Differential Analysis: The Key to Decision Making

Managers may choose to retain an unprofitable product line because it

attracts customers it helps to sell other products

A cost that can be eliminated in whole or in part by choosing one alternative over another is a(n):

avoidable

A(n) __________ cost is a cost that can be eliminated by choosing one alternative over another.

avoidable

When making a decision to either go to a movie or rent a DVD, choosing the movie instead of the DVD means that the cost of the DVD would be eliminated. This is an example of a(n):

avoidable cost relevant cost

The machine or process that is limiting overall output is a(n):

bottleneck

Joint costs:

cannot be avoided once a process is started are irrelevant in decisions regarding what to do with a product after split-off

Which of the following is a limited resource of some type that restricts the company's ability to satisfy demand?

constraint

When determining which product or service makes the best use of a constrained resource, a company has to determine which products or customers will maximize:

contribution margin

When a supplier pools demand from a number of companies, it may enjoy economies of scale, which can result in higher quality and lower costs than a company could obtain if it made the parts on its own. This is an advantage of using __________ suppliers instead of vertical integration.

external

If dropping a product line enables a company to avoid more in __________ costs than it loses in contribution margin, then its overall net operating income would improve by eliminating the product line.

fixed

One of the great dangers in allocating common __________ costs is that such allocations can make a product line look less profitable than it really is.

fixed

Bad decisions can easily result from erroneously including __________ costs and benefits when analyzing alternatives.

irrelevant

When making decisions, managers should ignore __________ costs.

irrelevant

If a cost is traced to a segment using activity-based costing,

it may or may not be an avoidable cost of the segment

Costs incurred up to the split-off point in a process in which two or more products are produced from a common input are called __________ costs.

joint

The split-off point is the point in the manufacturing process at which the __________ products can be recognized as separate products.

joint

Two or more products that are produced from a common input are known as __________ products.

joint

A __________ decision is a decision to carry out one of the activities in the value chain internally rather than to buy externally from a supplier.

make or buy

Costs that are relevant in one decision situation:

may not be relevant in another.

Any final decision to drop or add a business segment is going to hinge primarily on the impact the decision will have on net ___________ __________.

operating income

Space being used that would otherwise be idle has a(n) __________ cost of zero.

opportunity

To maximize total contribution margin when a constrained resource exists:

produce the products with the highest contribution margin per unit of the constrained resource

Product ABC has a contribution margin per unit of $10.00. Each unit of ABC requires 5 minutes of machine time. Product XYZ has a contribution margin per unit of $15.00 and each unit requires 10 minutes of machine time. If the company's constraint is machine hours, to maximize profit, they should first fill the demand for

product ABC The company should fill the demand for the product with the highest CM per unit of the constrained resource. ABC's is $2 per minute of machine time (CM of $10/5 minutes) while XYZ's is only $1.50 per minute of machine time (CM of $15/10 minutes.)

It is often possible for a manager to increase the capacity of a bottleneck, which is called __________ the constraint.

relaxing

Costs that differ between alternatives are called __________ costs.

relevant

Only rarely will enough information be available to prepare a detailed income statement for both alternatives in a decision. This makes isolating __________ costs desirable.

relevant

Only those costs and benefits that differ in total between alternatives are _______ in a decision.

relevant

When planning a trip and making a decision to drive or take the train, the cost of car repairs and maintenance is a(n) __________ cost.

relevant

Deciding what to do with a joint product at the split-off point is a(n) _________ or __________ __________ decision.

sell or process further

Deciding what to do with a joint product at the split-off point is a:

sell or process further decision

A(n) __________ order is a one-time order that is not considered part of the company's normal ongoing business.

special

A(n) __________ cost is a cost that has already been incurred and cannot be avoided regardless of what a manager decides to do.

sunk

A set of activities ranging from development to production to after-sales service is called

the value chain.

A(n) __________ __________ includes activities ranging from development to production to after-sales service.

value chain

Less dependence on suppliers is an advantage of

vertical integration

Goodstone Tire Corporation sells tires for $100 each. Per unit costs associated with producing and selling the tires are: Direct Materials $35 Direct Labor $10 Factory Overhead $20 Selling and Administrative $15 The variable portion of the factory overhead is $8 per unit. A foreign company wants to purchase 10,000 tires for $70 each. The order would not require any selling or administrative costs. The purchaser will pay the shipping costs, but Goodstone will have to pay a $100,000 inspection fee in order to be able to make the foreign sale. Accepting the special order will not affect current sales or production. What effect would accepting the special order have on Goodstone's net operating income?

$70,000 increase The revenue per tire is $70 and the cost is $63 (direct materials, direct labor, variable overhead and inspection fee of $10 ($100,000/10,000) tires) so each tire will generate $7 in net operating income.

Which of the following may be an advantage of making a part rather than buying it?

A smoother flow of parts and material for production Less dependence on outside suppliers

Which of the following statements are true?

Allocation of joint costs is needed for inventory valuation. Joint costs are common costs that are incurred to produce two or more products. Improper allocation of joint costs can lead to incorrect decisions.

Which of the following are ways in which to calculate the benefit of selecting one alternative over another?

An analysis that just looks at the relevant costs and benefits The difference between the net operating income for the two alternatives An analysis that looks at all costs and benefits and identifies those that are differential

Stephens Co. can purchase 20,000 units of Part XYZ from a supplier for $18 per part. Stephens' per unit manufacturing costs for 20,000 units is: Variable Manufacturing Cost - $12 per unit, total $240,000. Supervisory Salary - $3 per unit, total $60,000 Depreciation - $1 per unit, total $20,000 Allocated fixed overhead - $7 per unit, total $140,000 If the part is purchased, the supervisory position would be eliminated. The special equipment has no other use and no salvage value. Total allocated fixed overhead would be unaffected by the decision. Should the company buy the part or continue to make it?

Continue to make - $60,000 advantage. The avoidable costs of making the product are the variable costs plus the supervisor salary or $15 per unit. The total savings is $60,000 ($18 buy price - $12 variable cost - $3 supervisor salary = $3 advantage to make x 20,000 units).

Which of the following techniques describe how a bottleneck should be managed?

Focus business process improvement efforts on the bottleneck. Find ways to increase the capacity of the bottleneck. Ensure there is minimal lost time at the bottleneck due to breakdowns and set-ups.

Which of the following should not be included in the analysis when making a decision?

Non-differential future costs Sunk costs

Abba, Inc. is considering dropping a product line. During the prior year, the line had sales of $207,000 and a contribution margin of $124,000. Fixed expenses consist of: Salaries $60,000 Rent $50,000 Advertising $20,000 Administrative $35,000 Total Fixed Expenses $165,000 The product line manager's $60,000 salary is avoidable as is the $20,000 of advertising. Of the administrative expenses, $10,000 is avoidable. The rest are general allocated expenses that will not change if the product is dropped. The rent expense is allocated to product lines based on sales and represents a share of the total cost for the building. If this product line is dropped, what will happen to the company's overall net income?

Overall net income will decrease by $34,000. The company will lose the $124,000 contribution margin. Only $90,000 of the fixed costs (salary, advertising, and $10,000 of administrative) are avoidable, so net income will decrease by $34,000.

Which of the following are ways to increase the capacity of a bottleneck?

Shifting workers from processes that are not bottlenecks to the process that is the bottleneck Investing in additional machines at the bottleneck

Which of the following does not have an opportunity cost?

Space being used that has no alternative cost.

Which of the following is considered a sunk cost when planning a trip?

The original cost of the car

ABC Lumber spend $1,000 cutting down a tree. The result was 40 pieces of unfinished lumber that sell for $20.00 each and 100 bags of sawdust that sell for $1.00 each. If the unfinished pieces of luber are processed into finished luber at a cost of $8.00 each, they will sell for $35.00. A bag of sawdust can be processed into Presto Logs that sell for $1.25 at a cost of $0.75 per bag. Which of the following statements are true concerning whether the unfinished pieces of lumber should be processed into finished lumber and whether the sawdust should be processed into Presto Logs?

The pieces of unfinished lumber should be processed. The pieces of lumber have an incremental revenue of $15 ($35 - $20) and an incremental cost of $8 so they should be procesed. The sawdust should be sold as is without being processed into Presto Logs. The sawdust has an incremental revenue of $.25 ($1.25 - $1.00) and an incremental cost of $.75 so it should be sold as is.

True or false: Effectively managing an organization's constraints is a key to increased profits.

True