Managerial Accounting Ch. 12

Problem of Allocated Fixed Costs

(Rent, utilities, G&A) Such allocations can make a product line or other business segment look less profitable than it really is **May partially solve using a segment margin analysis (Sales- Variable Expenses= CM - Fixed Expenses= Segment Margin), but still have problem of traceable "sunk costs"-- take segment margin and add sunk costs= decrease in company's overall profits if line were discontinued

Steps for Differential Analysis

1. Assemble all costs and revenues 2. Eliminate sunk costs 3. Eliminate costs or revenues that don't change between alternatives 4. Base decision on remaining "differential" costs/revenues

Activity-Based Costing

Can be used to help identify potentially relevant costs for decision-making purposes; improves traceability of costs by focusing on the activities caused by a product or other segment. 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 an avoidable cost. That is not true. The costs provided by a well-designed activity-based costing system are only potentially relevant. Before making a decision, managers must still decide which of the potentially relevant costs are actually avoidable. Only these costs that are avoidable are relevant and the others should be ignored. A sunk cost is still a sunk cost regardless of whether it is traced directly to a particular segment on an activity basis, allocated to all segments on the basis of labor-hours, or treated in some other way in the costing process.

Relevant (Differential) Costs/Revenues

Costs/Revenues that differ between alternatives... If the total amount of a cost will be the same regardless of the alternative selected then the decision has no effect on the cost, so the cost can be ignored. An avoidable cost is a cost that can be eliminated by choosing one alternative over another. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs. Sunk costs (has already been incurred and cannot be avoided regardless of what a manager decides to do) and future "committed" costs that do not differ between alternatives are never relevant in decisions.

Opportunity cost

Idle space that has no alternative use has an opportunity cost of zero. If the space now being used to produce products could be used for some other purpose, that space would have an opportunity cost equal to the segment margin that could be derived from the best alternative use of the space. Opportunity costs are not recorded in the organization's general ledger because they do not represent actual dollar outlays. Rather, they represent economic benefits that are forgone as a result of pursuing some other course of action.

Relaxing the Constraint

Increasing the capacity of the bottleneck... "What would I do with the additional capacity at the bottleneck if it were available?" Can... Work overtime on the bottleneck Subcontract some of the processing that would be done at the bottleneck Invest in additional machines at the bottleneck Shift workers from processes that are not bottlenecks to the process that is the bottleneck Focusing business process improvement effects on the bottleneck Reducing defective units. Each defective unit that is processed through the bottleneck and subsequently scrapped takes the place of a good unit that could have been sold.

Multiple Constraints

Linear programing can be used to find the proper mix of products

Special Order

Managers must often evaluate whether a special order should be accepted, and if the order is accepted, the price that should be charged. A special order is a one-time order that is not considered part of the company's normal ongoing business. In general, a special order is profitable if the incremental revenue from the special order exceeds the incremental costs of the order. However, it is important to make sure that there is indeed idle capacity and that the special order does not cut into normal unit sales or undercut prices on normal sales. For example, if the company was operating at capacity, opportunity costs would have to be taken into account, as well as the incremental costs that have already been detailed above.

Joint Product

Two or more products produced from common input. (a single process produces several marketable products-- compare increase in revenue to the increase in cost and disregard the joint cost of production)

Utilization of a "Constrained" Resource... Solution:

commit resources to product line providing highest contribution margin per unit of constrained resource CM per unit of product/ Units of scarce resource required per unit of product... Produce up to market demand then shift to next most profitable product

Making has advantages of:

control over supply (smoother flow of parts and materials for production) & check quality (produce own parts and materials), profit from parts and materials it is "making" rather than "buying"

Joint Cost

costs incurred up to the split-off point

Disadvantages of making:

outside supplier has volume advantage and ability to adopt new technology

Split-off Point

point in the manufacturing process at which joint products can be recognized as separate products Sell or Process Further? Joint costs are irrelevant in decisions regarding what to do with a product from the split-off point forward. Once the split-off point is reached, the joint costs have already been incurred and nothing can be done to avoid them (should not be allocated for purposes of making decisions about individual products). 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.