Cost management accounting and control 6e by hansen mowen guan chapter 18

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan Chapter 18 Activity Resource Usage Model and Tactical Decision Making COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning Cengage Learning and South-Western are trademarks used herein under license Study Objectives Describe the tactical decision-making model Define the concept of relevant costs and revenues Explain how the activity resource usage model is used in assessing relevancy Apply the tactical decision-making concepts in a variety of business situations Tactical Decision Making Steps of the tactical decision making process Recognize and define the problem Identify alternatives as possible solutions to the problem, and eliminate alternatives that are not feasible Identify the predicted costs and benefits associated with each feasible alternative Eliminate the costs and benefits that are not relevant to the decision Tactical Decision Making Continued from previous slide Compare the relevant costs and benefits for each alternative, and then relate each alternative to the overall strategic goals of the firm and other important qualitative factors Select the alternative with the greatest benefit which also supports the organization’s strategic objectives Tactical Decision Making Step 1: Define the Problem Each year 25 percent of the harvest by an apple processor is small and odd-shaped These apples cannot be sold in the normal distribution channels and have simply been dumped in the orchards for fertilizer What should the firm with these apples? Tactical Decision Making Step 2: Identify Feasible Alternatives • Sell the apples to pig farmers – Eliminate: not enough local farmers • Bag the apples in five-pound bags and sell them to local supermarkets as seconds – Feasible • Rent a local canning facility and convert the apples to applesauce – Feasible • Rent a local canning facility and convert the apples to pie filling – Eliminate: major capital investment required • Continue with the current dumping practice – Eliminate: status quo Tactical Decision Making Step 3: Identify Predicted Costs and Benefits; Eliminate Irrelevant Costs Bagging Alternative Applesauce Alternative lbs of apples per bag Cost: $0.05 per pound for labor and materials (bags and ties) Revenue: $1.30 per bag lbs of apples to produce five 16ounce cans of applesauce Cost: $0.40 per pound for rent, labor, apples, cans, and other materials Revenue: $0.78 per can Tactical Decision Making Step 4: Compare Relevant Costs and Relate to Strategic Goals Bagging Alternative Applesauce Alternative Revenue per lb $0.26 Revenue per lb $0.65 Cost per lb 0.05 Cost per lb 0.40 Net benefit per lb Product $0.21 Net benefit per lb Forward $0.25 differentiation strategy integration strategy Tactical Decision Making Step 5: Select Best Alternative • The apple producer is reluctant to follow a forward integration strategy • The bagging alternative should be chosen Tactical Decision Making continued 10 Relevancy, Cost Behavior, and the Activity Resource Usage Model A company has five manufacturing engineers who supply a capacity of 10,000 engineering hours (2,000 hours each) The cost of this activity capacity is $250,000, or $25 per hour The firm expects to use 9,000 hours If the firm decides to reject a special order requiring 500 hours, the cost of engineering would be irrelevant 17 Relevancy, Cost Behavior, and the Activity Resource Usage Model The firm can purchase a component that will drop the demand from engineering hours from 9,000 to 7,000 Since engineering activity capacity is acquired in chunks of 2,000, the company can lay off one engineer or reassign the engineer to another plant 18 Relevancy, Cost Behavior, and the Activity Resource Usage Model 19 Illustrative Examples of Tactical Decision Making Assumptions of C-V-P Analysis The analysis assumes a linear revenue function and a linear cost function The analysis assumes that price, total fixed costs, and unit variable costs can be accurately identified and remain constant over the relevant range The analysis assumes that what is produced is sold For multiple-product analysis, the sales mix is assumed to be known The selling price and costs are assumed to be known with certainty 20 Illustrative Examples of Tactical Decision Making • Common Decisions – Make or Buy – Keep or Drop – Special Order – Sell or Process Further • Cost analysis informed by – Activity-based cost management system – Functional-based cost management system 21 Illustrative Examples of Tactical Decision Making Make-or-Buy Decision Talmage Company produces a mechanical part used in one of its engines (Talmage produces engines for snowblowers.) An outside supplier has offered to sell a part (Part 34B) for $4.75 The company normally produces 100,000 units of the part each year Flexible resources: Committed resources: • Using materials • Providing supervision • Using direct labor • Moving materials • Moving materials • Inspecting products • Providing power • Setting up equipment • Inspecting products 22 Illustrative Examples of Tactical Decision Making Make-or-Buy Decision ABC: buy the part 23 Illustrative Examples of Tactical Decision Making Make-or-Buy Decision Functional: make the part 24 Illustrative Examples of Tactical Decision Making Keep-or-Drop Decision If a segment is dropped only the traceable revenues and costs should vanish ABC classifications provide information on traceable costs Drop? 25 Illustrative Examples of Tactical Decision Making Keep-or-Drop Decision Dropping the product saves $45,000! 26 Illustrative Examples of Tactical Decision Making Accept or reject a special order Polarcreme, Inc., an ice-cream company, is operating at 80 percent of its 20 million half-gallon capacity A distributor from another geographic region offered to buy million units of premium ice cream at $1.75 per unit Distributor will provide their own label and pay transportation costs This sale is not subject to a sales commission Impact of special order on non-unit level activities: Purchase orders Receiving orders Setups increase increase increase 10,000 20,000 13 27 Illustrative Examples of Tactical Decision Making Accept or reject a special order Special order unit revenue Unit-level variable costs: Dairy ingredients $0.70 Sugar 0.10 Flavoring 0.15 Direct labor 0.25 Packaging Commissions Distribution 0.03 Other 0.05 Unit-level costs Non-unit-level variable costs for special order Purchasing ($8 ì 10,000) ữ 2M 0.040 Receiving ($6 ì 20,000) ữ 2M 0.060 Setting up ($8,000 ì 13) ÷ 2M 0.052 Non-unit-level costs Net benefit per unit on special order $1.75 $1.450 0.152 1.602 $0.148 28 Illustrative Examples of Tactical Decision Making Sell or Process Further Joint products have common processes and costs of Joint products with common processes production up to a split-off and common costs point Decision: Sell “Grade A” tomatoes as produce or process into hot sauce lb tomatoes yields bottle of hot sauce Revenue at split-off 1,000 lb × $0.40 Revenue from hot sauce 1,000 bottles × $1.50 Costs to process into hot sauce $1,000 29 Illustrative Examples of Tactical Decision Making Sell or Process Further Revenues Further Processing costs Total Sell $400 -$400 Differential Amount Process Further $1,500 1,000 $ 500 to Process $1,100 1,000 $ 100 Process further 30 COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan End Chapter 19 COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning Cengage Learning and South-Western are trademarks used herein under license 31 ... Process further 30 COST MANAGEMENT Accounting & Control Hansen Mowen Guan End Chapter 19 COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning Cengage Learning and South-Western... previous slide 12 Relevant Costs and Revenues • Relevant costs – future costs that differ across alternatives • Irrelevant Costs – Past costs: already incurred “sunk costs” are the same across... assumes a linear revenue function and a linear cost function The analysis assumes that price, total fixed costs, and unit variable costs can be accurately identified and remain constant over the relevant