18-1 hansen & mowen cost management accounting and control

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HANSEN & MOWENHANSEN & MOWEN

Cost ManagementCost ManagementACCOUNTING AND CONTROLACCOUNTING AND CONTROL

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Activity Resource Usage Model Activity Resource Usage Model And Tactical Decision MakingAnd Tactical Decision Making

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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.

ContinuedContinuedContinuedContinued

Tactical Decision MakingTactical Decision Making 1

The Tactical Decision-Making Process

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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.


The Tactical Decision-Making Process

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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?

Step 1: Define the Problem


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Step 2: Identify Feasible Alternatives

1. Sell the apples to pig farmers.2. Bag the apples in five-pound bags and sell them to

local supermarkets as seconds.3. Rent a local canning facility and convert the

apples to applesauce.4. Rent a local canning facility and convert the

apples to pie filling.5. Continue with the current dumping practice.


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Step 3: Predicting Costs and Benefits and Eliminating Irrelevant Costs

Labor and materials (bags and ties) for the bagging option would cost $0.05 per pound. A five-pound bag of apple could be sold for $1.30 to local supermarkets.

Making applesauce would cost $0.40 per pound for rent, labor, apples, cans, and other materials. It takes six pounds of apples to produce five, 16-ounce cans of applesauce. Each can sells for $0.78.


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Step 4: Comparing Relevant Costs and Relating to Strategic Goals.

The bagging alternative costs $0.25 to produce a five-pound bag ($0.05 x 5 pounds). The revenue is $1.30 per bag, or $0.26 per pound. The net benefit is $0.21 per pound ($0.26 – $0.05).

The net benefit of converting the apples into applesauce is $0.25 per pound ($0.65 – $0.40).


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Step 5: Select Best Alternative.

Since the apple producer is reluctant to follow a forward integration strategy, the bagging alternative should be chosen.


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Decision Model: Tactical Decision-Making ProcessDecision Model: Tactical Decision-Making ProcessDecision Model: Tactical Decision-Making ProcessDecision Model: Tactical Decision-Making Process

Step 1Example

What to do with small, ill-shaped apples.

Step 2 1. Sell to pig farmers.2. Sell bagged apples (feasible).3. Make applesauce (feasible).4. Make pie filling.5. Continue dumping.

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Step 3 Bagged alternative:a. Revenue $1.30 per bag ($0.26 per pound)b. Cost $0.05 per pound

Applesauce alternative:a. Revenue: $0.78 per can ($0.65 per pound)b. Cost: $0.40 per pound


Step 4 Bagged Applesauce

Revenue $0.26 $0.65Cost 0.05 0.40Net benefit $0.21 $0.25

Bagged: DifferentiationApplesauce: Forward integration


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Step 5 Select bagging alternative because it is profitable and is more consistent with strategic positioning desired by producer.


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Relevant costs are future costs that differ across alternatives. A cost must not only

be a future cost but must also differ between alternatives.

Relevant costs are future costs that differ across alternatives. A cost must not only

be a future cost but must also differ between alternatives.

Relevant Costs and RevenuesRelevant Costs and Revenues 2

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Sunk costs are past costs.

Example: The original cost of a building is a sunk cost when you are trying to decide whether or not to sell the business five years later.

Relevant Costs and RevenuesRelevant Costs and Revenues 2

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Flexible resources can be easily purchased in the amount needed

and at the time of use… like electricity.

Flexible resources can be easily purchased in the amount needed

and at the time of use… like electricity.

Relevancy, Cost Behavior, and the Relevancy, Cost Behavior, and the Activity Resource Usage ModelActivity Resource Usage Model 3

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a. Demand Changes Relevant

Flexible ResourcesFlexible Resources

b. Demand Constant Not Relevant


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Committed resources are purchased before they are

used, such as salaried employees.

Committed resources are purchased before they are

used, such as salaried employees.


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Committed ResourcesCommitted Resources

Supply – Demand = Unused Capacity

a. Demand Increase < Unused Capacity Not relevant

b. Demand Increase > Unused Capacity Relevant

c. Demand Decease (Permanent)

1. Activity Capacity Reduced Relevant

2. Activity Capacity Unchanged Not Relevant


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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.


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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.


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Resource demand and SupplyResource demand and SupplyResource demand and SupplyResource demand and Supply


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Assumptions of C-V-P Analysis1. 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.

4Illustrative Examples of Illustrative Examples of Tactical Decision MakingTactical Decision Making

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Important: Short-term PerspectiveImportant: Short-term Perspective

Make or Buy Keep or Drop Special Order Sell or Process Further


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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.

Make-or-Buy Decisions


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Buy the part!


ABC Make-or-Buy Analysis: Talmage CompanyABC Make-or-Buy Analysis: Talmage CompanyABC Make-or-Buy Analysis: Talmage CompanyABC Make-or-Buy Analysis: Talmage Company

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Make the part!


Functional-Based Make-or-Buy Functional-Based Make-or-Buy Analysis: Talmage CompanyAnalysis: Talmage Company

Functional-Based Make-or-Buy Functional-Based Make-or-Buy Analysis: Talmage CompanyAnalysis: Talmage Company

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ABC Segmented Income StatementABC Segmented Income StatementABC Segmented Income StatementABC Segmented Income Statement

DROP?DROP?

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ABC Keep-or-Drop AnalysisABC Keep-or-Drop AnalysisABC Keep-or-Drop AnalysisABC Keep-or-Drop Analysis

Dropping the product saves $45,000!

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Special-Order Cost

Polarcreme, Inc., an ice-cream company, is operating at 80 percent of its 20 million half-gallon capacity.

A distributor from another geographically area offered to buy 2 million units of premium ice cream at $1.75 per unit. They have agreed to

provide their own label and pay transportation costs. This sale would

avoid a sales commission.


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Variable costs:Dairy ingredients

$0.70Sugar

0.10Flavoring

0.15Direct labor

0.25Packaging

0.20Commissions

0.02Distribution

0.03Other

0.05 Total unit-level costs

$1.50

Which costs are irrelevant?

$1.45

Special-Order Cost


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The nonunit-level variable costs will also be incurred, producing a total increment cost of $304,000 or $0.152 per unit (for an order of 2 million units). Revenue per unit of $1.75, less the unit-level variable cost ($1.45) plus

the nonunit-level variable cost ($0.152) provides a net benefit of $0.148 per unit.

Thus Polarcreme’s profit would increase by $296,000 ($0.148 x 2,000,000).

Special-Order Cost


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Joint products have common processes and costs of production up to a split-off point.

The point of separation is called the split-off point.

Assume that Delrio can sell hot sauce for $1.50 per bottle. Also, assume that additional processing costs amount to $1,000. The total revenue at split-off for

Grade A tomatoes are $400 ($0.40 x 1,000 pounds). If the Grade A tomatoes are processed into hot sauce, the

total revenues are $1,500 ($1.50 per bottle).

Sell or Process Further


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Differential Amount Sell Process Further to Process FurtherRevenues $400 $1,500 $1,100

Processing costs ---- 1,000 1,000

Total $400 $ 500 $ 100

Decision: Further Process

Sell or Process Further


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End of End of Chapter 18Chapter 18

18-1 hansen & mowen cost management accounting and control

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