COST MANAGEMENT

Accounting & Control

Hansen▪Mowen▪Guan

Chapter 18
Activity Resource Usage Model
and Tactical Decision Making

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 1

Cengage Learning and South-Western are trademarks used herein under license.
 Study Objectives
1. Describe the tactical decision-making
model.
2. Define the concept of relevant costs and
revenues.
3. Explain how the activity resource usage
model is used in assessing relevancy.
4. Apply the tactical decision-making
concepts in a variety of business
situations.
2
 Tactical Decision Making
Steps of the tactical decision making process
1. Recognize and define the problem.
2. Identify alternatives as possible solutions to the
problem, and eliminate alternatives that are not
feasible.
3. Identify the predicted costs and benefits
associated with each feasible alternative.
Eliminate the costs and benefits that are not
relevant to the decision.

3
 Tactical Decision Making
Continued from previous slide
4. Compare the relevant costs and benefits for
each alternative, and then relate each
alternative to the overall strategic goals of the
firm and other important qualitative factors.
5. Select the alternative with the greatest benefit
which also supports the organization’s
strategic objectives.

4
 Tactical Decision Making
Step 1: Define the Problem

Each year 25 percent of the harvest by an apple

processor is small and odd-shaped.
These apples cannot be sold in the normal
distribution channels and have simply been
dumped in the orchards for fertilizer.
What should the firm do with these apples?

5
 Tactical Decision Making
Step 2: Identify Feasible Alternatives
• Sell the apples to pig farmers.
– Eliminate: not enough local farmers
• Bag the apples in five-pound bags and sell them to local
supermarkets as seconds.
– Feasible
• Rent a local canning facility and convert the apples to
applesauce.
– Feasible
• Rent a local canning facility and convert the apples to pie
filling.
– Eliminate: major capital investment required
• Continue with the current dumping practice.
– Eliminate: status quo 6
 Tactical Decision Making
Step 3: Identify Predicted Costs and Benefits;
Eliminate Irrelevant Costs
Bagging Alternative Applesauce Alternative
5 lbs of apples per bag 6 lbs of apples to produce five 16-
ounce cans of applesauce
Cost: $0.05 per pound for labor
and materials (bags and ties) Cost: $0.40 per pound for rent,
labor, apples, cans, and other
Revenue: $1.30 per bag materials

Revenue: $0.78 per can

7
 Tactical Decision Making
Step 4: Compare Relevant Costs and Relate to
Strategic Goals
Bagging Alternative Applesauce Alternative
Revenue per lb $0.26 Revenue per lb $0.65
Cost per lb 0.05 Cost per lb 0.40
Net benefit per lb $0.21 Net benefit per lb $0.25

Product Forward
differentiation integration
strategy strategy

8
 Tactical Decision Making
Step 5: Select Best Alternative
• The apple producer is reluctant to follow a
forward integration strategy
• The bagging alternative should be chosen

9
Tactical Decision Making

continued 10
Tactical Decision Making

Continued from previous slide

continued

11
Tactical Decision Making

Continued from previous slide

12
 Relevant Costs and Revenues
• Relevant costs
– future costs that differ across alternatives
• Irrelevant Costs
– Past costs: already incurred “sunk costs”
are the same across alternatives; ignore

13
Relevancy, Cost Behavior, and the
Activity Resource Usage Model
• Flexible Resources
– Easily purchased in the amount needed
– Purchased at the time of use
• Committed resources
– Purchased before they are used

14
Relevancy, Cost Behavior, and the
Activity Resource Usage Model
• Flexible resources
– The activity resources demanded equal the
resources supplied
Demand changes relevant
Demand constant not relevant

15
Relevancy, Cost Behavior, and the
Activity Resource Usage Model
• Committed resources
– Excess of supply over demand is unused
capacity
Demand increase < unused capacity not relevant
Demand increase > unused capacity relevant
Demand decrease
Activity capacity reduced relevant
Activity capacity unchanged non relevant

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Relevancy, Cost Behavior, and the
Activity Resource Usage Model
A company has five manufacturing engineers
who supply a capacity of 10,000 engineering
hours (2,000 hours each).
The cost of this activity capacity is $250,000,
or $25 per hour. The firm expects to use
9,000 hours.
If the firm decides to reject a special order
requiring 500 hours, the cost of engineering
would be irrelevant.

17
Relevancy, Cost Behavior, and the
Activity Resource Usage Model
The firm can purchase a component that will
drop the demand from engineering hours
from 9,000 to 7,000.
Since engineering activity capacity is
acquired in chunks of 2,000, the company
can lay off one engineer or reassign the
engineer to another plant.

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Relevancy, Cost Behavior, and the
Activity Resource Usage Model

19
 Illustrative Examples of
Tactical Decision Making
• Common Decisions
– Make or Buy
– Keep or Drop
– Special Order
– Sell or Process Further
• Cost analysis informed by
– Activity-based cost management system
– Functional-based cost management system

20
 Illustrative Examples of
Tactical Decision Making
Make-or-Buy Decision
Talmage Company produces a mechanical part used in one of
its engines. (Talmage produces engines for snowblowers.) An
outside supplier has offered to sell a part (Part 34B) for $4.75.
The company normally produces 100,000 units of the part each
year.
Flexible resources: Committed resources:
• Using materials • Providing supervision
• Using direct labor • Moving materials
• Moving materials • Inspecting products
• Providing power • Setting up equipment
• Inspecting products
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 Illustrative Examples of
Tactical Decision Making
Make-or-Buy Decision

ABC: buy the part 22

 Illustrative Examples of
Tactical Decision Making
Make-or-Buy Decision

Functional: make the part

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 Illustrative Examples of
Tactical Decision Making
Keep-or-Drop Decision

If a segment is
dropped only
the traceable
revenues and
costs should
vanish
ABC
classifications
provide
information on
traceable costs

Drop? 24
 Illustrative Examples of
Tactical Decision Making
Keep-or-Drop Decision

Dropping the product

saves $45,000! 25
 Illustrative Examples of
Tactical Decision Making
Accept or reject a special order
Polarcreme, Inc., an ice-cream company, is operating at 80
percent of its 20 million half-gallon capacity.
A distributor from another geographic region offered to buy 2
million units of premium ice cream at $1.75 per unit.
Distributor will provide their own label and pay transportation
costs. This sale is not subject to a sales commission.
Impact of special order on non-unit level activities:
Purchase orders increase 10,000
Receiving orders increase 20,000
Setups increase 13

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 Illustrative Examples of
Tactical Decision Making
Accept or reject a special order
Special order unit revenue $1.75
Unit-level variable costs:
Dairy ingredients $0.70
Sugar 0.10
Flavoring 0.15
Direct labor 0.25
Packaging
Commissions
Distribution 0.03
Other 0.05
Unit-level costs $1.450
Non-unit-level variable costs for special order
Purchasing ($8 × 10,000) ÷ 2M 0.040
Receiving ($6 × 20,000) ÷ 2M 0.060
Setting up ($8,000 × 13) ÷ 2M 0.052
Non-unit-level costs 0.152 1.602
Net benefit per unit on special order $0.148 27
 Illustrative Examples of
Tactical Decision Making
Sell or Process Further
Joint products have
common processes and costs Joint products with
of production up to a split-off common processes
point. and common costs

Decision: Sell “Grade A” tomatoes as produce or process into

hot sauce. 1 lb tomatoes yields 1 bottle of hot sauce.
Revenue at split-off 1,000 lb × $0.40
Revenue from hot sauce 1,000 bottles × $1.50
Costs to process into hot sauce $1,000

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 Illustrative Examples of
Tactical Decision Making
Sell or Process Further
Differential Amount
Sell Process Further to Process Further

Revenues $400 $1,500 $1,100

Processing costs ---- 1,000 1,000
Total $400 $ 500 $ 100

Process further

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COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan

End Chapter 19

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. 30

Cengage Learning and South-Western are trademarks used herein under license.