Accounting 312 Midterm

Lessons from Rick's Restaurant/Bar

1. "Taking a loss is not always a bad thing" 2. Value and importance of profit planning at the portfolio level rather than the product level 3. "Merchandising the line"

Controllability

1. A cost or benefit that a decision maker chooses to incur relative to doing nothing 2. The decision maker, must be able to control or heavily influence the level of cost or benefit

Budget Overview

1. A project is a plan using limited resources. 2. Budgets specify the goals to be achieved in a specific period and the plan to achieve these goals. 3. Many of the benefits from budgeting arrive because preparing them forces managers to examine various ways in which to get the most from organizational resources. 4. Organizations use budgets for three primary reasons: - planning - coordination - control

Accounting Systems

1. Accounting Systems are typically set up to track costs by business functions [product costs and period costs (SG +A)] as required by GAAP. 2. Data in financial accounting may not be directly useful for internal decision making because they combine fixed and variable cost and controllable and non-controllable.

Segmented Contribution Margin Statements

1. Allows firms to make decisions at the level of individual product segment or the firm as a whole 2. "Segments" can include products, regions, stores or even customers 3. A "segment" CM statement modifies the standard CM statement to include: - CM (Rev - VC) - Segment Margin (CM - traceable fixed costs) - PBT (summing all of the segment margins then subtracting "common" fixed costs in total)

Takeaways from John Deere Case

1. An effective performance and evaluation system aligns employee and organizational goals by attracting the "right" personnel to the organization, motivating them to work hard on the "right" activities, and encouraging them to share value-relevant information. 2. Changing the scope of employee decision making often necessitates changing how performance is measured and rewarded. - In this case, giving production team members the authority to organize production as they saw fit necessitates a change from individual plan to group plan. - We again gained an appreciation of the benefits and costs of decentralization.

The primary role of managerial accounting

1. Assisting in decision making 2. Valuing options 3. Identify the best options

CVP Analysis and Taxes

1. Assume profit after tax 2. PBT = Profit after tax/(1-tax rate) 3. TP Volume = [TP/(1-tax rate)+fixed costs]/UCM 4. TP Revenues = [TP/(1-tax rate)+ fixed costs]/CMR

Target Profit (TP)

1. Assumes PBT 2. TP Volume = (target profit+fixed cost)/UCM 3. TP Revenues = (target profit+fixed cost)/CMR

Breakeven Revenues (BER)

1. BER = BEV*sales price per unit 2. BER = FC/CMR

Sales Volume Variance (SVV)

1. Because the flexible budget and master budget only differ in sales volume, the differences in profit between the two budgets is referred to as the SVV. 2. The SVV is computed by subtracting MB for profit from FB for profit. SVV = MB UCM * (FB sales volume - MB sales volume) or SVV = AQ*BP - BQ*BP

Breakeven Volume (BEV)

1. Breakeven volume is the sales volume (units) at which profit =0 2. Enough units must be sold so that the CM at least covers fixed costs 0 = Breakeven volume *UCM - FC BEV = FC/ UCM

Cost Flows in Merchandising Organizations

1. Buy goods from suppliers and re-sell substantially the same product 2. Inventories play a vital role because products are both tangible and storable 3. Expense the cost of items when sold not purchased 4. Cost of merchandise flows through the inventory account to COGS Cost of Beg Inv + purchases = goods available for sale - ending inventory (physical count) = cost of goods sold ---> to income statement

JJ case - Why focus on the same long term planning years?

1. By focusing on the same two long range planning years over fie year horizon managers are forced to reconsider repeatedly how the competitive environment has changed and what steps they should put in place now to compete effectively when the planning year arrives. 2. Also, planning is taken seriously because everyone knows that the day will arrive when they will have to live with the 5/10 year forecast as part of the current profit plan. 3. Motivates learning and information sharing throughout the organization.

Contribution Margin (CM)

1. CM denotes the amount that remains after subtracting variable costs from revenues 2. CM is the amount that "contributes" toward covering fixed costs and earning a profit 3. Changes in proportion to activity (like revenues and variable costs)

CVP Analysis - A critical evaluation

1. CVP analysis is useful for numerous short-term decisions 2. However, a decision tool is only as good as the assumptions needed to make it work 3. Revenues increase proportionately with sales volume 4. Variable cost increases proportionately with sales volume 5. Selling price, UVC, FC are known with certainty 6. Single period 7. Product mix assumption 8. Availability of capacity 9. Does not always provide the "best" option to short term planning

Cost-Volume-Profit (CVP) Relation

1. CVP analysis is useful for profit planning and for making short term decisions such as changes in price, changes in cost structure and changes in product mix 2. Profit before taxes = Revenues - VC - FC 3. Over the short term fixed costs do not change with the number of units

High-low Method

1. Classifies costs as either fixed or variable 2. Useful for short-term decisions 3. For any level of activity, within the normal, total costs are defined by this equation: Total costs = FC +( unit variable cost * volume of activity) 4. Uses 2 observations to estimate total fixed costs and UVC 5. The 2 observations that are used represent the highest and lowest activity (not dollars) 6. May or may not be the observations with the highest or lowest cost 7. The 2 observations most likely define the normal range of operations

Revisiting Criticisms of Budgeting in the Context of JJ

1. Companies continue to restrict themselves by relying on inflexible budget processes 2. JJ's budgets are not static, but interactive, constantly incorporating changes in the environment (more costly, more appropriate when organizations are in a dynamic environment) 3. Budgets assume everything is translatable to dollars 4. Long run planning: only 4 financial estimates presented: sales volume, sales revenues, net income and ROI 5. Both superiors and subordinates lie in the info provided 6. 6 months is too long to be spending on this process

The Master Budget

1. Consists of a comprehensive set of operating and financial budgets and involves all facts of operations and links organizational activities. 2. Once organizational goals are set, the sales budget is often the starting point for the master budget. 3. Organizational goals - overall strategy which can be influenced by the budgeting process. 4. Companies look for sales trends, customer surveys, projections of the sales force, etc. to develop these forecasts 5. We use our sales forecast and inventory policy to determine our production budget - after that we forecast our work flow 6. But we must be careful to understand both the variability of costs (so we can make protections for many different production levels) and also gain an understanding of how these projections affect cost flows (Capacity?).

Estimating Costs

1. Cost and benefits are the result of activities 2. Activities are "drivers" of cost or benefits 3. Estimate the change in activity for an option 4. Calculate the financial impact of that change

Elements of Cost Allocations

1. Cost pool: total cost to be allocated (numerator value) 2. Cost driver: allocation basis 3. Allocation volume: total driver activity (denominator value) 4. Cost object: product(s) to which costs are allocated

Weaknesses of JJs Budgeting Process

1. Costly in terms of management time 2. Plans are too tightly linked to budget 3. To the extent company management feels it is vital to meet their objectives, they maybe focused on short-term action plans which could risk sacrificing 4. Overkill for a small business with 800 employees 5. Can EC members be competent enough to review 17 businesses

Product Costs versus Period Costs

1. Costs associated with getting products and services ready for sale are product costs: - costs flow through inventories to accomplish this ("inventoriable") - are expensed when the products they are associated with are sold 2. Product costs appear "above the line" for gross profit/gross margin (Revenues - product cost (COGS) = gross profit) 3. Period costs - not product cost always appear "below the line" 4. Period costs are expensed when incurred 4. "Matching principles"

Implement

1. Determine how and when to use the resources 2. Setting performance standards to motivate employees to achieve the formulated plan

Relevance

1. Differ = relevant 2. Ignore costs or benefits that do not differ between options 3. Cost and benefits that matter

Weaknesses of Standard Hour Plan

1. Encouraged to hide production knowledge 2. Did not encourage teamwork

Ethics and Decision Making

1. Ethics relates to every aspect of decision making 2. Some decision makers might approve an unethical act if it provides monetary benefits in excess of costs 3. Ethics could and should deter decision makers from including unethical options in the decision set

Hanson Ski Take Aways

1. Extreme importance of cash budgeting and management (especially for seasonal/growing firms). 2. The time period over which any analysis of financial statements takes place can make a difference (Quarters better than annual - months better than quarters)

Cost Allocations Overview

1. Firms can have multiple WIP and FG inventories, one for each product 2. Cost of material and labor can be directly assigned to WIP because of traceability 3. Assigning manufacturing overhead is a problem - Indirect and not traceable 4. A cost allocation process is used to allocate or distribute these common costs

Cost Hierarchy

1. Focus is on what causes costs to change 2. Broadens the concept of variability 3. Allows consideration of multiple activities 4. Misclassification = errors in cost estimation

Strengths of JJs Budgeting Process

1. Forces busy managers to do strategic planning 2. Causes constant interactions among all managers in the company 3. Motivates organizational info sharing and learning about markets, competitors, etc. 4. Sets agendas for debate of strategy and tactics 5. High level of involvement builds commitment 6. Managers are constantly developing action plans 7. The reward system is well-suited to the process

What are the costs of measuring and rewarding the team?

1. Free riding 2. Collusion agains management 3. Equity concerns - some of the best employees may go elsewhere 4. "Parking lot diplomacy"

Wighted Contribution Margin Ratio (WCMR) Method

1. Frequently, it is more convenient to express product mix in terms of the share of revenues from various products rather than units sold. 2. The WUCMR is the CMR averaged across multiple products with each product's share of revenues 3. WCMR = sum(% revenues*CMR) for each product 4. PBT = (WCMR*Total Revenues)- FC

Time and Controllability

1. Good managers distinguish between short term and long term decisions 2. More controllable with longer time horizon 3. Capacity: plant, equipment, salaried staff - short term: fixed and non-controllable - long term: capacity can be changed 4. Long-term decisions can include costs and benefits that are non-controllable for short term benefits 5. For short-term decisions treat capacity as if it were "sunk" - do not consider

GAAP Based Financial Statements

1. Group costs by business functions 2. Not useful for decision making

Scatter Plots

1. Helpful in inspecting historical data 2. Graphing helps determine the appropriate technique to use

CIPP Plan Weaknesses

1. Highest skilled employees may go elsewhere 2. "Parking lot diplomacy" 3. Might not work as hard

USing CVP analysis - Short Term Decisions

1. If demand is a constraint we can: - reduce price (will reduce CM but should increase volume) - Expand product line/mix - Launch ad campaign (increase fixed costs, but increase volume) - optimally allocate available capacity

Controllability and Relevance

1. If status quo is feasible option, then all controllable costs are relevant because, by definition they differ from status quo 2. If status quo is not a feasible option then some controllable costs may or may not be relevant

Coordination

1. In a decentralized company, departments must coordinate and communicate with each other to ensure that everyone is working toward the same corporate goals. 2. Budgets are a good way to communicate the plan targets to anyone in the organization.

The Account Classification Method

1. Includes systematically categorizing a company's cost accounts as fixed or variable 2. Change in variable cost can be estimated: - sum the accounts classified as variable - divide that sum by the specific activity related to the decision option (cost driver) to estimate unit cost - multiply the unit cost x change in activity to obtain total variable (controllable) cost 3. Advantage: very accurate Major Disadvantage: costly and time consuming to implement Element of subjectivity Incorrect classification = substantial error

Contribution Margin (CM)

1. Increasing CM also increases profit by an additional amount so for every unit sold, profit increases by an amount equal to the unit contribution margin (UCM) 2. CM = Revenues - VC Unit CM = unit price - unit variable cost

Key Features of the Standard Hour Plan

1. Individual performance required 2. Performance evaluated against a standard developer by engineers (removed from factory floor) and audited to ensure procedures are followed 3. Low quality items needed to be reworked 4. Relief for idle time 5. Non-production employees receive subjective rewards

The "As If" Budget

1. MB = BQ * BIP * BIP 2. FB = AQ * BIQ * BIP 3. As if = AQ * AIQ * BIP 4. A = AQ * AIQ * AIP 5. FB-MB = SVV 6. As if - FB = quantity/efficiency variance 7. A - As if = Price/rate variance

Regression Analysis

1. Major advantage: uses all data to estimate 2. Additional statistics to help evaluate the fitted equation

Input Quantity and Price Variances

1. Material price variance = AQ*(BP- AP) 2. Material price variance = BP*(BQ-AQ) 3. Labor rate variance = Actual hours*(BR - AR) 4. Labor efficiency variance = BR*(BH-AH)

Evaluate

1. Measuring actual performance 2. Understand the reasons for any deviations between actual and planned results

JJ case - Disadvantages of decentralization

1. More costly to coordinate decisions 2. May not have incentive to use the authority in the firms best interest (goal congruence)

CIPP Plan Strengths

1. More incentives to cooperate 2. More incentives to share production knowledge with co-workers and management

Strengths of Standard Hour Plan

1. Motivates employees to meet their standards 2. Attract employees skilled at doing this 3. Tight control over activities of employees

What specific roles can performance evaluation and reward systems play to help carry out this objective?

1. Motivating Role 2. Directing Role 3. Extracting Role 4. Attracting Role

Traceability

1. Pertains to the confidence with which a decision maker can estimate a cost or benefit of a decision option 2. The degree to which we can relate a cost or benefit to a decision option 3. Direct cost or direct benefit: uniquely relates to a decision option; they can be "fixed" or "variable" 4. Indirect cost or benefit: only a portion of the cost or benefit relates to a decision option; "allocated" cost or "common" cost; harder to estimate

The Planning and Control Cycle (P.I.E.R. Cycle)

1. Plan 2. Implement 3. Evaluate 4. Revise

Financial Profit Plan/ Second Year Forecast and Revision Process

1. Profit plan targets developed bottom up by each operating company based on 5 and 10 and second year forecast - profit plan very detailed - second year forecast - a little less detailed 2. Initial draft in summer for the following year 3. The EC focuses on revisions of the profit plan and second year forecast in march, june and november 4. The June revision is a full-blown rebudgeting from the lowest executive center. 5. A member of the EC receives weekly sales numbers and monthly variance reports

JJ case - Advantages of decentralization

1. Quicker decisions 2. More efficient 3. Employees in the business units have the best info to make decisions 4. More empowered/motivated (buy-in) 5. Trains future managers

Production processes in manufacturing organizations

1. Raw materials are purchased - added to materials inventory account 2. Cost of materials, labor, and overhead go to work in-process inventory account once production starts. 3. The sum of these costs added during the period are "total manufacturing costs" 4. Once production is complete, physically transferred from WIP to finished goods. 5. Costs of goods manufactured transferred from WIP inventory account to FG inventory account. 6. As finished goods are sold - cost transferred to COGS

What are the benefits of measuring and rewarding team (rather than individual performance)?

1. Reduce cost 2. Fosters co-operation/employees coordinated with one another 3. Mutual monitoring 4. Collegial atmosphere

Planning decisions

1. Relate to choices about acquiring and using resources to deliver products and services to customers 2. A plan is like a blueprint that specifies the actions required to achieve a goal

Control decisions

1. Relates to motivating, monitoring, and evaluating performance 2. Many control decisions involve examining past performance, with the purpose of improving subsequent plans

Contribution Margin Statements

1. Reorganizes data by grouping costs by their variability and reporting variable and fixed costs separately Revenues - Variable Costs = Contribution Margin - Fixed Costs = Profit Before Taxes (PBT)

Closing the Gap Between Demand and Supply

1. Sometimes demand exceeds supply ("excess demand") while at other times available supply exceeds demand ("excess capacity") 2. Decisions that deal with excess capacity include - Reduce prices to stimulate demand - Add a product? - Stock pile for future demand - Run ads or special promotion - Seasonality - In sourcing - make vs. buy decision - Aggressively price special orders 3. The opportunity cost of excess capacity is zero because there is no other profitable use for it.

The Four step Framework for Decision Making

1. Specify the decision problem: includes the decision makers goals and goals are objectives. 2. Identify options: many decisions have a large number of options, managers frequently distinguish themselves by their ability to identify the most promising options. 3. Measure options: every option presents a unique tradeoff between the benefits and the costs; value is the contribution of an option to the decision makers goals; the value of an option = its benefits less its costs; we measure value relative to the status quo, which is doing nothing; even though most businesses measure value in terms of money or profit, value need not be a monetary amount 4. Make the decision: the best choice is the option with the highest value to the decision maker; this is the only option who's value exceeds its opportunity cost

Sunk Costs

1. Sunk costs do not influence value because we cannot change the past 2. For valid options the benefits and costs must occur in the future

Key features of CIPP Plan

1. Team based plan 2. Employee teams designed production process as it saw fit 3. Employees team share in cost savings 4. Standards and benchmarks based on historical performance 5. Both production and non production workers under same plan are team members 6. Employee efficiency rate not impacted by quality problems not under their control

Contribution Margin Ratio (CMR)

1. The CMR represents the portion of revenues that contribute to cover fixed costs and ultimately profit 2. CMR = (Revenues-variable costs)/ Revenues = CM/Revenues

Revise, correct beliefs about

1. The best products and services to offer 2. The appropriate amount of resources 3. The feasibility of performance targets 4. The effectiveness of incentive schemes

Takeaways from JJ

1. The budgeting process can play an important role in facilitating communication and coordination among business units 2. Effective budgeting should promote coordination and cross-functional problem-solving in support of the firm's strategy 3. Budgeting, ideally creates value and is not merely an internal struggle for company resources. 4. Budgets sometimes create "perverse" behaviors. The goal for organizations is to carefully design reward systems to minimize the incentive to engage in perverse behaviors.

Takeaways cont.

1. The case highlights the importance of understanding the linkages between performance evaluation and reward system design and both the current circumstances an the strategic objectives of the organization. 2. While no performance evaluation and reward system will eliminate all "perverse" behaviors, it is always important to think about "what can go wrong" when designing the systems.

Characteristics of Short-Term Decisions

1. The decision of how much capacity to put into place is a long-term decision. 2. Organizations make capacity decisions on the expected volume of operations over a time horizon spanning many years. 3. Once installed, however it is not easy to change the capacity level. 4. Most-short-term decisions deal with temporary gaps between the demand for and supply of available capacity. 5. These temporary gaps result because in the short term, the supply of capacity is fixed. 6. In the short term, businesses must do the best with the capacity they have.

Flexible Budget (FB)

1. The flexible budget is used to deconstruct the TPV into 2 major components - Sales volume variance (SVV) - Flexible budget variance (FBV) 2. "Flexing" the MB changes the total budgeted revenues and total budgeted costs to correspond to any sales level (only VC changes) for all sales volumes 3. Any profit difference between the master budget and this FB is due solely to differences between budget and actual sales. 4. The FB represents expected profit or what profit should be at the actual sales level barring any other changes to the cost structure 5. For revenue variances we subtract budget from actual. 6. For cost variances we subtract actual from budgeted.

Flexible Budget Variance (FBV)

1. The flexible budget variance is the difference in profit between the actual results and the flexible budget. 2. Flexible budget variance = actual profit - FB profit 3. The FBV must then be broken down further into 3 components - Sales price variance - Fixed cost variance - Variable cost variance

Takeaways from Precision Worldwide Case

1. The importance of controllability of costs when measuring options. 2. Understanding the variability of costs in valuing options. 3. Financial accounting systems may not be best for decisions -> Financial accounting systems may not yet have shown "sunk costs" (COGS). But if it is sunk, they will - when not if.

Variance analysis

1. The master budget, prepared in CM format, is the benchmark for evaluation of actual results (also in CM format) performance and variance analysis. 2. Comparing the Master Budget to actual results will disclose total profit variances (TPV) favorable (F) or unfavorable (U) for every line item in the reporting period. 3. This initial variance analysis does not provide enough detail to determine exactly what happened. 4. A more systematic approach is needed.

Long Range Planning Process

1. The process starts in January and takes six months to complete. Inputs include the mission statement and 5/10 year plan from the previous year. 2. Business plans developed by segment, competitor activity analyzed (pro formal income statements and strategy statements created for each competitor) and each department prepares plans based on marketing plans (sales drive the budgeting process)

Sales Price Variance (SPV)

1. The sales price variance represents the effect on profit of any differences in actual selling prices as composed to what was expected in the flexible budget 2. SPV = actual sales quantity *(actual sales price - FB sales price)

Variable Cost Variances

1. These variances are the difference between the budgeted cost (FB) and actual costs 2. These variances cannot be attributed to changes in sales volume because the cost in FB - the benchmark for these variances - are already adjusted for actual volume

Allocation Procedure

1. Total Costs/Total driver volume = overhead allocation rate 2. Rate is applied to products each time they use/ consume a unit of cost driver activity

Estimating Cost Structure

1. Total costs for an organization are readily available from the accounting system and GAAP statements 2. For CM statements it is first necessary to estimate the variable and fixed portions ("cost structure") 3. First is to examine the historical data to determine which costs have varied with activity

Cost Flows in Service Organizations

1. Use a mix of human and capital resources to perform their functions. 2. Products offered are not tangible or storable 3. Make their facilities and people available for a fee

Cost Terminology in Manufacturing Organizations

1. Use labor, equipment etc. to transform inputs (raw materials, labor, overhead) into outputs (products) 2. Raw materials and labor represent variable manufacturing costs because they can be traced directly to products. They are direct costs and unit costs. 3. Manufacturers use other inputs (factories, equipment, machines, support staff) 4. These are indirect costs because many products share them and they cannot be traced to specific price and can be variable or fixed 5. They are referred to as variable overhead and fixed overhead. 6. Direct material, direct labor, and manufacturing overhead are product costs - and inventoriable costs. 7. Manufacturers also incur non-production costs (selling, general, and admin) - these are period costs and expensed as incurred

Berkshire Toy Company Takeaways

1. Variance analysis is a useful starting point to direct attention to problem areas (i.e. investigate all large variances whether they are favorable or unfavorable. 2. When investigating variances, it is critical to understand the interdependencies among them. 3. As discussed earlier, this case highlights 2 potential costs of decentralized decision making: - Employees may not have the incentives to make decisions in the firm's best interest - Coordinating decisions becomes more costly 4. In light of the potential costs of decentralized decision making, organizations need to put controls in place to ensure decentralized decision makers understand and incorporate the costs/benefits of their decisions on others in the organization, so they can reap the benefits of decentralized decision making.

Weighted Unit Contribution Margin (WUCM) Method

1. WUCM is simply the CM per average unit of product 2. It represents the sum of each product's percentage of unit sales multiplied by its UCM 3. WUCM = sum (% of sales in units*UCM) for each product 4. PBT = (WUCM*total unit sales - FC)

Sales Variances in a Multi-Product Firm

1. When analyzing the variances of multi-product firms, we also need to consider variations between the expected and actual sales mix. 2. MB = BQ * BM% * BP 3. FB = AQ * BM% * BP 4. AIB = AQ * AM% * BP 5. A = AQ * AM% * AP

Determining the Best Use of a Scarce Resource

1. When demand is high and a resource is in short supply, products should be ranked by the contribution margin per unit of scarce resource and not CM per unit of product. 2. This is a general rule for solving problems with excess demand. 3. The logic is that for a resource in short supply the opportunity cost of the resource is positive and so the resource must be put to the best possible use. 4. This means ensuring the CM per unit of resource from this use exceeds that forgone by putting it to the next best use. 5. Production rate (PR) = units of output per hour 6. CM per unit of capacity = UCM*PR

Qualitative Considerations

1. When making short-term decisions companies often ignore the potential longer-term implications of these short-term decisions to "keep it simple" 2. It is important to articulate and consider the longer-term implications of short-term decisions, even if on a qualitative basis because of trade-offs between short-term and long-term interests 3. An option may cost the company in the short term but may be the most beneficial from a long-term perspective. 4. Qualitative assessments may be the only ones possible. 5. Quantifying the longer-term implications is difficult.

Plan

1. Which products and services to offer 2. What resources to acquire 3. How much of each resource to acquire 4. Where to sell products and services

Managerial Accounting

1. information for decision makers inside the firm 2. useful for both planning and control 3. uses the most relevant data (financial or non financial) 4. evaluation of costs and benefits of decision options

Financial Accounting

1. information for users outside the firm 2. satisfies the needs of external users by issuing a comprehensive set of financial statements 3. issued in accordance with GAAP

Goal Congruence

1. organizations don't make decisions - individuals within organizations make decisions 2. individual goals may differ form those of the organization 3. aligning individual goals with organizational goals - policies + procedures - monitoring performance - incentive schemes + performance evaluations

Opportunity Costs

1. whenever we make a decision and choose an option we give something up 2. opportunity cost is the value of what you give up by making your decision 3. businesses typically measure value and opportunity cost in terms of money or profit 4. opportunity cost of any decision option is the value of the next best option 5. effective decision makers ensure that the value of the chosen decision option exceeds its opportunity cost 6. the concept of value and opportunity cost emphasize that every decision involves trading off what we get with what we give up

Contribution Margin Statements cont.

2. CM statement is well suited to short term decision options - In short term, decision maker cannot change capacity - Capacity costs are non-controllable in the short-term - CM statement captures this concept by separating out fixed costs which relate to capacity - CM statement focuses on revenues and variable costs which are usually controllable in the short term 3. Allows us to measure the cost of an option as: - the sum of changes in fixed costs - the variable unit cost x change in activity volume

Long Range Planning Process cont.

3. Only project: sales volume, estimated sales revenues estimated net income and ROI 4. May: series of meetings between functional managers and division president 5. June: Meeting with a member of JJ's executive board executive committee (review, challenge and adjustments) 6. Summary letter goes to CEO which serves as the basis of a "heated" session at november EC meeting (EC member becomes "champion" of the division)

Closing the Gap Between Demand and Supply cont.

4. Any use of excess capacity that generates a positive contribution margin in worth considering 5. Decisions that deal with excess demand - Increase prices - Prioritize product towards most profitable (Ration capacity) - Outsourcing (Buy vs. Make) 6. With excess demand, it becomes necessary to forego some profitable use of available-capacity 7. The opportunity cost of excess demand is positive because we have to give up something. 8. In this case, the decision is one of which opportunities to let go

High-low Method cont.

8. UVC = [total costs(high) - total costs(low)]/ [high activity level - low activity level] 9. Can be used with either the high or low observation to estimate fixed costs 10. Advantage: quick and easy 11. Disadvantage: only uses 2 data points and its a rough estimate

Controllable Benefit or Cost

A cost or benefit that a decision maker chooses to incur, relative to doing nothing.

Relevant Benefit or Cost

A cost or benefit that differs across decision options

Indirect Cost or Benefit

A cost or benefit that is not uniquely related to a decision option - only a portion relates to a decision option

Direct Cost or Benefit

A cost or benefit that is uniquely related to a decision option

Mixed Cost

A cost that contains both fixed and variable components

Fixed Cost

A cost that does not change as the volume of activity changes

Step Costs

A cost that increases in discrete steps as the volume of activity increases

Unit-level cost

A cost that increases or decreases in direct proportion to the number of units produced (used synonymously with variable cost)

Variable Cost

A cost that is proportional to the volume of activity

Batch-level cost

A cost that varies in proportion to the number of batches of units made (used synonymously with step cost)

Product-level cost

A cost that varies in proportion to the number of products

Decision Framework

A four step process that consists of specifying the decision goals, identifying available options, evaluating these options, and then selecting the option that best meets the decision maker's goals

Sunk Cost

A past expenditure that cannot be changed

Batch-level Costs

Batch (group of units) - "step cost"

Finished Goods Inventory

Beg FG inv + Cost of goods manufactured (from WIP inv) - End FG Inv = COGS ----> Income statement

Raw Materials Inventory

Beg RM Inv + purchases - end RM Inv (count) = cost of materials used ---> WIP inv

Work-in Process Inventory

Beg WIP inv + cost of materials used (from RM inv) + direct labor + manufacturing overhead - end WIP inv = cost of goods manufactured ---> FG inv

A mixed cost

Both variable and fixed.

Revenue Budget

Budgeted Sales * price/unit

Planning

Budgets promote a culture of organization wide planning by compelling managers to choose the best course of action from available options.

Control

Budgets provide a basis or benchmark for evaluating performance

Decision

Choosing an option from a set of options to achieve a goal

Facility-level cost

Cost required to sustain the organization that does not vary at the unit, batch, or product level

Planning Decisions

Decisions about acquiring and using resources to deliver products and services to customers

Control Decisions

Decisions related to motivating, monitoring, and evaluating performance

Production Budget

Desired ending inventory + Budgeted Sales = Total Requirements - Beginning Inventory = Budgeted production

Fixed Cost Spending Variance (FCSV)

FCSV = Budget FC - Actual FC

Unit Level Costs

Increases or decreases in direct proportion to activity level (or # of units) - "variable"

Goals

Objectives that decision makers try to achieve

Planning and Control Cycle

Plan, Implement, Evaluate, and Revise

Variability

Relationship between costs/benefits and activity

A fixed cost

Remains unchanged in total with changes in activity level. Graph of total costs vs. activity level is flat.

Facility Level Costs

Required to sustain the business

Step Costs

Stays the same within a range of activities then changes

Value

The benefits less the costs of a decision option

Cost Hierarchy

The classification of costs into unit, batch, product, and facility

Traceability

The degree to which we can directly relate a cost or revenue to a decision option

Variability

The relation between a cost or benefit and an activity

Opportunity Cost

The value of the next best option

A variable cost

changes in total in direct proportion to a change in activity level. Graph of total cost vs. activity level increases. Graph of unit cost vs. activity level is flat.

Product-Level Costs

increases with products

This system would work best with

large, diverse, organizations where the "best" info about markets, customers, products, etc. is dispersed throughout the organization.

A decision

simply choosing one option from a set of options to achieve a goal