ch 11 accounting 213

Contribution margin per unit of the constrained resource

Contribution margin ratio per unit/time required to produce one unit

Joint Products

two or more products that are produced from a common input

Vertically Integrated

The involvement by a company in more than one of the activities in the entire value chain from development through production, distribution, sales, and after-sales service.

Avoidable Cost

a cost that can be eliminated by choosing one alternative over another in a decision. Synonymous with relevant cost and differential cost. Avoidable costs and incremental costs are always relevant costs Unavoidable costs are irrelevant ex. cost of ticket to go to movies if decide to rent a movie.

Sunk Costs

a cost that has already been incurred and cannot be changed by any decision made now or in the future they are irrelevant and should be ignored when making decisions

Relevant Costs

a cost that should be considered when making decisions

Make or buy decision

a decision concerning whether an item should be produced internally or purchased from an outside supplier

Bottleneck

a machine or some other part of a process that limits the total output of the entire system

Special Order

a one-time order that is not considered part of the company's normal ongoing business

Differential Analysis

focusing on the future costs and benefits that differ between the alternatives Everything else is irrelevant and should be ignored

Differential Revenue

future revenue that differs between any two alternatives

Split off point

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

Opportunity Cost

the potential benefit that is given up when one alternative is selected over another

Additional contribution margin

Contribution margin per unit x additional units that can be processed in one hour

6 Key concepts to make intelligent decisions

#1: Define the alternatives being considered #2: identify the criteria for choosing among them by distinguishing between relevant and irrelevant costs and benefits #3: the key to effective decision making is differential analysis. Everything else is irrelevant and should be ignored #4: Sunk costs are always irrelevant when choosing among alternatives #5: Future costs and benefits that do not differ between alternatives are irrelevant to the decision making process #6: Opportunity costs also need to be considered when making decisions

4 Steps to help determine the most profitable use of a constrained resource

1. Calculate each product's contribution margin per unit 2. Identify the constraining resource and the quantity of that resource that is consumed to make one unit of each product 3. Calculate each products contribution margin per unit of the constraining resource 4. Rank the products from the highest contribution margin per unit of the constraining resource to the lowest

3 Steps to quantify the financial advantage(disadvantage) of discontinuing a business

1. Calculate the contribution margin that would disappear if the segment is dropped. Put this number in parenthesis to denote it as a cash outflow 2. Calculate the fixed costs that would be avoided if the segment is dropped. Do not put this number in parenthesis (thereby it is a cash inflow) 3. Add the amounts from steps 1 and 2. If the result is a negative number (a net cash outflow) then do not drop the segment. If it is a positive number (a net cash inflow), then choose to drop the segment.

3 steps to calculate the financial advantage (disadvantage) associated with sell or process further decisions

1. Calculate the sales value if processed further minus the sales value at the split off point 2. Determine the cost of further processing beyond the split off point 3. Take the amount in step 1 and subtract from it the amount in step 2. If the result is a positive number, then choose to process further. If the result is a positive number, then choose to process further. If it is a negative number, then choose to sell at the split off point

3 steps to quantify the financial advantage (disadvantage) of a make or buy decision

1. Calculate the total amount that would be paid to the supplier if the buy option is chosen 2. Calculate the total differential manufacturing costs. These are the variable manufacturing costs and traceable fixed manufacturing costs that will be incurred if the company chooses to make, but avoided if the company chooses to buy 3. Calculate the difference between the amounts from steps 1 and 2. If the amount from step 1 exceeds the amount from step 2, then choose the make option. If the amount from step 1 is less than the amount from step 2, the choose the buy option.

3 Steps to quantify the financial advantage (disadvantage) of accepting a special order

1. Calculate the total revenue generated by the special order 2. Calculate the total incremental costs that will be incurred to produce the special order 3. Take the amount in step 1 and subtract from it the amount in step 2. If the result is a positive number then accept the special order. If it is a negative number, then reject the special order

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.

Differential Cost

A future cost that differs between any two alternatives.

Constraint

A limitation under which a company must operate, such as limited available machine time or raw materials, that restricts the company's ability to satisfy demand.

Relaxing (or elevating) the constraint

An action that increases the amount of a constrained resource. Equivalently, an action that increases the capacity of the bottleneck.

Incremental Cost

Used to describe differential costs. An increase in cost between two alternatives

Relevant Benefits

a benefit that should be considered when making decisions

Financial Disadvantage

exists when an alternative fails the cost/benefit test the differential benefits are less than it differential costs

contribution margin per hour of the constrained resource

contribution margin per minute of the constrained resource x minutes per hour

maximizing profit

contribution margin per unit x number of units produced

Joint costs

costs that are incurred up to the split-off point in a process that produces joint products

Financial Advantage

exists if pursuing an alternative exists if the alternative's differential benefits (cash inflows) exceed its differential costs (cash outflows)

Contribution margin per unit

selling price per unit-variable cost per unit

Irrelevant costs and Irrelevant Benefits

should be ignored when making decisions