1. Don R. Hansen Maryanne M. Mowen
COST MANAGEMENT
Don R. Hansen
Maryanne M. Mowen

2. Chapter Nineteen
Activity Resource Usage Model and Relevant Costing: Tactical Decision Making

3. Learning Objectives
Describe and explain the tactical decision- making model.
Define ad explain the concept of relevant costs and revenues.

4. Learning Objectives (continued)
Explain how the activity resource usage model is used in assessing relevancy.
Apply the tactical decision-making concepts in a variety of business situations.

5. The Tactical Decision-Making Process
Tactical decision making consists of choosing among alternatives with an immediate or limited end in view.
Tactical cost analysis is the use of relevant cost data to identify the alternative that provides the greatest benefit to the organization.

6. The Tactical Decision-Making Process (continued)
Recognize and define the problem.
Identify alternatives as possible solutions to the problem, and eliminate alternatives that are not feasible.
Identify the predicted costs and benefits associated with each feasible alternative. Eliminate the costs and benefits that are not relevant to the decision.

7. The Tactical Decision-Making Process (continued)
Compare the relevant costs and benefits for each alternative, and relate each alternative to the overall strategic goals of the firm and other important qualitative factors.
Select the alternative with the greatest benefit which also supports the organization’s strategic objectives.

8. Qualitative Factors
How should qualitative factors be handled in the decision-making process?
1. They must be identified.
2. The decision maker should try to quantify them.
3. True qualitative factors should be taken into consideration in the final step of the decision-making process.

9. Relevant Costs Defined
Costs that differ across alternatives
Costs that deal with future courses of action

10. Irrelevant Cost Sunk costs are past costs.
Example: The original cost of a building is a sunk cost when you are selling the building five years later.

11. Activity Resource Usage Model and Assessing Relevancy
Flexible Resources
Resources Acquired as Needed
a. Demand Changes
b. Demand Constant
Relevant
Not Relevant

12. Activity Resource Usage Model and Assessing Relevancy (continued)
Committed Resources
Acquired in Advance (Short Term)
a. Demand Increase < Unused Capacity
b. Demand Increase > Unused Capacity
c. Demand Decrease (Permanent)
1. Activity Capacity Reduced
2. Activity Capacity Unchanged
Not Relevant
Relevant
Relevant
Not Relevant

13. Some Types of Decisions Illustrated
Make or Buy
Keep or Drop
Special Order
Sell or Process Further
Important: Short-term Perspective

14. Activity and Cost Information
Part
Expected B
Activity Activity Activity Units of
Activity Cost Driver Cost Formula Capacity Usage Usage Purchase
Using materials Units Y = $0.5X As needed 100, ,000 1
Using direct labor Units Y = $2X As needed 100, ,000 1
Providing Number of Y = $300,
supervision lines
Moving materials Number of Y = $250, , ,000 40,000 25,000
moves $0.60X
Providing power Machine Y = $3X As needed 30,000 30,000 1
hours
Inspecting Inspection Y = $280, ,000 14,000 2,000 2,000
products hours $1.50X
Setting Setup hours Y = $600,000 60,000 58,000 6,000 2,000
up equipment
Providing space Square feet Y = $1,000,000 50,000 50,000 5,000 50,000
Equipment Units Y = $0.50X 120, , ,000 15,000
depreciation

15. Make-or-Buy Decisions
Assume the following cost data related to the decision to produce
12,000 units of a product or buy from an external source:
Total Costs Unit Cost
Rental of equipment $15,000 $1.25
Equip. depreciation 3,
Direct materials 12,
Direct labor 24,
Variable overhead 9,
Fixed overhead 36,
Total $99,000 $8.25
====== ====
Purchase price from an outside vendor is $5.50 per unit

16. Make-or-Buy Decision (continued)
Alternatives Differential
Make Buy Cost to Make
Rental of equip. $15, $15,000
Direct materials 5, ,000
Direct labor 24, ,000
Variable overhead 9, ,000
Purchase cost $66,000 ($66,000)
Relevant costs $53,000 $66,000 ($13,000)
====== ====== ======
Decision: Manufacture parts in-house

17. Keep-or-Drop Decisions
Assume the following:
Regular Deluxe Total
Sales units
Sales revenue $200,000 $150,000 $350,000
Less variable expenses:
Variable cost of sales 96,000 60, ,000
Variable selling & admin , , ,500
Contribution margin $ 94,000 $ 82,500 $176,500
Less direct fixed expenses:
Direct fixed costs , , ,000
Product margin $ 64,000 $ (2,500) $ 61,500
Less common fixed costs ======= ======= ,000
Net income $ 31,500
=======
Should the Deluxe product line be eliminated?

18. Keep-or-Drop (continued)
Differential
Keep Drop Amount to Keep
Sales $150, $150,000
Variable expenses (67,500) (67,500)
Contribution margin $ 82, $ 82,500
Direct fixed expenses (85,000) (85,000)
Relevant benefit/loss $ (2,500)
======
Decision: Drop the Deluxe product line but investigate alternative
use of facilities. This analysis provides a benchmark for future
decisions.

19. Special-Order Decisions
Assume the following price quotation sheet for the XYX Company who
has received an offer buy at $38 per unit.
Direct materials $12
Direct labor 14
Variable overhead 4
Variable selling and administrative 2
Fixed manufacturing 20
Total $52
Markup--50% 26
Target selling price $78
===
Important: XYZ Company has idle capacity and can produce the
special order without affecting its current production.

20. Special-Order Decisions (continued)
Decision Rule: The “floor” for establishing a price for a special
order is incremental cost(variable cost in this case).
Incremental Costs:
Direct materials $12 Sales price $38
Direct labor 14 Incremental costs
Variable overhead 4 Additional income $ 6 per unit
Variable S & A ===
Total $32
===
Question: What impact is this decision likely to have on existing
customers?

21. Joint Products
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.

22. Decisions to Sell or Process Further
Product A
Separate
Processing
Joint Input
Joint Costs
Should the company
process further?
Product B
Separate
Processing
Split-off
point
Joint products

23. Decisions to Sell or Process Further (continued)
Sell or process further decision:
Products
A B
Sales value at split-off $240,000 $300,000
Sales value after additional processing 320, ,000
Allocated joint product costs 160, ,000
Cost of further processing 100, ,000
Incremental revenue from processing $ 80,000 $180,000
Cost of additional processing 100, ,000
Profit (loss) from further processing $(20,000) $ 60,000
Decision Sell at split-off Process further
Joint costs are irrelevant

24. End of Chapter 19