MANAGERIAL ACCOUNTING Charles E Davis Elizabeth Davis Using

MANAGERIAL ACCOUNTING Charles E. Davis Elizabeth Davis Using Accounting Information to Make Managerial Decisions

• Identifying Relevant Information • Special Order Pricing • Outsourcing • Allocating Constrained Resources • Keeping or Eliminating Operations

Identifying Relevant Information 1. What two criteria must information meet to be considered relevant for decision making? 2. Define the terms avoidable and unavoidable in the context of decision making. Provide a decision scenario and identify the avoidable and unavoidable costs. 3. What is a sunk cost? Could sunk costs ever be informative?

Exercise 1 Cherry, Inc. , currently has a machine that costs $10, 000 per year to operate. The machine can produce 50, 000 units per year. Three years ago the company borrowed $200, 000 to purchase the machine; it still owes $125, 000 of that amount. Cherry could sell the machine for $70, 000 and purchase a new, more efficient machine at a cost of $220, 000. The new machine can produce 85, 000 units per year; its annual operating costs would be $12, 000. Required Identify each piece of information in this scenario and indicate whether it is relevant or irrelevant to the decision to purchase the new machine.

Exercise 2 Madison Ironworks made 500 defective units last month. Fortunately, the units were identified as defective before they were sold to customers. They are currently included in Madison’s ending inventory balance at $200 each. At the end of the quarter, the company will have to write off their $100, 000 cost, since the units have no value in their present condition. The production manager has determined that the units could be reworked for $10 each and then sold for $100. He has also received a bid from a liquidation company to purchase the defective units for $80 each. Required a. What alternatives are available to Madison? b. What information is irrelevant to the decision? c. Which alternative would generate the best financial result?

Special Order Pricing 1. Why might a business be willing to sell a product or service for an amount that is lower than the normal price? 2. If a business continually has the capacity to accept special orders, what should managers consider? 3. How should a company that is operating at capacity decide whether to accept a special order? 4. What is the minimum price that a business could charge for a special order and not lose money on the order?

Exercise 4 Graham Corporation has the excess manufacturing capacity to fill a special order from Nash, Inc. Using Graham’s normal costing process, variable costs of the special order would be $15, 000 and fixed costs would be $25, 000. Of the fixed costs, $4, 000 would be for unavoidable overhead costs, and the remainder for rent on a special machine needed to complete the order. Required What is the minimum price Graham should quote to Nash?

Exercise 5 Byways Production has an annual capacity of 80, 000 units per year. Currently, the company is making and selling 78, 000 units a year. The normal sales price is $100 per unit; variable costs are $65 per unit, and total fixed expenses are $2, 000. An out-of-state distributor has offered to buy 5, 000 units at $75 per unit. Byways’ cost structure should not change as a result of this special order. Required By how much will Byways’ income change if the company accepts this order?

Outsourcing 1. What kinds of processes or inputs can be outsourced? 2. What information needs to be evaluated in an outsourcing arrangement? 3. What is an opportunity cost? How does it relate to an outsourcing decision?

Exercise 8 The Outland Company manufactures 1, 000 units of a part that could be purchased from an outside supplier for $12 each. Outland’s cost to manufacture each part are as follows: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total $2 3 4 8 $17 All fixed overhead is unavoidable and is allocated based on direct labor. The facilities that are used to manufacture the part have no alternative uses. Required a. Should Outland continue to manufacture the part? Show your calculations. b. Would your answer change if Outland could lease the manufacturing facilities to another company for $5, 000 per year? Show your calculations.

Exercise 9 Thomas Corporation makes bicycles. It has always purchased its bicycle tires from the Firelock Company at $12 each, but is currently considering making the tires in its own factory. The estimated costs per unit of making the tires are as follows: Direct materials Direct labor Variable manufacturing overhead $3 $4 $1 The company’s fixed expenses would increase by $28, 000 per year if managers decided to make the tire. Required a. Ignoring qualitative factors, if the company needs 5, 000 tires a year, should it continue to purchase them from Firelock or begin to produce them internally? b. What qualitative factors should Thomas consider in making this decision?

Allocating Constrained Resources 1. What are some limited resources that can constrain business operations? 2. How should managers determine the best way to allocate constrained resources among products or operations? 3. How does customer demand impact the allocation of constrained resources? 4. What is a bottleneck? 5. What are some ways a bottleneck can be alleviated?

Exercise 12 Balloon, Inc. produces three types of balloons—small, medium, and large—with the following characteristics: Selling price per unit Variable cost per unit Contribution margin per unit Machine hours per unit Demand in units Small Medium Large $5 $8 $ 10 3 5 6 $2 $3 $4 1 2. 4 3 500 1, 000 800 The company has only 2, 000 machine hours available each month. Required How many units of each type of balloon should the company make to maximize its total contribution margin?

Keeping or Eliminating Operations 1. What event or series of events often motivates managers to consider eliminating an operation or product line? 2. Define the term segment margin. 3. What is an allocated cost? What happens to allocated costs if one of the cost objects (operations, products) is eliminated? 4. If a product has a positive segment margin but isn’t as profitable as other products, what should managers do?