Chapter 12: Differential Analysis - The Key to Decision Making
Constraint
A limitation under which a company must operate, such as limited available machine time or raw materials, that restrict a company's ability to satisfy demand
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
From a decision-making point of view, should joint costs be allocated among joint products?
Although allocation of joint product costs is needed for some purposes, allocations of this kind are extremely misleading for decision making
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
Sunk Cost
Any cost that has already been incurred and that cannot be changed by any decision made now or in the future
Joint Costs
Costs that are incurred up to the split-off point in a process that produces joint products
Give at least four examples of possible constraints.
Examples of constraints include direct labor time, machine time, raw material, space, etc.
What guideline should be used in determining whether a joint product should be sold at the split-off point or processed further?
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 cost incurred after the split-off point
If a product is generating a loss, should it be discontinued? Explain.
No; a product should only be discontinued if its contribution margin is less that its fixed costs
Are all future costs relevant in decision making? Explain.
No; future costs that do not differ between alternatives should be ignored in decision making
Are sunk costs always fixed costs? Explain.
No; sunk costs are any costs that have already been incurred and cannot be avoided regardless of what a manager decides to do
Are variable costs always relevant costs? Explain.
No; variable costs are only relevant if they differ between alternatives
What is the danger in allocating common fixed costs among products or other segments of an organization?
One of the great dangers is allocating common fixed costs is that such allocations can make a product line or other business segment look less profitable than it really is
How does opportunity cost enter into a buy or make decision?
Opportunity costs enter into a make or buy decision because they represent economic benefits that are forgone as a result of pursuing some course of action
Relevant Benefit
A benefit that differs between alternatives in a decision; differential revenue is a relevant benefit
Avoidable Cost
A cost that can be eliminated by choosing one alternative over another in a decision
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
Make or Buy Decision
A decision concerning whether an item should be produced internally or purchased from an outside supplier
Differential Cost
A difference in cost between any two alternatives
Relevant Cost
A difference in cost between any two alternatives; synonyms are avoidable cost, differential cost, and incremental cost
Differential Revenue
A difference in revenue between any two alternatives
How will relating product contribution margins to the amount of the constrained resource they consume help a company maximize its profits?
Profits are maximized when the total contribution margin is maximized; a company can maximize its total contribution margin by focusing on the products with the greatest amount of contribution margin per unit of the constrained resource
Split-Off Point
That point in the manufacturing process where some or all of the joint products can be recognized as individual products
Vertical Integration
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
Opportunity Cost
The potential benefit that is given up when one alternative is selected over another
Joint Products
Two or more products that are produced from a common input
