1. MANAGERIAL ACCOUNTING
CHAPTER 7
MANAGERIAL ACCOUNTING
10TH EDITION BY
MAHER, STICKNEY & WEIL
PowerPoint Presentation by
Gail B. Wright Professor Emeritus of Accounting Bryant University
© Copyright 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license.
DIFFERENTIAL COST ANALYSIS FOR OPERATING DECISIONS

2. LEARNING OBJECTIVES
Explain differential principle & know how to identify costs for differential analysis.
Explain relation between costs & prices.
Explain how to base target costs on target prices.
Describe how to use differential analysis to measure customer profitability.
Continued

3. LEARNING OBJECTIVES
Explain how businesses apply differential analysis to product choice decisions.
Explain the theory of constraints.
Identify factors underlying make-or-buy decisions.
Explain how to identify costs of producing joint products & relevant costs for decisions to sell or process further.
Continued

4. LEARNING OBJECTIVES
Explain use of differential analysis to determine when to add or drop parts of operations.
Identify factors of inventory management decisions.
Explain how linear program optimizes use of scarce resources (Appendix 7.1).
Identify use of economic order quantity model (Appendix 7.2).

5. ☼ ☼
CHAPTER GOAL
This chapter explains how managers can use differential analysis to examine the effects on profits. Differential analysis helps managers answer relevant questions such as:
What activities differ between the alternatives?
How does that difference affect costs & profits?

6. DIFFERENTIAL ANALYSIS: Definition
LO 1
DIFFERENTIAL ANALYSIS: Definition
Is the analysis of differences among particular alternative actions.

7. CASH FLOW Differential analysis focuses on cash flow because
Cash is the medium of exchange in business
Cash is a common objective measure of the costs & benefits of alternatives

8. UEM
MANAGERS WANT TO KNOW!
LO 2
SPECIAL ORDERS
Ullman has an opportunity for a 1-time only special order to sell 100 units at $25 each. The regular price is $28. Should they take it?
Continued

9. UEM
LO 2
Yes! Since normal operations should be used to cover FC, not special orders, this special order adds $300 to the bottom line.
EXHIBIT 7.3

10. What is UEM’s minimum selling price?
MANAGERS WANT TO KNOW!
LO 2
What is UEM’s minimum selling price?
The minimum selling price in the short run must cover variable costs. For UEM, the minimum selling price is $22.

11. LO 2
PRICING DECISIONS
Use of full cost in pricing decisions is justified because
In the long run, prices must cover all costs to survive
Long term contractual agreements must cover all costs
Prices in regulated industries are often based on full cost
Although full cost + profit may be used initially, short term adjustments may reflect market conditions.

12. LO 6
THEORY OF CONSTRAINTS
The theory of constraints (TOC) acknowledges that businesses often have constraints or limits on what can be done. TOC encourages managers to identify where constraints arise and to develop methods to manage them. 3 factors predominate:
Throughput contribution
Investments
Other operating costs

13. BOTTLENECK: Definition
LO 6
BOTTLENECK: Definition
Is an operation in which the work to be performed equals or exceeds the available capacity.

14. MANAGING THE BOTTLENECK
LO 6
MANAGING THE BOTTLENECK
Recognize that the bottleneck resource determines throughput contribution of product
Search for, find bottleneck
Resource with large quantities of inventory waiting to be worked on
Subordinate all non-bottleneck resources to the bottleneck resource
Increase bottleneck efficiency, capacity
Repeat 4 steps for any new bottleneck

15. PPC
LO 6
EXAMPLE: Pete’s Pizza
Pete’s Pizza Co. (PPC) is a pizza delivery company that will only accept orders that can be delivered within 30 minutes. This policy creates a bottleneck in delivery totaling 60 hours per month, resulting in orders being turned away. VC is $6; SP is $15.
Preparation
Cooking
Delivery
Hourly capacity
15 units
12 units
10 units
Monthly capacity (60 hours)
900 units
720 units
600 units
Monthly possible production (60 hours)
Continued

16. PPC: Solution Alternatives
MANAGERS WANT TO KNOW!
PPC
LO 6
PPC: Solution Alternatives
Examine differential costs for each alternative
1. Eliminate bottleneck idle time
Hiring 1 employee for cooking & prep work will increase delivery capacity by 120 units per month. Throughput contribution increases by $1,080 but extra employee will cost $1,200.
2. Shift from bottleneck to non-bottleneck production
Selling pizzas for pickup will increase production during bottleneck by 120 units, reducing SP to $12 & VC to $5 but increasing labor costs by $600. Throughput contribution increases by $240.
Continued

17. PPC: Solution Alternatives
MANAGERS WANT TO KNOW!
PPC
LO 6
PPC: Solution Alternatives
Examine differential costs for each alternative
3. Increase capacity of bottleneck process
Hiring 1 driver for bottleneck hours will increase delivery capacity by 120 units and cost $900. Throughput contribution will increase by $1,080.

18. LO 7
MAKE-OR-BUY
The make-or-buy decision is one where the firm must decide whether to meet its needs internally or to acquire goods or services externally. Both cost & non-quantitative factors are considered.

19. B&J
LO 7
EXAMPLE: Ben & Jerry’s
Ben & Jerry Cookie Co. (B&J) produces & sells cookies. B&J has an opportunity to buy some product for $12 per unit. The affect on current conditions follows:
Buy
Make
Unit SP $ $
Volume
800 / mo.
Unit VC $ $
Purchased ingredients/unit $ $
Total FC
$3,840
$4,800

20. MANAGERS WANT TO KNOW!
LO 8
JOINT PRODUCTS
In some circumstances, multiple products can be produced from a single production process. The question for management is: What is the effect of additional processing/production on profits?

21. SPLITOFF POINT: Definition
LO 8
SPLITOFF POINT: Definition
Is the point up to which all costs are joint and after which additional processing costs are identified with other products.

22. EXAMPLE: Hanson Dairy HD
LO 8
EXAMPLE: Hanson Dairy
Hanson Dairy (HD) produces 7,000 gallons of whole milk (SP $1) & 3,000 gallons of cream at a joint cost of $11,000. Processing the milk further into 6,500 gallons of skim milk would cost $0.20 & be sold for $1.25 per gallon.
Process
Sell
Revenue
$ 8,125
$7,000
Less additional processing costs
1,300
CM before splitoff
$ 6,825

23. MANAGERS WANT TO KNOW!
LO 9
ADD OR DROP
Managers must decide when to add or drop products; when to open or abandon sales territories. The differential principle involved can be stated:
If differential revenue from selling exceeds differential costs of product, the product is profitable & firm should continue production.

24. MANAGERS WANT TO KNOW!
LO 10
INVENTORY MANAGEMENT
Inventory has a direct affect on profit and must be carefully managed. Key questions for managers are:
How many units should be on hand for use or sale?
How often should the firm order an item and what is the optimal order size?

25. LO 10
JUST-IN-TIME (JIT)
JIT is a philosophy, not a tool, that dovetails with total quality management (TQM) in that TQM requires reliable processing systems & disallows defective units. Flexible manufacturing that reduces both setup & inventory levels also enhances JIT.

26. CHAPTER 7
THE END