Intro to Managerial Accounting: Relevant Costs and Decision Making (Chapter 11)

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Introduction to Managerial Accounting Professor Savita Sahay Please visit our website at http://raw.rutgers.edu TIME STAMPS Relevant Costs: 0:35 Practice Problem: 3:26 --- Relevant cost (& make vs. buy decision) problem Total and Differential Approach: 5:41 Accepting a Special Order: 6:28 Practice Problem: 7:12 --- Change in operating profits (with special sales order) Make vs. Buy Decision: 9:00 Practice Problem: 10:02 --- Make vs. Buy Adding or Dropping a Segment: 11:36 Practice Problem: 12:17 --- Determining whether or not to discontinue a product Product Mix Decisions: 15:14 Practice Problem: 16:10 --- Computing the contribution margin per unit and per machine hour --- Excess capacity and machine breakdowns - which product is more profitable? Equipment Replacement Decision: 18:31 Practice Problem: 19:23 --- Determining sunk cost, relevant costs, and difference between keeping old machine and disposing of old machine Relevant costs are those that pertain to the future and differ between alternatives. Irrelevant costs are sunk costs and future costs that do not differ among alternatives. The total approach requires an income statement for each alternative. The difference between the two income statements gives us the differential column. The differential approach isolates the relevant costs and benefits. It can be used even if enough information is not available to prepare a detailed income statement. It is much short and avoids mingling relevant costs with irrelevant costs. A special order is not a part of the company's normal business. Companies must determine whether or not to accept or reject this new potential contract. A special order within the relevant range doe snot affect the fixed costs. Only the incremental revenues and costs - usually the variable cost of production - are relevant. Companies often have to decide whether to make a product or buy the parts needed for production. It is important to take note of fixed costs here. Even if you believe it is cheaper to buy it, fixed costs will still be incurred (since you will have them whether you produce or not). Management must also take idle capacity into account and determine the opportunity cost (i.e. the cost of the next best alternative). When a branch, segment, or product of the company shows continuous losses (and is not making any profit) the company may consider closing it. The company should drop a segment only if it believes that dropping it will cause the company's overall profit to increase. It is important to take note of allocated fixed costs here. When a segment is dropped, fixed costs will have to be incurred by remaining business segments (in a sense, it increases the fixed cost per unit for the other products / departments of the company). If the fixed costs are unavoidable, then the decision should be based on the lost CM (contribution margin). Product mix decisions often involve constraints and bottlenecks. A company may have limited raw material, limited skilled labor, and limited space or limited machine time. They aim to manage these business constraints. To maximize the contribution margin per unit of the constraint, they must first calculate the contribution margin per unit for EACH product, find the per unit consumption of the constrained resource, and divide to get the contribution margin per unit of the constrained resource. To make an equipment replacement decision, it should be known that the original cost, accumulated depreciation, current book value, as well as the potential gain or loss on the sale of the existing equipment are all irrelevant costs (since they are sunk costs that you can no longer influence). Salvage value, however, IS relevant. Management must determine whether or not it is better to continue using the old equipment or to buy the new one.