $3,000 worth of costs with this alternative.Give the decision rule in deciding whether to sell or process materials further.Study Objective 5Sell or Process FurtherMany manufacturers have the option of selling products at a given point in the production cycle or continuing to process with the expectation of selling them at a higher price.The sell-or-process further decision should be made on the basis of incremental analysis.The basic decision rule in a sell or process further decision is: Process further as long as the incremental revenue from such processing exceeds the incremental processing costs. Assume that Woodmasters, Inc. makes tables. The cost to manufacture an unfinished table is $35, computed as follows:Question: Should Woodmasters sell the unfinished tables or process them further?Sell or Process FurtherThe selling price per unfinished unit is $50. Woodmasters currently has unused productive capacity that is expected to continue indefinitely and can be used to finish the tables and sell them for $60 each. For a finished table direct materials and direct labor costs will increase $2 and $4, respectively. Variable overhead will increase by $2.40 (60% of direct labor). There will be no increase in fixed overhead.Direct materials $ 15Direct labor 10Variable manufacturing overhead 6Fixed manufacturing overhead 4Total manufacturing costs $35Sell-or Process Further:Incremental AnalysisThe incremental analysis on a per unit basis is as follows:Decision:It would be advantageous for Woodmasters to process the tables further. In this case, the per unit incremental revenue of $10.00 from the additional processing is $1.60 higher than the per unit incremental processing costs of $8.40. Process Net Income  Sell Further Increase (Decrease)Sales per unit $50.00 $60.00 $10.00 Cost per unit Direct materials 15.00 17.00 (2.00) Direct labor 10.00 14.00 (4.00) Variable manufacturing overhead 6.00 8.40 (2.40) Fixed manufacturing overhead 4.00 4.00 - 0 - Total $35.00 $43.40 $(8.40) Net income per unit $15.00 $16.60 $ 1.60 Illustration 9-9Identify the factors to be considered in retaining or replacing equipment.Study Objective 6Retain or Replace EquipmentManagement often has to decide whether to continue using an asset or replace it.In a decision to retain or replace equipment, management compares the costs which are affected by the two alternatives. Generally, these are variable manufacturing costs and the cost of the new equipment.The book value of the old machine is a sunk cost which is a cost that cannot be changed by any present or future decision. Sunk costs are not relevant in incremental analysis.Any trade-in allowance or cash disposal value of the existing asset is relevant, however.Assume that Jeffcoat Company has a factory machine with a book value of $40,000 and a remaining useful life of four years. A new machine is available that costs $120,000 and is expected to have zero salvage value at the end of its 4-year useful life. If the new machine is acquired, variable manufacturing costs are expected to decrease from $160,000 to $125,000 annually and the old unit will be scrapped.Question:Should Jeffcoat Company retain or replace the machine?Retain or Replace EquipmentRetain or Replace:Incremental AnalysisThe incremental analysis for the 4-year period is as follows:Decision:In this case, it would be to the company’s advantage to replace the equipment. The lower variable manufacturing costs due to replacement more than offset the cost of the new equipment. Net Income  Retain Replace Increase (Decrease)Variable manufacturing costs $640,000a $500,000b $140,000 New machine cost 120,000 (120,000) Total $640,000 $620,000 $ 20,000 a(4 years x $160,000)b(4 years x $125,000)Illustration 9-10Explain the factors that are relevant in deciding whether to eliminate an unprofitable segment.Study Objective 7Eliminate an Unprofitable SegmentManagement sometimes needs to decide whether to eliminate an unprofitable business segment. Again, the key is to focus on the data that change under the alternative courses of action.Often fixed costs allocated to the unprofitable segment must be absorbed by the other segments. It is possible, therefore, for net income to decrease when an unprofitable segment is eliminated.In deciding whether to eliminate an unprofitable segment, management should choose the alternative which results in the highest net income for the company as a whole. Assume that Martina Company manufactures tennis racquets in three models: Pro, Master, and Champ. Pro and Master are profitable lines, whereas Champ operates at a loss. Condensed income statement data are:Eliminate an Unprofitable Segment Pro Master Champ Total Sales $800,000 $300,000 $100,000 $1,200,000 Variable expenses 520,000 210,000 90,000 820,000Contribution margin 280,000 90,000 10,000 380,000Fixed expenses 80,000 50,000 30,000 160,000Net income $200,000 $ 40,000 $(20,000) $ 220,000Question:Should the Champ segment be eliminated?Although it appears that income would increase if the Champ line was discontinued, it is possible for income to decrease if Champ was discontinued. The reason is that the fixed expense allocated to Champ will have to be absorbed by the other products. To illustrate, assume that the $30,000 of fixed costs are allocated 2/3 to Pro and 1/3 to Master. The revised income statement data is:Eliminate an Unprofitable Segment Pro Master Total Sales $800,000 $300,000 $1,100,000Variable expenses 520,000 210,000 730,000Contribution margin 280,000 90,000 370,000Fixed expenses 100,000 60,000 160,000Net income $200,000 $ 40,000 $ 210,000Decision: Total net income has decreased $10,000 ($220,000 – $210,000). Unprofitable Segment:Incremental AnalysisThis result is also obtained in the following incremental analysis:Decision:Once again, total net income has decreased $10,000 ($220,000 – $210,000). This corresponds to the Champ segment’s contribution margin. Thus, management should not discontinue the Champ segment unless other lines can recover some or all of the sales/contribution margin lost by the discontinued segment. Net Income Continue Eliminate Increase (Decrease Sales $100,000 $ - 0 - $(100,000) Variable expenses 90,000 - 0 - 90,000 Contribution margin 10,000 - 0 - (10,000) Fixed expenses 30,000 30,000 - 0 - Net income $(20,000) $ 30,000) $ (10,000) Illustration 9-13Explain the term “sales mix” and its effects in determining break-even sales.Study Objective 8Sales MixOne of the assumptions of CVP analysis (discussed in Chapter 5) is that if more than one product is involved, the sales mix of the products remains constant. Sales mix is the relative combination in which a company’s products are sold. For example, if 4 chairs are sold with each table, the sales mix of chairs to tables is 4:1.Break-Even SalesBreak-even sales can be computed for a mix of two or more products by determining the weighted average unit contribution margin of all the products. To illustrate, assume that Vargo Video sells both VCRs and TVs at the following per unit data: Unit Data VCRs TVsSelling price $500 $800Variable costs 300 400Contribution margin $200 $400Sales mix 3 1Illustration 9-14Break-Even SalesThe total contribution margin for the sales mix of 3 VCRs to 1 TV is $1,000, computed as follows: [($200 x 3) + ($400 x 1)] = $1,000The weighted average unit contribution margin, which is total CM divided by the number of units in the sales mix is $250, computed as follows:$1,000/4 units = $250Break-Even Formula:Sales MixThen use the weighted average unit contribution margin to compute break-even sales as follows:Assume Vargo Video has $200,000 of fixed costs.Fixed CostsWeighted Average Unit Contribution MarginBreak-even Point in Units=$200,000$250800 units=Break-Even SalesNote that with a sales mix of 3:1, ¾ of the units sold will be VCRs and ¼ will be TVs. Therefore, in order to break even, Vargo Video must sell 600 VCRs (¾ x 800) and 200 TVs (¼ x 800). This can be verified by the following:Management should continually review the company’s sales mix. At any level of units sold, net income will be greater if more high CM units are sold than low CM units.Product Unit Sales x Unit CM = Total CMVCRs 600 x $200 = $120,000TVs 200 x 400 = 80,000 800 $200,000Illustration 9-16Determine sales mix when a company has limited resources.Study Objective 9Limited ResourcesWhen a company has limited resources (floor space, raw materials, or machine hours), management must decide which products to make and sell in order to maximize net income. In an allocation of limited resources decision, it is necessary to find the contribution margin per unit of limited resource.This is obtained by dividing the contribution margin per unit of each product by the number of units of the limited resource required for each product.Production should be geared to the product with the highest contribution margin per unit of limited resource.Assume that Collins Co. manufactures deluxe and standard pen and pencil sets. The limited resource is machine capacity, which is 3,600 hours per month. Relevant data consists of:Limited ResourcesQuestion:Should Collins Co. shift its sales mix toward deluxe or standard sets? Deluxe StandardContribution margin per unit $8 $6Machine hours required per unit .4 .2Based on the previous data, it might appear that deluxe is more profitable since they have a higher contribution margin. However, standard sets take fewer machine hours. Therefore, it is necessary to find the contribution margin per unit of limited resource, as shown below:Limited ResourcesDecision: Since the standard set has the higher contribution margin per unit of limited resource, sales mix should shift towards that product. Deluxe StandardContribution margin per unit (a) $8 $6Machine hours required per unit (b) .4 .2Contribution margin per unit of  limited resource (a  b) $20 $30Limited Resources:Incremental AnalysisThis result is confirmed by the following incremental analysis:Decision:Once again, it is clear that standard sets produce more contribution margin. Thus, given adequate demand for standard sets, the sales mix should shift to that product in order to maximize Collins Company’s income. If Produce If Produce Deluxe Sets Standard SetsMachine hours (a) 600 600 Contribution margin per unit of  limited resource (b) $20 $30 Contribution margin (a x b) $12,000 $18,000 Illustration 9-19Other Considerations in Decision MakingIn this chapter, the focus was primarily on the quantitative (those attributes that can be easily expressed in terms of numbers) factors that affect a decision. Many of the decisions involving incremental analysis have important qualitative features that