Acct final ch 12

Key Concept Decision Making #5

-future costs and benefits that do not differ between alternatives are irrelevant to the decision making process

Value of a constrained resource:

-increasing the capacity of a constrained resource should lead to increased production and sales

Using the differential approach is desirable for two reasons:

-only rarely will enough information be available to prepare detailed income statements for both alternatives -mingling irrelevant costs with relevant costs may cause confusion and distract attention away from the information that is really critical

Key Concept Decision Making #6

-opportunity costs also need to be considered when making decisions

When doing differential analysis of any segment you do NOT...

include shared or common fixed costs (ex. allocated general fact overhead)

Avoidable costs:

is a cost that can be eliminated by choosing one alternative over another

Sunk costs:

is a cost that has already been incurred and cannot be changed regardless of what a manager decides to do, they are always irrelevant when choosing among alternatives (cost of car)

Vertical integration-advantages:

smoother flow of parts and materials, better quality control, realize profits

Split off point:

that point in the manufacturing process where some or all of the joint products can be recognized as a separate product

Joint products:

two or more products that are produced from a single raw material input

Constraint:

when a limited resource of some type restricts the company's ability to satisfy demand

Irrelevant costs:

(annual cost of insurance, parking fee) irrelevant because must be paid regardless of driving or taking the train

Activity Based Costing and Relevant Costs:

-ABC can be used to help identify potentially relevant costs for decision making purposes -However, managers should exercise caution against reading more into this "traceability" than really exists -People have a tendency to assume that if a cost is traceable to a segment, then the cost is automatically avoidable, which is NOT true. Before making a decision, managers must decide which of the potentially relevant costs are actually avoidable

Joint costs:

-Are irrelevant in decisions regarding what to do with a product from the split off point forward. Therefore, these costs should not be allocated to end products for decision making purposes -With respect to sell or process further decisions, it is profitable to continue processing a joint product after the split off point so long as the incremental revenue from such processing exceeds the incremental processing costs incurred after the split off point

Vertical integration-disadvantages:

-Companies may fail to take advantage of suppliers who can create economies of scale advantage by pooling demand from numerous companies -while the economies of scale factor can be appealing, a company must be careful to retain control over activities that are essential to maintaining its competitive position

Utilization of a Constrained Resource:

-Fixed costs are usually unaffected in these situations, so the product mix that maximizes the company's total contribution margin should ordinarily be selected. -A company should not necessarily promote those products that have the highest unit contribution margins. -Rather, total contribution margin will be maximized by promoting those products or accepting those orders that provide the highest contribution margin in relation to the constraining resource. -The key is the contribution margin per unit of the constrained resource

The pitfalls of Allocation:

-Joint costs are traditionally allocated among different products at the split-off point. A typical approach is to allocate joint costs according to the relative sales value of the end products. -Although allocation is needed for some purposes such as balance sheet inventory valuation, allocations of this kind are very dangerous for decision making.

Adding or dropping segments Part 1:

-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 hinges primarily on its financial impact -to asses this impact, it is necessary to carefully analyze the costs -contribution margin approach -comparative income approach

Key Concept Decision Making #4

-Sunk costs are always irrelevant when choosing among alternatives

Beware of allocated fixed costs...

-allocated fixed costs can distort the keep/drop decision -the answer lies in the way we allocate common fixed costs to our products -including unavoidable common fixed costs makes the product line appear to be unprofitable, when in fact dropping the product line would decrease the company's overall net operating income

sell or process further decision:

A decision as to whether a joint product should be sold at the split-off point or sold after further processing. -it is profitable to continue processing a joint product after the split off point so long as the incremental revenue from such processing exceeds the incremental processing costs incurred after the split off point

Volume Trade off Decisions:

Companies are forced to make volume trade off decisions when they do not have enough capacity to produce all of the products and sales volumes demanded by their customers. -in these situations, companies must trade off, or sacrifice production of some products in favor of others in an effort to maximize profits

Relevant costs: (to make)

Direct materials Direct labor Variable manufacturing overhead

Key Concept Decision Making #1

Every decision involves choosing from among at least two alternatives. Therefore, the first step in decision making is to define the alternatives being considered

Special orders:

Is a one time order that is not considered part of the company's normal ongoing business -when analyzing a special order, only the incremental costs and benefits are relevant -since the existing fixed manufacturing overhead costs would not be affected by the order, the are NOT relevant Incremental Revenue-Incremental cost=financial advantage or disadvantage of accepting the order

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: -Working overtime on the bottleneck. -Subcontracting some of the processing that would be done at the bottleneck. -Investing in additional machines at the bottleneck. -Shifting workers from non-bottleneck processes to the bottleneck. -Focusing business process improvement efforts on the bottleneck. -Reducing defective units processed through the bottleneck.

Key Concept Decision Making #2

Once you have defined the alternatives, you need to identify the criteria for choosing them... -relevant costs and relevant benefits should be considered -irrelevant costs and irrelevant benefits should be ignored when making decisions

Key Concept Decision Making #3

The key to effective decision making is differential analysis-focusing on the future costs and benefits that differ between the alternatives. Everything else is irrelevant and should be ignored... -differential cost -future revenue that differs between any two alternatives is known as differential revenue -an incremental cost is an increase in cost between two alternatives -avoidable cost

The Make or Buy Decision:

When a company is involved in more than one activity in the entire value, it is vertically integrated. A decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier is called the "make or buy" decision

Differential costs:

a future cost that differs between any two alternatives

Bottleneck:

a machine or process that is limiting the overall output of the entire system