Managerial Accounting: An Introduction To Concepts, Methods, And Uses Chapter 7 Differential Cost Analysis for Operating Decisions Maher, Stickney and Weil

Learning Objectives (Slide 1 of 3)  Explain the differential principle & know how to identify costs for differential analysis.  Explain the relation between costs & prices.  Explain how to base target costs on target prices.  Describe how to use differential analysis to measure customer profitability.

Learning Objectives (Slide 2 of 3)  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 & the relevant costs for decisions to sell or process further.

Learning Objectives (Slide 3 of 3)  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 scare resources (Appendix 8.1)  Identify the use of the economic order quantity model (Appendix 8.2)

Describe & Define Differential Analysis

Differential Analysis Model Alternative -Status Quo =Difference Revenue Change in Revenue Less Variable Costs (VC) VC -VC = Change in VC Total Contribution Margin (CM) CM Change in CM Less Fixed Costs Fixed Costs -Fixed Costs = Change in Fixed Costs Operating Profit Profit -Profit = Change in Profit

Differential Analysis Cont.  A cost (or revenue) is relevant only if it differs between alternatives under consideration  Focus is typically on cash flows because:  Cash is the medium of exchange  Cash is a common, objective measure of benefits and costs of alternatives

What are the three major influences on pricing?

Review Short-Run vs. Long- Run Pricing Decisions  Time horizon of a decision is important in determining relevant costs in a pricing decision  Short-run decisions include pricing for a one-time special order  Long-run decisions include pricing a main product in a major market

What is the differential approach to pricing?

Long-Run Pricing Decisions (Slide 1 of 3)  Define Full cost

Review the Value Chain

Long-Run Pricing Decisions (Slide 3 of 3)  Full cost approach is justified in pricing decisions when:  Entering into long-term contracts to supply a product  Developing and producing a customized product  Initially setting prices, then adjusting for market conditions

Review Life-Cycle Product Costing and Pricing

Explain Using Target Prices to Set Target Costs

Explain Legal Issues Relating Costs to Prices

Customer Profitability  Differential analysis is useful in determining which customers to keep or drop  Dropping a customer should result in cost savings in excess of lost revenue  Alternative uses of extra capacity available after dropping a customer should be included in the analysis

What are the four general categories of customer costs? Customer costs generally consist of the following 4 categories of activities: ABC provides a better understanding of the cost of these activities

Build a Chart of Activities to Compute Customer Costs

Comment on Decisions when Scarce Resources are Limited

Decisions with Scarce Resources

Define the Following  Theory of Constraints  Bottleneck  Throughput Contribution

List the Five Steps to Managing Bottlenecks

Name Three Options to Relieve a Bottleneck

Explain Make or Buy Decisions

Define the Following  Split-Off Point  Joint Costs  Additional Processing Costs

How do you decide whether to process further or not?

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