COST MANAGEMENT Accounting Control HansenMowenGuan Chapter 18 Activity

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COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • Chapter 18 • Activity Resource Usage Model

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • Chapter 18 • Activity Resource Usage Model and Tactical Decision Making 1

Study Objectives 1. Describe the tactical decision-making model. 2. Define the concept of relevant

Study Objectives 1. Describe the tactical decision-making model. 2. Define the concept of relevant costs and revenues. 3. Explain how the activity resource usage model is used in assessing relevancy. 4. Apply the tactical decision-making concepts in a variety of business situations. 2

Tactical Decision Making Steps of the tactical decision making process 1. Recognize and define

Tactical Decision Making Steps of the tactical decision making process 1. Recognize and define the problem. 2. Identify alternatives as possible solutions to the problem, and eliminate alternatives that are not feasible. 3. Identify the predicted costs and benefits associated with each feasible alternative. Eliminate the costs and benefits that are not relevant to the decision. 3

Tactical Decision Making Continued from previous slide 4. Compare the relevant costs and benefits

Tactical Decision Making Continued from previous slide 4. 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. 5. Select the alternative with the greatest benefit which also supports the organization’s strategic objectives. 4

Tactical Decision Making Step 1: Define the Problem Each year 25 percent of the

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 do with these apples? 5

Tactical Decision Making Step 2: Identify Feasible Alternatives • Sell the apples to pig

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 6

Tactical Decision Making Step 3: Identify Predicted Costs and Benefits; Eliminate Irrelevant Costs Bagging

Tactical Decision Making Step 3: Identify Predicted Costs and Benefits; Eliminate Irrelevant Costs Bagging Alternative Applesauce Alternative 5 lbs of apples per bag 6 lbs of apples to produce five 16 ounce cans of applesauce Cost: $0. 05 per pound for labor and materials (bags and ties) Revenue: $1. 30 per bag Cost: $0. 40 per pound for rent, labor, apples, cans, and other materials Revenue: $0. 78 per can 7

Tactical Decision Making Step 4: Compare Relevant Costs and Relate to Strategic Goals Bagging

Tactical Decision Making Step 4: Compare Relevant Costs and Relate to Strategic Goals Bagging Alternative Applesauce Alternative Revenue per lb Cost per lb $0. 26 0. 05 Net benefit per lb Cost per lb $0. 21 Product differentiation strategy $0. 65 0. 40 Net benefit per lb $0. 25 Forward integration strategy 8

Tactical Decision Making Step 5: Select Best Alternative • The apple producer is reluctant

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 9

Tactical Decision Making continued 10

Tactical Decision Making continued 10

Tactical Decision Making Continued from previous slide continued 11

Tactical Decision Making Continued from previous slide continued 11

Tactical Decision Making Continued from previous slide 12

Tactical Decision Making Continued from previous slide 12

Relevant Costs and Revenues • Relevant costs – future costs that differ across alternatives

Relevant Costs and Revenues • Relevant costs – future costs that differ across alternatives • Irrelevant Costs – Past costs: already incurred “sunk costs” are the same across alternatives; ignore 13

Relevancy, Cost Behavior, and the Activity Resource Usage Model • Flexible Resources – Easily

Relevancy, Cost Behavior, and the Activity Resource Usage Model • Flexible Resources – Easily purchased in the amount needed – Purchased at the time of use • Committed resources – Purchased before they are used 14

Relevancy, Cost Behavior, and the Activity Resource Usage Model • Flexible resources – The

Relevancy, Cost Behavior, and the Activity Resource Usage Model • Flexible resources – The activity resources demanded equal the resources supplied Demand changes relevant Demand constant not relevant 15

Relevancy, Cost Behavior, and the Activity Resource Usage Model • Committed resources – Excess

Relevancy, Cost Behavior, and the Activity Resource Usage Model • Committed resources – Excess of supply over demand is unused capacity Demand increase < unused capacity not relevant Demand increase > unused capacity Demand decrease relevant Activity capacity reduced Activity capacity unchanged relevant non relevant 16

Relevancy, Cost Behavior, and the Activity Resource Usage Model A company has five manufacturing

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

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

Relevancy, Cost Behavior, and the Activity Resource Usage Model 19

Illustrative Examples of Tactical Decision Making Assumptions of C-V-P Analysis 1. The analysis assumes

Illustrative Examples of Tactical Decision Making Assumptions of C-V-P Analysis 1. The analysis assumes a linear revenue function and a linear cost function. 2. The analysis assumes that price, total fixed costs, and unit variable costs can be accurately identified and remain constant over the relevant range. 3. The analysis assumes that what is produced is sold. 4. For multiple-product analysis, the sales mix is assumed to be known. 5. The selling price and costs are assumed to be known with certainty. 20

Illustrative Examples of Tactical Decision Making • Common Decisions – Make or Buy –

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

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 34 B) 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 • 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 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 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

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!

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.

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 2 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 10, 000 20, 000 13 27

Illustrative Examples of Tactical Decision Making Accept or reject a special order Special order

Illustrative Examples of Tactical Decision Making Accept or reject a special order Special order unit revenue $1. 75 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 × 10, 000) ÷ 2 M 0. 040 Receiving ($6 × 20, 000) ÷ 2 M 0. 060 Setting up ($8, 000 × 13) ÷ 2 M 0. 052 Non-unit-level costs 0. 152 $1. 450 28 1. 602

Illustrative Examples of Tactical Decision Making Sell or Process Further Joint products have common

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. 1 lb tomatoes yields 1 bottle of hot sauce. Revenue at split-off Revenue from hot sauce Costs to process into hot sauce 1, 000 lb × $0. 40 1, 000 bottles × $1. 50 $1, 000 29

Illustrative Examples of Tactical Decision Making Sell or Process Further Sell Revenues Processing costs

Illustrative Examples of Tactical Decision Making Sell or Process Further Sell Revenues Processing costs Total $400 ---$400 Differential Amount Process Further to Process Further $1, 500 1, 000 $ 500 $1, 100 1, 000 $ 100 Process further 30

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • End Chapter 19 31

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • End Chapter 19 31