ACCT 2122 Chapter 12
contribution margin
selling price per unit - variable cost per unit
opportunity cost
the potential benefit that is given up when one alternative is selected over another > relevant cost
The constraint, or bottleneck, in the system is determined by ___
the step that limits total output because it has the smallest capacity
if the improvement efforts are successful, eventually the weakest link will ___
improve to the point where it is no longer the weakest link > At that point, the new weakest link (i.e., the new constraint) must be identified
future costs and benefits that do not differ between alternatives are ___ to the decision-making process
irrelevant > Ex. If you are going to buy the same pizza regardless of your movie-watching venue, the cost of the pizza is irrelevant when choosing between the theater and the rental
Joint costs are ___
irrelevant in decisions regarding what to do with a product after split-off
Idle space that has no alternative use has an opportunity cost of ___
zero
The key to choosing among alternatives is distinguishing between ___ and ___ costs and benefits
> relevant > irrelevant
But what if the space now being used to make shifters could be used for some other purpose?
In that case, the space would have an opportunity cost equal to the segment margin that could be derived from the best alternative use of the space
avoidable cost
a cost that can be eliminated by choosing one alternative over another in a decision. > synonymous with differential and incremental costs
sunk cost
a cost that has already been incurred and that cannot be changed by any decision made now or in the future > irrelevant cost
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
changing the amount of sales also changes ___
the amount of variable expenses
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
Managers must often evaluate whether a special order ___
should be accepted, and if the order is accepted, the price that should be charged
split-off point
that point in the manufacturing process where some or all of the joint products can be recognized as individual products
segment margin
the amount of net profit or net loss generated by a portion of a business
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 because 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 those costs that are avoidable are relevant and the others should be ignored
when solving make or buy problems, make sure that ___
there isn't some technicality like "oh well actually this part of the fixed cost can be avoided see we put a little asterisk there lol isn't that funny"
when faced with volume trade-off decisions, companies must ___
trade off, or sacrifice production of some products in favor of others in an effort to maximize profits
joint products
two or more products that are produced from a common input
which of the following involves increasing the capacity of a bottleneck?
relaxing the constraint
In general, a special order is advantageous if ___
the incremental revenue from the special order exceeds the incremental costs of the order > 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 > Ex. 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.
The capacity of a bottleneck can be effectively increased in a number of ways, including:
1.) Working overtime on the bottleneck. 2.) Subcontracting some of the processing that would ordinarily be done at the bottleneck. 3.) Investing in additional machines at the bottleneck. 4.) Shifting workers from processes that are not bottlenecks to the process that is the bottleneck. 5.) Focusing business process improvement efforts on the bottleneck. 6.) 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.
make or buy decision
a decision concerning whether an item should be produced internally or purchased from an outside supplier.
differential cost
a future cost that differs between any two alternatives > relevant cost > synonymous with avoidable and incremental costs
constraint (bottleneck)
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
special order
a one-time order that is not considered part of the company's normal ongoing business
value chain
all activities, from development, to production, to after-sales service
incremental cost
an increase in cost between two alternatives > synonymous with avoidable and differential costs
to find the less profitable product:
divide a product's contribution margin per unit by the amount of the constrained resource required to make a unit of that product
When making a volume-trade off decision, managers should ignore:
fixed costs
Activity-based costing improves the traceability of costs by ___
focusing on the activities caused by a product or other segment
differential revenue
future revenue that differs between any two alternatives > relevant benefit
when there is a constrained resource, the best way to increase profits is to:
increase the capacity of the bottleneck
activity-based costing can be used to help identify ___
potentially relevant costs for decision-making purposes
to make sell or process further decisions, managers need to follow a three step process:
1.) always ignore all joint costs because they remain the same whether the manager chooses to sell a joint product at the split-off point or process it further 2.) determine the incremental revenue that is earned by further processing the joint product. This computation is performed by taking the revenue earned after further processing the joint product and subtracting the revenue that could be earned by selling the joint product at the split-off point. 3.) take the incremental revenue from step two and subtract the incremental costs associated with processing the joint product beyond the split-off point. If the resulting answer is positive, then the joint product should be processed further and sold for a higher price. If the answer is negative, then the joint product should be sold at the split-off point without any further processing.
Vertical integration provides certain advantages:
1.) an integrated company is less dependent on its suppliers and may be able to ensure a smoother flow of parts and materials for production than a non-integrated company 2.) companies feel that they can control quality better by producing their own parts and materials, rather than by relying on the quality control standards of outside suppliers 3.) an integrated company realizes profits from the parts and materials that it is "making" rather than "buying," as well as profits from its regular operations
distinguishing relevant and irrelevant costs/benefits is an important concept because ___
1.) being able to ignore irrelevant data saves decision makers tremendous amounts of time and effort. 2.) bad decisions can easily result from erroneously including irrelevant costs and benefits when analyzing alternatives
Managers should focus much of their attention on:
1.) managing the bottleneck 2.) emphasizing products that make the most profitable use of the constrained resource 3.) make sure that products are processed smoothly through the bottleneck, with minimal lost time due to breakdowns and setups 4.) try to find ways to increase the capacity at the bottleneck
Product DGH has a monthly demand of 5,000 units. Its contribution margin is $18 per unit and $36 per direct labor hour. Product RBG has a monthly demand of 4,000 units. lt's contribution margin is $15 per unit and $60 per direct labor hour. lf the company only has 1,500 direct labor hours available, the company should produce ___ units of Product DGl-i and ___ units of Product RBG.
> 1,000 because RBG has the highest CM per hour and requires 1.000 hours to meet demand. The remaining 500 hours can be used to make 1,000 units of DGH ($36/$18 = 2 units per hour) > 4,000 because the company should produce all units of RBG demanded because it has the highest CM per hour, ($60/$15 = 4 units per hour) or 1,000 hours needed for 4,000 units.
When a constraint exists, companies need to focus on maximizing ___
contribution margin per unit of constraint
relevant costs and relevant benefits
cost and benefits that should be considered when making decisions
irrelevant costs and irrelevant benefits
costs and benefits that shouldn't be considered when making decisions
joint costs
costs that are incurred up to the split-off point in a process that produces joint products
volume trade-off decisions
decisions companies are forced to make when they do not have enough capacity to produce all of the products and sales volumes demanded by their customers
the first step in decision making is to ___
define the alternatives being considered