ACC Chapter 12

vertical integration disadvantages

- companys may fail to take advantage of suppliers who can create the economies of scale advantage by pooling demand from numerous companies - while the economies of scale factor can be appealing a company must be careful to retain control over activities that are essential to maintaining its competitive position

Vertical Integration Advantages

- smoother flow of parts and materials - better quality control - realize profits

Different questions a manager could ask?

- what is the per unit dollar advantage (or dis) of purchasing from the outside supplier? - what is the total cost if you make the product? - what is the net income if you make the product in house compared to outsourcing production

relaxing or elevating the constraint

manager to increase the capacity of the bottleneck

to identify the costs that are avoidable in a specific decision situation these steps should be followed

o Eliminate costs and benefits that do not differ between alternatives (sunk and future costs) o Use of the remaining cost and benefits that do differ between alternatives in making the decision (differential or avoidable costs)

value chain

all of the activities from development, to production to after sales service

in the total cost approach, ?

all the revenue and costs are displayed in the income statement then the different in NOI between the two alternatives is compared

constriant

anything that prevents an organization from satisfying demand o Favor the products that provide the highest contribution margin per unit of the constrained resource

make or buy this component part? decision rule:

choose the alternative that has the greatest net incremental revenues over incremental costs

sell or process further decisions

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

examples of relevant costs

incremental, differential, marginal

allocated common fixed costs can

make a product line appear to be unprofitable

Isolating relevant costs is desirable for at least two reasons

o Rarely will enough information be available to prepare a detailed income statement for both alternatives o Mingling irrelevant costs with relevant costs may cause confusion and distract attention from the information that is really critical

examples of irrelevant costs

sunk and future costs

people have a tendency to assume that if a cost is traceable to a segment, then

the cost is automatically an avoidable cost (not true)

bottleneck

the machine or process that is limiting overall output

split off point

the point in the manufacturing process at which the joint products can be recognized as separate products

real or economic depreciation

the reduction in resale value of an asset through use or over time

In the differential approach, only

the relevant costs are considered

joint products

two or more products that are produced from a common input

joint cost

used to describe the costs incurred up to the split off point o Common costs that are incurred to simultaneously produce a variety of end products o Are irrelevant in decisions regarding what to do with a product from the split off point forward

accept a special order? decision rule:

if its incremental revenue exceeds the incremental expense of producing it

avoidable cost definition

a cost that can be eliminated in whole or in part by choosing one alternative over another

make or buy decision

a decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier

special order

a one time order that is not considered part of the companys normal ongoing business - only incremental costs and benefits are relevant

sunk cost

cost that has already been incurred and cannot be avoided regardless of what a manager decides to do

relevant cost defintiion

costs that differ between alternatives

continue to process joint products after the split off point? decision rule:

if the incremental revenue after further processing exceeds the incremental costs of more processing

irrelevant costs?

do not differ between alternatives and are therefore UNAVOIDABLE

if fixed costs are less than the contribution margin then

dont drop

Drop this segment or retain it? decision rule:

drop a segment if its avoidable fixed costs exceed its contribution margin; or if its segment margin is negattive

how much of a constrianed resource to be used for each product? decision rule:

emphasize the products with the greatest contribution margin per unit of constrained resource

the capacity of a bottleneck can be effectively increased in a number of ways including:

o Working overtime on the bottleneck o Subcontracting some of the processing that would be done at the bottleneck o Investing in additional machines at the bottleneck o Shifting workers from processes that are not bottlenecks to the process that is the bottleneck o Focusing business process improvement efforts such as Six Sigma on the bottleneck o Reducing defective units

linear programming

quantitative method to find the proper combination or mix of products

vertically integrated

• When a company is involved in more than one activity in the entire value chain