Presentation on theme: "Managerial Accounting: An Introduction To Concepts, Methods, And Uses"— Presentation transcript:
1 Managerial Accounting: An Introduction To Concepts, Methods, And Uses Chapter 8Differential Cost Analysisfor Production DecisionsMaher, Stickney and Weil
2 Learning Objectives (Slide 1 of 2) Explain why businesses apply differential analysis to product choice decisions.Explain the theory of constraints.Identify the factors underlying make-or-buy decisions.Explain how to identify the costs of producing joint products and the relevant costs for decisions to sell or process further.
3 Learning Objectives (Slide 2 of 2) Explain the use of differential analysis to determine when to add or drop parts of operations.Identify the factors of inventory management decisions.Explain how linear programming optimizes the use of scarce resources.Identify the use of the economic order quantity model.
4 Product Choice Decisions (Slide 1 of 2) Due to capacity limitations, firms must often choose which goods to make and services to provideWhen the firm has a scarce resource used in production (e.g., machine time, skilled labor)Firm should produce product that gives the largest contribution margin per unit of constrained resourceIf more than one scarce resource is involved, choice is more difficultMay use linear programming to determine best product mix
5 Product Choice Decisions (Slide 2 of 2) Incorrect use of accounting informationIn making short-run product choice decisions, one should not rely on product cost information that includes cost allocationsFull-absorption product costing allocates fixed manufacturing costs to units producedMay result in incorrect decisions
6 Theory of Constraints (Slide 1 of 3) Focuses on increasing the excess of differential revenue over differential costs when firms face bottlenecksBottleneck-an operation in which the work performed equals or exceeds the available capacityResults in inventory waiting until the bottleneck is free
7 Theory of Constraints (Slide 2 of 3) Encourages managers to find ways to increase profits by relaxing constraints and increasing throughputFocuses on the following factors:Throughput contribution - Sales dollars minus variable costsInvestments - Assets required for production and salesOther operating costs - Other than short-run variable costs
8 Theory of Constraints (Slide 3 of 3) Objective is to maximize throughput contribution while minimizing investments and operating costsKey steps involved:Recognize that bottlenecks determine throughput contribution for the plant as a wholeFind the bottleneck resourceSubordinate all nonbottleneck resources to the bottleneck resourceIncrease bottleneck efficiency and capacity
9 Make-or-Buy Decisions Involve the decision of whether to meet needs internally or to acquire goods and services from external sources (often called outsourcing)Decision depends on cost factors as well as nonquantitative factorsDifferential cost analysis is useful in making these decisions
10 Example-Make or Buy Decision (Slide 1 of 2) Ben & Jerry Cookie Co. can buy part of its product or produce it internally. Relevant info is as follows:Buy MakeUnit Selling Price $ $ 30Sales Volume 800/mth. 800/mth.Unit Variable Costs $ $ 22Purchased Ingredients $ $Total Fixed Costs $3,840 $4,800
12 Joint Products: Sell or Process Further As part of a single production process, multiple products are producedThe point in the production process at which identifiable products emerge is called the splitoff pointCosts incurred up to this point are called joint costsCosts incurred after the splitoff point are called additional processing costs
13 Joint Production Process AdditionalProcessing CostsIncurredJoint Costs:Direct MaterialsDirect LaborOverheadSale ofProduct ASale ofProduct BSplitoff Point
14 Adding or Dropping Parts of Operations General Rule: If differential revenue from sale of a product > differential costs of providing the product, then the product generates profits and firm should continue productionEven though product may show a loss on financial statements due to overhead allocation to the productThis rule applies to short-run decisionsIf more profitable uses of the facilities can be found, it may outweigh the contribution margin lost by dropping a product
15 Inventory Management Decisions Inventory management affects profitabilityHaving correct amount and type of inventory can:Prevent production shutdownsAvoid lost salesInventory is costly to maintainCosts include storage, insurance, losses from damage and theft, property taxes, etc.
16 Differential Costs for Inventory Management Two opposing costs to considerSetup or order costs - costs of setting up machinery for a production run or costs to process a purchase orderCarrying Costs - e.g., cost of maintaining warehouse facilitiesManagement would like to find the optimal trade-off point between these two costsCalled the economic order quantity (EOQ)
17 Estimating Costs of Maintaining Inventory Differential Costs to consider include:Order costs - costs of salaries, lost time for production setups, receiving and inspecting orders, processing invoices, and freight costsCarrying costs - insurance, inventory taxes, opportunity cost of funds invested in inventory, additional warehouse space
18 Just-in-Time (Slide 1 of 2) JIT is a method of managing purchasing, production, and sales where the firm attempts to:Produce items only as needed for the next step in the production process, orTime purchases so items arrive just in time for production or saleCan substantially reduce inventory levels
19 Just-in-Time (Slide 2 of 2) Requires lay out of production process so there is a continuous flow once production startsRequires reliable processing systems
20 Linear ProgrammingManagers may face short-run constraints in production resources such as factory capacity, personnel time, floor space, etcLinear programming is used to address production decisions involving limited resourcesReferred to as a constrained optimization technique
21 Economic Order Quantity Can be determined through trial and error or use the following formula: N=D/QWhere: Q =N = optimal number of ordersQ = economic order quantityD = period demandK0= order or setup costKc= cost of carrying one unit in inventory
22 Dr. Donald R. Trippeer, CPA Colorado State University-Pueblo If you have any comments or suggestions concerning this PowerPoint Presentation for Managerial Accounting, An Introduction To Concepts, Methods, And Uses, please contact:Dr. Donald R. Trippeer, CPAColorado State University-Pueblo