CHAPTER PowerPoint Presentation by LuAnn Bean Professor of Accounting Florida Institute of Technology Differential Cost Analysis for Operating Decisions © 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Managerial Accounting 11E Maher/Stickney/Weil ☼ CHAPTER GOAL ☼ This chapter explains how managers can use differential analysis to examine the effects on profits Differential analysis helps managers answer relevant questions such as: What activities differ between the alternatives? How does that difference affect costs and profits? LO DIFFERENTIAL DIFFERENTIAL ANALYSIS: ANALYSIS: Definition Definition Is the analysis of differences among particular alternative actions U E M LO EXAMPLE: Ullman Educational Media Ullman Educational Media (UEM) is a company that produces tutorial videos for primary and preschool use UEM developed the following estimates: Units made and sold 800 per month Maximum production and sales capacity Selling price 1,200 units per month $ 30 Continued U E M LO ACTIVITY & COSTS Ullman Educational Media provides the following information about activities and costs: VC per unit FC per month Manufacturing Marketing and Administrative Total costs $ 17 $ 3,060 1,740 $ 22 $4,800 Continued LO U E M Profit Profit decreases decreases by by$1,000 $1,000 EXHIBIT 7.2 LO CASH FLOW Differential analysis focuses on cash flow because Cash is the medium of exchange in business Cash is a common objective measure of the costs and benefits of alternatives LO MANAGERS WANT TO KNOW! Customer Competitors’ Actions Demands Will Willraising raising prices priceslose lose customers customers totoaa competitor competitor or orcause cause them themtoto substitute substitute cheaper cheaper goods? goods? Pricing Decisions Cost of Products Managers Managersmust must consider consider competitors competitors actions actionsboth both nationally nationallyand and internationally internationally Internal Internalfocus focus on oncontinuous continuous improvements improvements isiskey keytoto cutting cuttingcosts costs U E M MANAGERS WANT TO KNOW! LO SPECIAL ORDERS Ullman Ullman has has an an opportunity opportunity for for aa one-time one-time only only special special order order to to sell sell 100 100 units units at at $25 $25 each each The The regular regular price price is is $28 $28 Should Should they they accept accept the the special special order? order? Continued UE M LO EXHIBIT 7.3 Yes! Yes!Since Since normal normal operations operations should shouldbe beused usedtoto cover coverFC, FC,not not special specialorders, orders, this thisspecial specialorder order adds adds$300 $300to tothe the bottom bottomline line 10 LO What is target cost? Target cost is the target price less the target profit 15 Value Valueengineering engineeringisisaa systematic systematicevaluation evaluationof of all allaspects aspectsof ofthe the business business EXHIBIT 7.5 LO 16 LO USING ACTIVITY-BASED COSTING: Analyze Profitability Customer cost Activities Cost to acquire customer Promote product; campaign to win lost customers; run advertising campaign Cost to provide goods and services Process order; deliver product; process returns Cost to maintain customers Bill customers; process payments; issue refunds Cost to retain customers Follow-up calls 17 LO THEORY OF CONSTRAINTS The The theory theory of of constraints constraints (TOC) (TOC) acknowledges acknowledges that that businesses businesses often often have have constraints constraints or or limits limits on on what what can can be be done done TOC TOC encourages encourages managers managers to to identify identify where where constraints constraints arise arise and and to to develop develop methods methods to to manage manage them them Three Three factors factors predominate: predominate: 1 Throughput Throughput contribution contribution 2 Investments Investments 3 Other Other operating operating costs costs 18 LO BOTTLENECK: BOTTLENECK: Definition Definition Is an operation in which the work to be performed equals or exceeds the available capacity 19 MANAGING THE BOTTLENECK LO Recognize that the bottleneck resource determines throughput contribution of product Search for, find bottleneck Resource with large quantities of inventory waiting to be worked on Subordinate all non-bottleneck resources to the bottleneck resource Increase bottleneck efficiency, capacity Repeat steps for any new bottleneck 20 LO MAKE-OR-BUY The The make-or-buy make-or-buy decision decision is is one one where where the the firm firm must must decide decide whether whether to to meet meet its its needs needs internally internally or or to to acquire acquire goods goods or or services services externally externally Both Both cost cost and and nonnonquantitative quantitative factors factors are are considered considered 21 MANAGERS WANT TO KNOW! LO JOINT PRODUCTS In In some some circumstances, circumstances, multiple multiple products products can can be be produced produced from from aa single single production production process process The The question question for for management management is: is: What What is is the the effect effect of of additional additional processing/production processing/production on on profits? profits? 22 LO SPLITOFF SPLITOFF POINT: POINT: Definition Definition Is the point up to which all costs are joint and after which additional processing costs are identified with other products 23 LO MANAGERS WANT TO KNOW! ADD OR DROP Managers Managers must must decide decide when when to to add add or or drop drop products; products; when when to to open open or or abandon abandon sales sales territories territories The The differential differential principle principle involved involved can can be be stated: stated: If If differential differential revenue revenue from from selling selling exceeds exceeds differential differential costs costs of of product, product, the the product product is is profitable profitable and and the the firm firm should should continue continue production production Click the button to skip Example 24 MANAGERS WANT TO KNOW! LO 10 INVENTORY MANAGEMENT Inventory Inventory has has aa direct direct affect affect on on profit profit and and must must be be carefully carefully managed managed Key Key questions questions for for managers managers are: are: 1 How How many many units units should should be be on on hand hand for for use use or or sale? sale? 2 How How often often should should the the firm firm order order an an item item and and what what is is the the optimal optimal order order size? size? 25 LO 10 JUST-IN-TIME (JIT) JIT JIT is is aa philosophy, philosophy, not not aa tool, tool, that that dovetails dovetails with with total total quality quality management management (TQM) (TQM) in in that that TQM TQM requires requires reliable reliable processing processing systems systems and and disallows disallows defective defective units units Flexible Flexible manufacturing manufacturing that that reduces reduces both both setup setup and and inventory inventory levels levels also also enhances enhances JIT JIT 26 LO 11 LINEAR PROGRAMMING Linear Linear programming: programming: (a) (a) finds finds the the product product mix mix that that will will maximize maximize profits profits given given the the constraints, constraints, (b) (b) provides provides opportunity opportunity costs costs of of constraints, constraints, and and (c) (c) allows allows for for sensitivity sensitivity analysis analysis 27 ECONOMIC ORDER QUANTITY (EOQ) LO 12 The The economic economic order order quantity quantity (EOQ) (EOQ) model model is is aa mathematical mathematical model model that that gives gives the the optimal optimal amount amount of of goods goods to to order order when when demand demand reduces reduces inventory inventory to to aa level level called called the the “reorder “reorder point.” point.” 28 End of CHAPTER 29 ... managers managers to to identify identify where where constraints constraints arise arise and and to to develop develop methods methods to to manage manage them them Three Three factors factors predominate:... costs and benefits of alternatives LO MANAGERS WANT TO KNOW! Customer Competitors’ Actions Demands Will Willraising raising prices priceslose lose customers customers totoaa competitor competitor... of goods goods to to order order when when demand demand reduces reduces inventory inventory to to aa level level called called the the “reorder “reorder point.” point.” 28 End of CHAPTER 29