Accounting Differential Analysis

What companies enjoy economics of scale? -What are the benefits of economics of scale?

-An unintegrated company -higher quality and lower costs

The three costs needed to find unit product cost are:

-Direct Materials -Direct Labor -Manufacturing Overhead

In general, a company will accept a special order if:

-Incremental revenue exceeds the incremental costs -There is idle capacity available

Three methods of increasing the capacity of a bottleneck are:

-Shifting more workers to the process that is the bottleneck -Focusing business process improvement efforts on the bottleneck -Reducing defective units

The four steps to strengthen a company's flow are:

1. Identify the constraint 2. Do not overload the constraint 3. Concentrate improvement efforts on the constraint 4. When improvement efforts succeed, identify the new bottleneck and repeat the process

Why is it important to ignore irrelevant data?

1.It saves time for decision makers 2.Bad decisions can result from erroneously including irrelevant costs and benefits

***Over Idle Capacity Example***

A company is already at their maximum capacity. The company usually makes $1.50 profit per unit when selling to typical customers. A company is deciding if they should do a special order of 5,000 units. The special order would pay $5 per unit, with total incremental costs of $2 per unit. (incremental costs will have to be calculated when doing actual problems; they will not be given) Incremental Revenue ($5x 5000 units): $25,000 Less: Incremental Cost ($3X 5000 units): ($15,000) Incremental Net Operating Income: $10,000 Less: Opportunity Cost: ($7,500) Total change in Net Operating Income: $2,500 The opportunity cost exists because, since the company is at maximum capacity, they will have 5,000 less units to sell to their typical customers. The profit that they would make on those units is the opportunity cost of doing the special order. The company would do the special order because they still make money, even though they will have 5,000 less units to sell to their typical customers.

A decision to either carry out one of the activities in the value chain internally or to buy externally is called: (to produce it yourself or to buy it)

A make or buy decision

A one time order that is not considered part of the company's normal ongoing business is:

A special order

In a make or buy decision, the depreciation on equipment is:

A sunk cost, there for irrelevant -However, its salvage value is relevant (if you can sell the old equipment, it is considered an incremental revenue of buying rather than producing yourself)

What type of companies have better quality control?

A vertically integrated company

What type of company can count on a smoother flow of parts and materials for production?

A vertically integrated company

a cost that can be eliminated by choosing one alternative over another is:

An avoidable cost

Fixed manufacturing overhead is a(n) __________ cost when deciding whether or not to conduct a special order.

An irrelevant cost

When considering the entire operation (production of all joint products), Joint Costs ___________ relevant.

Are

When considering a single joint product inside of an operation, Joint Costs ____________ relevant.

Are not

Another name for a constraint is a:

Bottleneck

Anything that prevents you from getting more of what you want is a:

Constraint

Contribution Margin per unit of constrained resource =

Contribution Margin Per Unit / Amount of units of the constrained resource used to produce a unit of that product

Calculate the Contribution margin per unit of constrained resource Constrained Resource: Minutes needed on stitching machine Selling Price Per Unit: $25 Variable Cost Per Unit: $10 Amount of minutes needed on stitching machine: 3 minutes

Contribution Margin Per Unit = $25 - $10 = $15 Units of constrained resource needed: 3 minutes Contribution Margin per unit of constrained resource = 15/3 = $5 per minute

When deciding to keep or drop a segment, what things are relevant? -Are common fixed expenses relevant?

Contribution margin and traceable fixed costs -Common fixed expenses are not relevant because they will not be avoided if the segment is dropped

When a constraint cannot be improved (example: limited floor space in a retail store), to increase profits, you sell more of the product with the highest:

Contribution margin per unit of the constrained resource

A difference in cost between two alternatives is known as:

Differential Cost

A difference in revenue between any two alternatives is known as:

Differential Revenue

A cost that is never used in decision making that with be incurred later, regardless of your decision is a:

Future Cost

***Idle capacity explanation****

If a company is capable of producing 30,000 units, but is currently producing 25,000, they can produce up to 5,000 units from special orders. Any amount of units produced from a special order that exceeds the total amount of capacity creates an opportunity cost. The opportunity cost is considered an additional cost (that would go below incremental costs) of producing the special order.

***Relaxing the constraint example*** Contribution Margin Per Unit of the Constrained resource (in minutes): $7.50 per minute. (in hours): $750 per hour Pay rate for worker on constrained resource: $20/hour $30/ hour for overtime

If the company has whoever works on the constrained resource work overtime, the company only has to pay him $30 an hour to gain an addition $750 of contribution margin per hour. ***The $10 extra that the company pays the worker is called a premium***

What quality of costs and benefits make them considered to be relevant?

If they differ between alternatives

Another way to increase profits with a constraint/ bottleneck present is to:

Increase the capacity of that bottleneck operation (Buy another machine, buy more floor space, hire more workers, pay workers overtime, etc)

The rows used (from top to bottom) to determine whether a special order should be conducted are:

Incremental Revenue Less: Incremental Costs: Variable Costs: Fixed Costs: Total Incremental Costs: Incremental Net Operating Income:

You should continue producing a joint product if:

Incremental revenue from the processing exceeds the incremental processing cost incurred after the split off point

You should sell a joint product if:

Incremental revenue from the processing is less than the incremental processing cost incurred after the split off point

A product that is not finished in production, but could still be sold to others in the market is a:

Intermediate product

Unavoidable costs are ________ costs

Irrelevant costs

The costs incurred up to the split off point are:

Joint Costs

What costs are irrelevant in decisions regarding what to do with a product from the split-off point forward?

Joint Costs

Two or more products that are produced from a common input are:

Joint Products

A company with multiple possible constraints determines what mix of products to produce using:

Linear Programming (Only need to know the term, not how to do it)

What costs are not recorded in an organizations general ledger but can change decisions (especially in a make or buy decision)

Opportunity Costs

When a manager increases the capacity of the bottleneck, it is called:

Relaxing (or elevating) the constraint

Avoidable costs are ___________ costs

Relevant

Another name for differential costs and differential revenues are:

Relevant costs and relevant benefits

The rows from top to bottom when trying to find differential cost and benefits are:

Sales Variable Expenses Contribution Margin Fixed Expenses Net Operating Income

Decisions where you decide to sell or to continue producing a joint product are called:

Sell or Process further decisions

Contribution Margin per unit =

Selling Price per unit - Variable Cost per unit

Opportunity Costs should/should not be considered in decision making?

Should

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

Split Off Point

A cost that is never used in decision making that has already been incurred and cannot be avoided regardless of what a manager decides to do is a:

Sunk Cost

A special order is denied when:

The change in net operating income is negative

A special order is accepted when:

The change in net operating income is positive

If a segment's contribution margin is more than it's traceable/ avoidable fixed costs:

The company would lose money by dropping it

If a segment's traceable/ avoidable fixed costs are more than it's contribution margin:

The company would make money by dropping it

Differential Analysis focuses on:

The costs and benefits that differ between two alternatives

Common fixed costs are:

Unavoidable/ Irrelevant

A company that is involved in more than one activity in the entire value chain is:

Vertically integrated

To determine whether to make or buy:

You calculate if the avoidable costs of buying are </> the actual costs of buying -If cost of buying > the avoidable costs of buying, continue producing yourself -If cost of buying < the avoidable costs of buying, buy the product instead of producing it yourself

A value chain is:

all the activities done from development, to production, to after-sales service

The potential benefit that is given up when one alternative is selected over another is:

an Opportunity Cost

A fundamental concept for differential analysis is:

costs that are relevant in one decision situation are not necessarily relevant in another AKA- Managers need different costs for different purposes