Professional Documents
Culture Documents
Decision Making
Chapter 12
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright2012byTheMcGrawHillCompanies,Inc.Allrightsreserved.
12-2
Learning Objective 1
12-3
12-4
12-5
12-6
12-7
$24,000
$24,000 cost
cost $10,000
$10,000 salvage
salvage value
value 5 years
12-8
7
8
9
10
11
12
13
$ 0.026
$
104
????
$
40
????
????
$
25
12-9
12-10
12-11
12-12
12-13
12-14
Current
Situation
$
200,000
Situation
With New
Machine
$
200,000
Differential
Costs and
Benefits
-
70,000
40,000
10,000
120,000
80,000
70,000
25,000
10,000
105,000
95,000
15,000
15,000
62,000
62,000
18,000
62,000
3,000
65,000
30,000
(3,000)
(3,000)
12,000
12-15
Situation
With New
Machine
$
200,000
Differential
Costs and
Benefits
15,000
15,000
(3,000)
(3,000)
12,000
12-16
12-17
Learning Objective 2
Prepare an analysis
showing whether a
product line or other
business segment should
be added or dropped.
12-18
Adding/Dropping Segments
One of the most important
decisions managers
make is whether to add
or drop a business
segment. Ultimately, a
decision to drop an old
segment or add a new
one is going to hinge
primarily on the impact
the decision will have on
net operating income.
To assess this
impact, it is
necessary to
carefully analyze
the costs.
12-19
Adding/Dropping Segments
12-20
12-21
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
Less: variable expenses
Variable manufacturing costs
Variable shipping costs
Commissions
Contribution margin
Less: fixed expenses
General factory overhead
Salary of line manager
Depreciation of equipment
Advertising - direct
Rent - factory space
General admin. expenses
Net operating loss
$ 500,000
$ 120,000
5,000
75,000
$ 60,000
90,000
50,000
100,000
70,000
30,000
200,000
$ 300,000
400,000
$ (100,000)
12-22
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
$ 500,000
Less:
variable
expenses
An
investigation
has
An
investigation
has revealed
revealed that
that the
the fixed
fixed
Variable
manufacturing
costs and
$ 120,000
general
factory
overhead
fixed
general
general
factory
overhead
and
fixed
general
Variable shipping costs
5,000
administrative
be
by
administrative expenses
expenses will
will not
not
be affected
affected
by
Commissions
75,000
200,000
dropping
digital
Contribution
margin
$ 300,000
dropping the
the
digital watch
watch line.
line. The
The fixed
fixed general
general
Less:
fixed expenses
factory
overhead
factory
overhead and
and general
general administrative
administrative
General factory overhead
$ 60,000
expenses
assigned
to
this
product
would be
expenses
Salary
of line assigned
manager to this product
90,000 would be
reallocated
to
lines.
reallocated
to other
other product
product
lines.
Depreciation
of equipment
50,000
Advertising - direct
100,000
Rent - factory space
70,000
General admin. expenses
30,000
400,000
Net operating loss
$ (100,000)
12-23
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
$ 500,000
Less: variable expenses
The
used
to
The equipment
equipment
usedcosts
to manufacture
manufacture
Variable
manufacturing
$ 120,000
digital
watches
has
Variable
shipping
costs
5,000
digital
watches
has no
no resale
resale
Commissions
200,000
value
value or
or alternative
alternative use.
use. 75,000
Contribution margin
$ 300,000
Less: fixed expenses
General factory overhead
$ 60,000
Salary of line manager
90,000
Should
retain
Should Lovell
Lovell
retain or
or drop
drop
Depreciation of equipment
50,000
Advertising - direct the
100,000segment?
the digital
digital watch
watch
segment?
Rent - factory space
70,000
General admin. expenses
30,000
400,000
Net operating loss
$ (100,000)
12-24
$ (300,000)
260,000
$ (40,000)
12-25
12-26
contribution
contribution margin.
margin.
12-27
12-28
12-29
12-30
12-31
12-32
12-33
12-34
Learning Objective 3
12-35
12-36
Better quality
control
Realize profits
12-37
12-38
9
5
1
3
2
10
$ 30
12-39
12-40
12-41
The
The depreciation
depreciation of
of the
the special
special equipment
equipment represents
represents aa sunk
sunk
cost.
cost. The
The equipment
equipment has
has no
no resale
resale value,
value, thus
thus its
its cost
cost and
and
associated
associated depreciation
depreciation are
are irrelevant
irrelevant to
to the
the decision.
decision.
12-42
Not
Not avoidable;
avoidable; irrelevant.
irrelevant. IfIf the
the product
product is
is
dropped,
dropped, itit will
will be
be reallocated
reallocated to
to other
other products.
products.
12-43
12-44
Opportunity Cost
An opportunity cost is the benefit that is
foregone as a result of pursuing some
course of action.
Opportunity costs are not actual cash
outlays and are not recorded in the
formal accounts of an organization.
How would this concept potentially relate
to the Essex Company?
12-45
Learning Objective 4
Prepare an analysis
showing whether a
special order should be
accepted.
12-46
12-47
Special Orders
Jet, Inc. makes a single product whose normal
selling price is $20 per unit.
A foreign distributor offers to purchase 3,000
units for $10 per unit.
This is a one-time order that would not affect the
companys regular business.
Annual capacity is 10,000 units, but Jet, Inc. is
currently producing and selling only 5,000 units.
12-48
Special Orders
$8 variable cost
12-49
Special Orders
If Jet accepts the special order, the incremental
revenue will exceed the incremental costs. In
other words, net operating income will increase
by $6,000. This suggests that Jet should accept
the order.
Increase
Increase
Increase
$ 30,000
24,000
$ 6,000
12-50
Quick Check
Northern Optical ordinarily sells the X-lens for
$50. The variable production cost is $10, the
fixed production cost is $18 per unit, and the
variable selling cost is $1. A customer has
requested a special order for 10,000 units of the
X-lens to be imprinted with the customers logo.
This special order would not involve any selling
costs, but Northern Optical would have to
purchase an imprinting machine for $50,000.
(see the next page)
12-51
Quick Check
What is the rock bottom minimum price below
which Northern Optical should not go in its
negotiations with the customer? In other words,
below what price would Northern Optical
actually be losing money on the sale? There is
ample idle capacity to fulfill the order and the
imprinting machine has no further use after this
order.
a. $50
b. $10
c. $15
d. $29
12-52
Quick Check
What is the rock bottom minimum price below
which Northern Optical should not go in its
negotiations with the customer? In other words,
below what price would Northern Optical
actually be losing money on the sale? There is
ample idle capacity to fulfill the order and the
Variable
production
costuse$100,000
imprinting
machine
has no further
after this
+ 50,000
order. Additional fixed cost
$150,000
a. $50 Total relevant cost
10,000
b. $10 Number of units
Average cost per unit =
$15
c. $15
d. $29
12-53
Learning Objective 5
12-54
12-55
12-56
12-57
Should
Should Ensign
Ensign focus
focus its
its efforts
efforts on
on
Product
Product 11 or
or Product
Product 2?
2?
12-58
Quick Check
How many units of each product can be
processed through Machine A1 in one
minute?
Product 1
a.
b.
c.
d.
1 unit
1 unit
2 units
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
12-59
Quick Check
How many units of each product can be
processed through Machine A1 in one minute?
Product 1
a.
b.
c.
d.
1 unit
1 unit
2 units
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
12-60
Quick Check
What generates more profit for the company, using
one minute of machine A1 to process Product 1 or
using one minute of machine A1 to process
Product 2?
a. Product 1
b. Product 2
c. They both would generate the same profit.
d. Cannot be determined.
12-61
Quick Check
What generates more profit for the company,
using one minute of machine A1 to process
Product 1 or using one minute of machine A1 to
process Product 2?
a. Product 1
b. Product 2
c. They
would generate
theA1,
same
profit.
With both
one minute
of machine
Ensign
could
d. Cannot
determined.
make 1be
unit
of Product 1, with a contribution
12-62
12-63
Ensign
Ensign can
can maximize
maximize its
its contribution
contribution margin
margin
by
by first
first producing
producing Product
Product 22 to
to meet
meet customer
customer
demand
demand and
and then
then using
using any
any remaining
remaining
capacity
capacity to
to produce
produce Product
Product 1.
1. The
The
calculations
calculations would
would be
be performed
performed as
as follows.
follows.
12-64
12-65
12-66
12-67
Product 1
1,300
$
24
$ 31,200
Product 2
2,200
$
15
$ 33,000
12-68
Learning Objective 6
12-69
12-70
12-71
Quick Check
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
12-72
Quick Check
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
12-73
Quick Check
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
12-74
Quick Check
Chairs
Selling price per unit
$80
Variable cost per
unit price
$30
Selling
Board feet per unit
2
Variable
cost
Monthly demand
600
Tables
Chairs Tables
$400
$200
$ 80 $ 400
10
30
200
100
80
12-75
Quick Check
As before, Colonial Heritages supplier of
hardwood will only be able to supply 2,000
board feet this month. Assume the company
follows the plan we have proposed. Up to how
much should Colonial Heritage be willing to pay
above the usual price to obtain more hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero
12-76
Quick Check
As before,
Colonial
Heritages
supplier
of make
The
additional
wood
would be
used to
hardwood
onlyuse,
be able
to board
supplyfoot
2,000
tables. will
In this
each
of
board feetwood
this month.
Assume
the company
additional
will allow
the company
to earn
follows the plan we have proposed. Up to how
an
additional $20 of contribution margin and
much should Colonial Heritage be willing to pay
above the usual priceprofit.
to obtain more hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero
12-77
Managing Constraints
It is often possible for a manager to increase the capacity of a
bottleneck, which is called relaxing (or elevating) the constraint,
in numerous ways such as:
1. Working overtime on the bottleneck.
2. Subcontracting some of the processing that would be done
at the bottleneck.
3. Investing in additional machines at the bottleneck.
4. Shifting workers from non-bottleneck processes to the
bottleneck.
5. Focusing business process improvement efforts on the
bottleneck.
6. Reducing defective units processed through the bottleneck.
These methods and ideas are all consistent with the Theory
of Constraints, which was introduced in Chapter 1.
12-78
Learning Objective 7
Prepare an analysis
showing whether joint
products should be sold
at the split-off point or
processed further.
12-79
Joint Costs
In some industries, a number of end
products are produced from a single raw
material input.
Two or more products produced from a
common input are called joint
products
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
split-off point.
12-80
Joint Products
Oil
Joint
Input
Common
Production
Process
Gasoline
Chemicals
Split-Off
Point
For example,
in the petroleum
refining industry,
a large number
of products are
extracted from
crude oil,
including
gasoline, jet fuel,
home heating oil,
lubricants,
asphalt, and
various organic
chemicals.
12-81
Joint Products
Joint costs
are incurred
up to the
split-off point
Joint
Input
Common
Production
Process
Oil
Gasoline
Chemicals
Split-Off
Point
Separate
Processing
Final
Sale
Final
Sale
Separate
Processing
Separate
Product
Costs
Final
Sale
12-82
12-83
12-84
12-85
Per Log
Lumber
Sawdust
$
140
$
40
270
176
50
50
24
20
12-86
12-87
270
140
130
50
80
Sawdust
50
40
10
20
(10)
12-88
270
140
130
50
80
Sawdust
50
40
10
20
(10)
12-89
12-90
End of Chapter 12