30-11-1© 2012 The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

30-2

Cost-Revenue Analysis forDecision Making

Cost-Revenue Analysis forDecision Making

Section 1: The Decision Process

Chapter

30

Section Objectives1. Explain the basic steps in the decision-making

process.2. Prepare income statements using the

absorption costing and direct costing methods.3. Using the contribution approach, analyze the

profits of segments of a business.4. Determine relevant cost and revenue data for

decision-making purposes.

30-3

Explain the basic steps in the decision-making process

Objective 1

30-4

1. Define the problem.

2. Identify workable alternatives.

3. Determine relevant cost and revenue data.

4. Evaluate the cost and revenue data.

5. Consider appropriate nonfinancial factors.

6. Make a decision.

The Decision-Making ProcessThe Decision-Making Process

30-5

All manufacturing costs (variable and fixed) are included in the cost of goods manufactured.

The value of ending inventory includes fixed costs.

Absorption CostingAbsorption Costing

30-6

Prepare income statements using the absorption costing and direct costing methods

Objective 2

30-7

Fixed and variable manufacturing costs are included

Income Statement Using Absorption Costing

30-8

Only variable costs are included in the cost of goods manufactured.

Fixed manufacturing costs are charged to expense during the period.

Fixed manufacturing costs are not included in: Cost of goods sold, or Ending inventories.

Direct costing is not acceptable for GAAP financial reporting purposes.

Direct Costing (also called Variable Costing)

Direct Costing (also called Variable Costing)

30-9

Manufacturing Margin:

Direct CostingDirect Costing

Sales minus the variable cost of goods sold.

Marginal Income on Sales:

Net Income:

Manufacturing margin minus variable operatingexpenses.

Marginal income on sales minus fixed manufacturing costs and fixed selling and administrative expenses.

30-10

Only variable manufacturing costs are included

Income Statement Using Direct Costing

30-11

Using the contribution approach, analyze the profits of segments of a business

Objective 3

30-12

Contribution margin is the excess of revenues over variable costs of the business segment.

Profitability of a business segment is judged by its contribution toward covering common costs.

Controllable fixed costs of each segment are deducted to determine the segment’s contribution to the overall profit.

Common costs are costs not directly traceable to a specific segment of a business. Common costs are not considered when computing the contribution margin.

Contribution MarginContribution Margin

30-13

Controllable fixed costs are costs that the segment manager can control.

ANSWER:

QUESTION:

What are controllable fixed costs?

30-14

Common costs are costs not directly traceable to a specific segment of the business.

ANSWER:

QUESTION:

What are common costs?

30-15

Determine relevant cost and revenue data for decision-making purposes

Objective 4

30-16

Relevant Cost: Future or expected cost that will change as a result of a decision.

Sunk Cost: A cost that has already been incurred.

Types of CostsTypes of Costs

When making decisions, sunk costs are irrelevant.

Differential Cost: The difference in cost between one alternative and another.

Opportunity Cost: The potential earnings or benefits that are given up because a certain course of action is taken.

30-17

Opportunity CostOpportunity Cost

Dilemma Decision Opportunity Cost

To purchase equipment or invest in securities.

Purchase equipment.

Amount of interest or dividends received on securities if they had been purchased.

30-18

Cost-Revenue Analysis forDecision Making

Cost-Revenue Analysis forDecision Making

Section 2: Cost-Revenue Analysis

Chapter

30

Section Objectives

5. Apply an appropriate decision process in three situations:

a. Pricing products in special cases.b. Deciding whether to purchase new

equipment.c. Deciding whether to make or buy a part.

30-19

Apply An Appropriate Decision Process In Three Situations:

a. Pricing products in special cases

b. Deciding whether to purchase new equipment

c. Deciding whether to make or to buy a part

Objective 5

30-20

Direct costing is often useful in setting prices and considering purchase offers in special

circumstances.

Product Pricing in Special Situations

I better talk to accounting about this?

30-21

* Includes fixed costs, which are not relevant in this situation.

Customer offers to buy 1,000 units at $25 per unit. The order will require $1 per unit in shipping costs.

Management’s Analysis using Absorption Costing:

Manufacturing costs ($220,000 ÷ 10,000 units) $22.00

Selling and administrative costs ($145,000 ÷ 9,000 units) 16.11

Management’s Analysis using Direct Costing:

Variable manufacturing costs $15.00

Variable selling and administrative expenses 5.00

Variable costs per unit $20.00

Additional shipping cost 1.00

Potential Profit

$25 - $21 = $4 per unit

Total average cost per unit * $38.11

Total variable cost per unit $21.00

Product Pricing in Special Situations

30-22

Does the company have sufficient manufacturing capacity?

Will the special order jeopardize sales to existing customers?

Do federal laws prohibit price differentials?

Management needs to consider all relevant factors when analyzing special pricing situations:

Product Pricing in Special Situations

30-23

Purchasing New Equipment

The net income under each alternative must be calculated and compared

30-24

* Includes depreciation for the new machine and effects of other changes in fixed costs.

CORT Industries Inc. is considering the purchase of new machinery.

Purchasing New Equipment

Income would increase by $5,000 per year

30-25

Employee morale

Product quality with the new machine

Income Tax Considerations

Timing of future cash receipts and expenditures

Before purchasing the new equipment however, management needs to consider all relevant factors, including:

Purchasing New Equipment

30-26

Making or Buying a Part

Fixed manufacturing overhead costs are not considered because they remain the same whether the part is purchased or made.

30-27

Making or Buying a PartMaking or Buying a Part

CORT Industries Inc. is weighing the alternatives of buying a part from an outside vendor, or making the part themselves.

30-28

Thank Youfor using

College Accounting, 13th Edition

Price • Haddock • Farina