Differential Analysis and Product Pricing Chapter 12 ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Learning Objectives ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Learning Objective Prepare differential analysis reports for a variety of managerial decisions ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Differential Analysis Step 1: Identify the of the decision Step 2: Identify the courses of action Step 4: Make a Step 4: _, , and the results of the decision Step 3: Gather relevant _ ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Differential Analysis • Differential analysis looks at the effects of different alternatives – _ – _ – _ ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Differential Analysis in Six Situations Leasing or selling equipment Discontinuing an unprofitable segment Manufacturing or purchasing a needed part Replacing fixed assets Processing further or selling an intermediate product Accepting additional business at a special price ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Lease or Sell • Karnes Company has equipment to dispose The equipment originally cost $200,000, and accumulated depreciation is $120,000 • Two alternatives: • Lease the equipment for $160,000 less $35,000 in repairs, taxes, etc • Sell the equipment for $100,000 less 6% commission ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Lease or Sell Exhibit 2: Differential Analysis Report-Lease or Sell Exhibit 3: Traditional Analysis Decision: Leasing the equipment would increase overall income by $31,000 NOTE: The $80,000 book value is a sunk cost and is ignored in differential analysis ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Discontinue a Segment or Product • Montana Wheat Cereal Co produces and sells three kinds of cereal Bran Flakes exhibits an operating loss so the company is considering discontinuing production and sale of the product • If fixed costs remain the same, is this the right decision? Exhibit 4: Income (Loss) by Product ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Discontinue a Segment or Product Exhibit 5: Differential Analysis Report- Discontinue an Unprofitable Segment Exhibit 6: Traditional Analysis Decision: Discontinuing Bran Flakes would reduce overall profit by $15,000 because that is the amount that Bran Flakes contributes to covering _ ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Total Cost Concept Markup % = • Nebular Inc desires a profit equal to 20% of total assets If total assets are $800,000, the desired profit is $160,000, or $1.60 per unit, assuming 100,000 units • Assuming 100,000 units, the total cost per unit is as follows: • After adding the markup to the total cost the selling price per unit is: ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Total Cost Concept Markup % = _ × (1 + markup percentage) = _Selling price ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Product Cost Concept Markup % = • The product cost concept applies the markup to the _ cost per unit • Assuming 100,000 units, the _ cost per unit is as follows: ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Product Cost Concept Markup % = + Manufacturing Cost/Unit × _Markup % = _Markup ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Variable Cost Concept Markup % = + • The variable cost concept applies the markup to the cost per unit • Assuming 100,000 units, the _ cost per unit is as follows: ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Variable Cost Concept Markup % = + _Variable Cost/Unit × _ Markup % = Markup ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Choosing a Cost-Plus Approach Cost Concept • Each method requires different estimates of costs and expenses • Things to consider when choosing a method: Exhibit 11: Cost-Plus Approach to Setting Normal Selling Prices • _ • _ • _ ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Other Cost Concepts • Costing • Identifies and traces costs to specific activities • _ Costing • Combines market-based pricing with cost reduction Exhibit 12: Target Cost Concept ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Learning Objective Compute the relative profitability of products in bottleneck production processes ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Production Bottleneck • Occurs at the point in the process where the _ for the product exceeds the _ the product • The theory of constraints focuses on _ the influence of bottlenecks on a process ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Analyzing a Bottleneck • The contribution margin per unit suggests that the large wrench is the most profitable However… ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Analyzing a Bottleneck • …the contribution margin per unit of constrained resource suggests the small wrench is the most profitable Small Wrench Unit Contribution Margin Bottleneck Hours Medium Wrench Unit Contribution Margin Bottleneck Hours Large Wrench Unit Contribution Margin Bottleneck Hours $90 hour $100 hour $120 = $90 per hr = $25 per hr = $15 per hr hour ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Product Pricing in Bottleneck Situations • The per unit of resource can be used to set product prices • Products that use a _ amount of the constrained resource require a _ contribution margin ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part Product Pricing in Bottleneck Situations • Mathematical equations can help determine the needed contribution margin and product selling price in a bottleneck situation • Assume that the variable cost per unit and the heat treatment hours for the large wrench cannot be decreased • The price of the large wrench that would make it as profitable as the small wrench is determined as follows: ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part End of Chapter 12 ©2013 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part ... • A company currently produces an average of 10,000 basketballs per month; factory has a monthly capacity of 12, 500 basketballs – Variable costs are $12. 50 per ball – Fixed costs are $7.50 per... decrease in cost of $30,000 Focus the analysis on relevant costs The book value of the equipment ($100,000) is a _ and is not considered Relevant costs include the cost savings of more efficient... raw material into gasoline selling at $1.25 per gallon for an additional cost of $650 per batch; 20% of the gallons of kerosene will evaporate during production • Should the company sell or process