Management Accounting - Hansen Mowen CH17

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Tactical Tactical Decision Decision MakingMaking

CHAPTERCHAPTER

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1. Describe the tactical decision-making model.2. Explain how the activity resource usage model

is used in assessing relevancy.3. Apply tactical decision-making concepts in a

variety of business situations.4. Choose the optimal product mix when faced

with one constrained resource.5. Explain the impact of cost of pricing decisions.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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6. Use linear programming to find the optimal solution to a problem of multiple constrained resources. (Appendix)

ObjectivesObjectivesObjectivesObjectives

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Model for Making Tactical DecisionsStep 1. Recognize and define the problem.

ContinuedContinuedContinuedContinued

Increase capacity for warehousing and production.Step 2. Identify alternatives as possible solutions to

the problem; eliminate alternatives that are clearly not feasible.

1. Build new facility2. Lease larger facility; sublease current facility3. Lease additional facility4. Lease warehouse space5. Buy shafts and brushings; free up needed space

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Model for Making Tactical Decisions

Lease warehouse space:

Variable production costs$345,000

Warehouse lease135,000

Buy shafts and bushings externally:

Purchase price$460,000

Step 3. Identify the costs and benefits associated with each feasible alternative. Classify costs and benefits as relevant or irrelevant, and eliminate irrelevant ones from consideration.


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Model for Making Tactical DecisionsStep 4. Total the relevant costs and benefits for each

alternative.


Lease warehouse space:

Variable production costs$345,000

Warehouse lease 135,000

Total$480,000

Buy shafts and bushings externally:

Purchase price$460,000

Differential cost $ 20,000

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Model for Making Tactical Decisions

Step 5. Assess qualitative factors.

1. Quality of external suppliers

2. Reliability of external suppliers

3. Price stability

4. Labor relations and community image

Step 6. Make the decision.

Quality of shafts and brushing is significantly lowerNot reliable

Continue to produce shafts and bushings internally; lease warehouse

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Relevant Costs DefinedRelevant Costs DefinedRelevant Costs DefinedRelevant Costs Defined

Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but most also

differ between alternatives.

Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but most also

differ between alternatives.

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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.

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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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Activity Resource Usage Model and Activity Resource Usage Model and Assessing Relevancy Assessing Relevancy


a. Demand Changes Relevant

Flexible ResourcesFlexible Resources

b. Demand Constant Not Relevant

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Committed Resources(Short-Term)

Committed Resources(Short-Term)

Supply – Demand = Unused Capacity

a.. Demand Increased < Unused Capacity Not relevant

b. Demand Increased > Unused Capacity Relevant

c. Demand Decease (Permanent)1. Activity Capacity Reduced Relevant

2. Activity Capacity Unchanged Not Relevant

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Committed Resources(Multiperiod Capacity)

Committed Resources(Multiperiod Capacity)

Supply – Demand = Unused Capacity

a.. Demand Increased < Unused Capacity Not relevant

b. Demand Decreased (Permanent) Relevant

c. Demand Increase > Unused Capacity Capital Decision

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Important: Short-term PerspectiveImportant: Short-term PerspectiveImportant: Short-term PerspectiveImportant: Short-term Perspective

Illustrative Examples of Relevant Cost Applications

Make or Buy

Keep or Drop

Special Order

Sell or Process Further

Product Mix

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Make or BuyMake or Buy

Swasey Manufacturing currently produces an electronic component used in one of its printers. Swasey must produce 10,000 of these parts. The

firm has been approached by a supplier who offers to build the component to Swasey’s

specifications for $4.75 per unit.

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Total Cost Unit CostRental of equipment $12,000 $1.20Equipment depreciation 2,000 0.20Direct materials 10,000 1.00Direct labor 20,000 2.00Variable overhead 8,000 0.80General fixed overhead 30,000 3.00 Total $82,000 $8.20

The full absorption cost for the 10,000 parts is computed as follows:

Enough material is on hand to make 5,000 parts.

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Alternatives Differential Make Buy Cost to Make

Rental of equipment $12,000 ------- $12,000Direct materials 5,000 ------- 5,000Direct labor 20,000 ------- 20,000Variable overhead 8,000 ------- 8,000Purchase cost ------- $47,500 -47,500Receiving Dept. labor ------- 8,500 - 8,500 Total $45,000 $56,000 $-11,000

The cost to make or buy 5,000 units follows:

MakeMake

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Norton Materials, Inc. produces concrete blocks, bricks, and roofing tile. The controller prepared the following income statements:

Keep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop Decisions

Blocks Bricks Tile TotalSales revenue $500 $800 $150 $1,450Less: Variable expenses 250 480 140 870Contribution margin $250 $320 $ 30 $ 580Less direct fixed expenses:

Advertising $ 10 $ 10 $ 10 $ 30Salaries 37 40 35 112Depreciation 53 40 10 103 Total $100 $ 90 $ 55 $ 245

Segment margin $150 $230 $- 45 $ 335Less: Common fixed exp. 125

Operating income $ 210

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Differential Keep Drop Amount to KeepSales $150 ---- $150

Less: Variable expenses 140 ---- 140Contribution margin $ 10 ---- $ 10Less: Advertising -10 ---- -10 Cost of supervision -35 ---- -35Total relevant benefit (loss) $- 35 $ 0 $- 35

Preliminary figures indicate that the tile Preliminary figures indicate that the tile segment should be dropped!segment should be dropped!

Preliminary figures indicate that the tile Preliminary figures indicate that the tile segment should be dropped!segment should be dropped!

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Keep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop DecisionsTom Blackburn determines that dropping the tile section will reduce sales in all sections as follows: $50,000 for blocks, $64,000 for bricks, and $150,000 for roofing tile. His summary in thousands is shown below:

Sales $1,450 $1,186.0 $264.0Less: Variable expenses 870 666.6 203.4Contribution margin $ 580 $ 519.4 $ 60.6Less: Advertising -30 -20.0 -10.0 Cost of supervision -112 -77.0 -35.0Total $ 438 $ 422.4 $ 15.6

Differential Keep Drop Amount to Keep

Keep roofing tile segment!Keep roofing tile segment!Keep roofing tile segment!Keep roofing tile segment!

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The marketing manager sees the market for floor tile as stronger and less competitive than roof tile. He submits the following figures for floor tile sales:

Alternate Use of FacilitiesAlternate Use of Facilities

Sales $100,000Less: Variable expenses 40,000Contribution margin $ 60,000Less: Direct fixed expenses 55,000 Segment margin $ 5,000

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Alternate Use of FacilitiesAlternate Use of Facilities

Drop and Differential Keep Replace Amount to KeepSales $1,450 $1,286.00 $164.00

Less: Variable expenses 870 706.60 163.40

Contribution margin $ 580 $ 579.40 $ 0.60$1,450 – $150 $1,450 – $150 –$50 – $64 + –$50 – $64 +

$100$100$870 – $140 – $870 – $140 – $25 – $38.40 + $25 – $38.40 +

$40$40Decision: Continue making roof tile!Decision: Continue making roof tile!Decision: Continue making roof tile!Decision: Continue making roof tile!

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Special-Order DecisionsSpecial-Order DecisionsSpecial-Order DecisionsSpecial-Order Decisions

An ice cream company is operating at 80 percent of its

productive capacity (20 million half gallon units). The unit costs

associated with producing and selling 16 million units are shown

on the next slide.

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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 variable costs

$ 1.50

Wholesale Wholesale price = price = $2.00$2.00

Total fixed costs 0.097 Total costs $1.597

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An ice cream distributor from a geographic region not normally

served by the company has offered to buy two million units at $1.55 per unit, provided its own label can be

attached to the product. The distributor has agreed to pay the

transportation cost.

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$0.70Sugar

0.10Flavoring

0.15Direct labor

0.25Packaging

0.20Commissions

0.02Distribution

0.03Other


$1.50

Total fixed costs 0.097 Total costs $1.597

Which costs are irrelevant?

$1.45$1.45

$1.45$1.45

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$ 0.70Sugar

0.10Flavoring

0.15Direct labor

0.25Packaging

0.20Commissions

0.02Distribution

0.03Other


$ 1.50

Total fixed costs 0.097 Total cost $1.597

Which costs are irrelevant?

$1.45$1.45

$1.45$1.45

Accept the offer ($0.10 x 2,000,000 = $200,000

more profit).

Accept the offer ($0.10 x 2,000,000 = $200,000

more profit).

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Sell or Further ProcessYield at Split-Off

Grade AGrade A800 lb800 lbSell for $0.40 lbSell for $0.40 lb

Grade BGrade B600 lb600 lb

Grade CGrade C600 lb600 lb

Joint Cost $300

BaggedBagged120 Bags120 BagsCost $0.05/BagCost $0.05/BagSell for $1.30/BagSell for $1.30/Bag

ApplesauceApplesauce500 16-oz Cans500 16-oz CansCost $0.10/lbCost $0.10/lbSell for $0.75 canSell for $0.75 can

Further Processing

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Sell or Further Process

Process Differential Amount Further Sell to Process Further

Revenues $450 $150 $300Processing cost 120 ---- 120Total $330 $150 $180

Further process!Further process!

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Two Approaches to Pricing

1. Cost-Based Pricing

2. Target Costing and Pricing

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Revenues $856,500

Cost of goods sold:

Direct materials $489,750

Direct labor 140,000

Overhead 84,000 713,750

Gross profit $142,750

Selling and administrative expenses 25,000

Operating income $117,750

Cost-Based Pricing

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Markup on COGS =

(S & A expenses + Operating income) ÷ COGS

= ($25,000 + $117,750) ÷ $713,750

= 0.20

Determining Markup Percentages

Markup on direct materials =

(DL + OH + S & A expenses + Oper. income) ÷ Direct mater. =

($140,000 + $84,000 + $25,000 + $117,750) ÷$489,750 = 0.749

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Determining Markup Percentages

Direct materials (computer components, etc.) $100,000Direct labor (100 x 6 hours x $15) 9,000Overhead (60 percent of direct labor cost) 5,400Estimated cost of goods sold $114,400Plus 20 percent markup of COGS 22,880 Bid price $137,280

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Target Costing and Pricing

Target costing is a method of determining the cost of a product or service based on the price (target price) that customers are willing to pay.

This is referred to as price-driven costing.

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Legal Aspects of PricingLegal Aspects of Pricing

Predatory pricing. The practice of setting prices below cost for the purpose of injuring or eliminating competitors.

Price discrimination. Charging different prices to different customers for essentially the same product.

The Robinson-Patman Act is the most potent weapon against price discrimination, but it doesn’t

cover services and intangibles.

The Robinson-Patman Act is the most potent weapon against price discrimination, but it doesn’t

cover services and intangibles.

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Linear ProgrammingLinear ProgrammingLinear ProgrammingLinear Programming

The maximum demand for Gear X is 15,000 units and the maximum demand for Gear Y is 40,000 units. The

contribution margin for X is $25 and for Y is $10.

Z = $25X x $10Y

Two machine hours are used for each unit of Gear X, and 0.5 machine hour is used for a unit of Gear Y.

2X + 0.5Y 40,000

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Max. Z = $25X x $10Y

2X + 0.5Y 40,000X 15,000Y 40,000X 0Y 0

Subject to:

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80 –75 –70 –65 –60 –55 –50 –45 –40 –35 –30 –25 –20 –15 –10 –5 –0 – 5 10 15 20 25 | | | | |

Machine Hours Constraint 2X + 0.5Y 40,000

Demand Constraint X 15,000

Demand Constraint Y 40,000

Feasibility Feasibility RegionRegion

A B

C

DE

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Corner Point X-Value Y-Value Z = $25X + $10Y

A 0 0 $ 0B 15 0 375C 15 20 575D 10 40 650E 0 40 400

Manufacture 10,000 units of Gear X and 40,000 of Gear Y.

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The EndThe EndThe EndThe End

Chapter SeventeenChapter Seventeen

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Management Accounting - Hansen Mowen CH17