Accounting Question

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Avoid plagiarism, the work should be in your own words.All answers must be typed using Times New Roman (size 12, double-spaced) font.Use APA style for reference.Please follow the instructions as described in the assignment

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College of Administration and Finance Sciences
Assignment (2)
Deadline: Saturday 11/11/2023 @ 23:59
Course Name: Cost Accounting
Student’s Name:
Course Code: ACCT 301
Student’s ID Number:
Semester: 1st
CRN:
Academic Year: 1445 H
For Instructor’s Use only
Instructor’s Name:
Students’ Grade:
/15
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
• The Assignment must be submitted on Blackboard (WORD format only) via allocated
folder.
• Assignments submitted through email will not be accepted.
• Students are advised to make their work clear and well presented, marks may be
reduced for poor presentation. This includes filling your information on the cover
page.
• Students must mention question number clearly in their answer.
• Late submission will NOT be accepted.
• Avoid plagiarism, the work should be in your own words, copying from students or
other resources without proper referencing will result in ZERO marks. No exceptions.
• All answers must be typed using Times New Roman (size 12, double-spaced) font.
No pictures containing text will be accepted and will be considered plagiarism.
• Submissions without this cover page will NOT be accepted.
College of Administration and Finance Sciences
Assignment Question(s):
(Marks 15)
Q1. Discuss with suitable examples why activity-based costing (ABC) is better than the
traditional costing system. Provide a suitable numerical example of ABC in the manufacturing
sector and show all the necessary calculations required under the ABC system.
(3 Marks)
Note: Your answer must include suitable numerical examples showing all the calculations of the
ABC system. You are required to assume values of numerical examples of your own and they should
not be copied from any sources.
(Chapter 7)
Answer:
Q2. “A non-routine decision is one that is taken in response to a non-repetitive, operational
scenario.” Comment on this statement and explain with suitable examples the various types of
non-routine operating decisions that a company makes under such a scenario. Support your
answer with numerical examples along with qualitative considerations involved in making such
decisions.
(4 Marks)
Note: Your answer must include suitable numerical examples for various types of non-routine
operating decisions. You are required to assume values of numerical examples of your own and they
should not be copied from any sources.
Answer:
(Chapter 4)
College of Administration and Finance Sciences
Q3. ADLG Company has two support departments, SS1 and SS2, and two operating
departments, OD1 and OD2. The company has decided to use the direct method and allocate
variable SS1 dept. costs based on the number of transactions and fixed SS1 dept. costs based on
the number of employees. SS2 dept. variable costs will be allocated based on the number of
service requests and fixed costs will be allocated based on the number of computers. The
following values have been extracted for the allocation:
(4 Marks)
Support Departments
Operating Departments
SS1
SS2
OD1
OD2
Total Department variable costs
16,000
19,000
105,000
68,000
Total department fixed costs
19,500
34,000
120,000
55,000
Number of transactions
50
55
250
140
Number of employees
18
24
47
38
Number of service requests
37
22
26
32
Number of computers
20
25
31
37
You are required to allocate variable and fixed costs.
(Chapter 8)
Answer:
Q4. JKL Company processes a direct material and produces three products: P1, P2, and P3. The
joint costs of the three products in 2018 were SAR 120,000. The total number of units for each
product and the selling price per unit is given below:
(4 Marks)
Product
Units
Selling Price per unit
P1
55,000
SAR 70
College of Administration and Finance Sciences
P2
34,500
SAR 58
P3
10,500
SAR 44
You are required to use the physical volume method and sales value at the split-off method to
allocate the joint costs to each product.
Answer:
(Chapter 9)
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 7
Activity-Based Costing and
Management
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 7: Activity-Based Costing and
Management
Learning objectives
•
Q1: What is activity-based costing (ABC)?
•
Q2: What are activities and how are they identified?
•
Q3: What process is used to assign costs in an ABC system?
•
Q4: What is activity-based management?
•
Q5: What are GPK and RCA?
•
Q6: How does information from ABC, GPK, and RCA affect
managers’ incentives and decisions?
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Activity-Based Costing (ABC)
• ABC is a method of cost system refinement.
• Indirect costs are divided into “sub-pools” of
costs of activities.
• Activity costs are then allocated to the final cost
objects using a cost allocation base (more
commonly called cost drivers in ABC).
• Activities are measurable, making it more likely
that cost drivers can be found so that a final cost
object will absorb indirect costs in proportion to
its use of the activity.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Traditional Costing vs. ABC
Traditional costing systems:
Indirect
Costs
Indirect costs are
grouped into one (or a
small number) of cost
pools; a cost allocation
base assigns costs to
the individual products
© John Wiley & Sons, 2011
Product A
Direct Costs
Product B
Direct Costs
Product C
Direct Costs
The individual
products are
the final cost
objects.
Direct costs are
traced to the
individual
products.
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Traditional Costing Systems
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Traditional Costing vs. ABC
Activity-based costing systems:
Activity 1
Indirect
Costs
Activity 2
Product A
Direct Costs
Product B
Direct Costs
Product C
Direct Costs
Activity 3
Indirect costs are
assigned (traced &
allocated) to various
pools of activity costs.
© John Wiley & Sons, 2011
Activity costs are
allocated to
products
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
The individual products
are the final cost objects
& direct costs are traced
to the individual products.
Slide # 6
Q1: ABC Costing Systems
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q2: What are Activities and How are They
Identified?
The ABC cost hierarchy includes the following activities:
• organization-sustaining – associated with overall
organization
• facility-sustaining – associated with single manufacturing
plant or service facility
• customer-sustaining – associated with a single customer
• product-sustaining – associated with product lien or
single product
• batch-level – associated with each batch of product
• unit-level – associated with each unit produced
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2: ABC Cost Hierarchy Example
Some of the costs incurred by the Dewey Chargem law firm are listed
below. This firm specializes in immigration issues and family law. For each
cost, identify whether the cost most likely relates to a(n) (1) organiz-ationsustaining, (2) facility-sustaining, (3) customer-sustaining, (4) productsustaining, (5) batch-level, or (6) unit-level activity and explain your choice.
Cost
Cost Hierarchy Level
Bookkeeping software
Salary for partner in charge of family law
Office supplies
Subscription to family law update journal
Telephone charges for local calls
Long distance telephone charges
Window washing service
Salary of receptionist
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q3: What Process is Used to Assign Costs in an
ABC system?
1. Identify the relevant cost object.
2. Identify activities and group homogeneous
activities.
3. Assign costs to the activity cost pools.
4. Choose a cost driver for each activity cost
pool.
5. Calculate an allocation rate for each
activity cost pool.
6. Allocate activity costs to the final cost
object.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q3: How Are Cost Drivers Selected for
Activities?
• For each activity, determine its place
in the ABC cost hierarchy.
• Look for drivers that have a good
cause-and-effect relationship with the
activities’ costs.
• Use a reasonable driver when there is
no cause-and-effect relationship.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q3: ABC in Manufacturing Example
Alphabet Co. makes products A & B. Product A is a low-volume
specialty item and B is a high-volume item. Estimated factory- wide
overhead is $800,000, and the number of DL hours for the year is
estimated to be 50,000 hours. DL costs are $10/hour. Each product
uses 2 DL hours. Compute the traditional cost of each product if
Products A & B use $25 and $10 in direct materials, respectively.
First, compute the estimated overhead rate:
Estimated overhead rate = $800,000/50,000 hours = $16/hour.
Direct materials
Direct labor (2hrs @ $10)
Overhead (2 hrs @ $16)
© John Wiley & Sons, 2011
Product A
$25
20
32
$77
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Product B
$10
20
32
$62
Slide # 12
Q3: ABC in Manufacturing Example
Alphabet Co. is implementing an ABC system. It estimated the costs
and activity levels for the upcoming year shown below.
Estimated Estimated Activity Levels
Costs
Prod. A Prod. B
Total
Machine set-ups
$200,000 3,000 2,000 5,000
Inspections
140,000
500
300
800
Materials handling
80,000
400
400
800
Machining dep’t
320,000 12,000 28,000 40,000
Quality control dep’t
60,000
600
150
750
$800,000
Cost Driver
# set-ups
# inspections
# mat’l requistions
# machine hours
# tests
First, compute the estimated overhead rate for each activity:
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q3: ABC in Manufacturing Example
Estimated
Costs
Estimated Activity
Overhead Rate
$40
Machine set-ups
$200,000 5,000 set-ups
$40/setup
/setup
$175
Inspections
140,000
800 inspections
$175/inspection
/inspection
Materials handling
80,000
800 mat’l requistions $100
$100/requisition
/requisition
$8
Machining dep’t
320,000 40,000 machine hours
$8/mach
/machhrhr
$80
Quality control dep’t
60,000
750 tests
$80/test
/test
$800,000
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q3: ABC in Manufacturing Example
Alphabet recently completed a batch of 100 As and a batch of 100 Bs.
Direct material and labor costs were as budgeted. Information about each
batch’s use of the cost drivers is given below. Compute the overhead
allocated to each unit of A and B.
100 As 100 Bs
Machine set-ups
60
10
Inspections
10
2
Overhead allocated: 100 As 100 Bs
Materials handling
4
2
Machine set-ups
$2,400 $400
Machining dep’t
240
120
Inspections
1,750
350
Quality control dep’t
3
1
Materials handling
400
200
Machining dep’t
1,920
960
Quality control dep’t
240
80
Overhead for batch $6,710 $1,990
Overhead per unit
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
$67.10 $19.90
Slide # 15
Q3: ABC in Manufacturing Example
Compute the total cost of each product and compare it to the costs
computed under traditional costing.
Prod A Prod B
Direct material $25.00 $10.00
Direct labor
20.00 20.00
Overhead
67.10 19.90
$112.10 $49.90
Total
Traditional costing
assigned $77 to a unit of
Product A and $62 to a
unit of Product B.
•
The only difference between the two costing systems is that
Product A is assigned more overhead costs under ABC.
•
The additional overhead assigned to Product A reflects Product
A’s consumption of resources.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q4: Activity-Based Management (ABM)
• ABM is the process of using ABC information to
evaluate opportunities for improvements in an
organization.
• Examples include managing & monitoring
• customer profitability
• product and process design
• environmental costs
• quality
• constrained resources
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q4: ABM & Customer Profitability
• Activities can be defined so that different costs of
servicing customers are accumulated.
• Examples include
• analyzing the types of bank transactions used
by various categories of customers
• comparing the costs of servicing insurance
contracts sold to married versus single
individuals
• comparing the costs of different distribution
channels
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 18
Q4: ABM & Product/Process Improvements
• Activities can be defined so that the costs of stages
of production or of a business process are
accumulated.
• Examples include
• determining the costs of non-value-added
activities so the most costly can be reduced or
eliminated
• changing the steps in the accounts payable
function to reduce the number of personnel
• determining the most costly stages of product
development so that the time to market is
reduced
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 19
Q4: ABM & Environmental Costs
• Activities can be defined so that types of
environmental costs are accumulated.
• Examples include
• capturing the costs of contingent liabilities for
waste disposal site remediation
• comparing the cost of recycling packaging to the
cost of disposal
• computing the costs of treating different kinds of
emissions
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 20
Q4: ABM & Quality Costs
• Activities can be defined so that categories of costs
of managing quality are accumulated.
• Common categories of quality costs are
• costs of prevention activities
• costs of appraisal activities
• costs of production activities
• costs of postsales activities
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 21
Q5: What are GPK and RCA?
• Costing approaches similar to ABC because they
involve multiple pools and multiple drivers
• GPK can be described as marginal planning and
cost accounting
– Each cost is traced to a cost center (smaller than a
department) which performs a single repetitive activity,
and is the responsibility of one manager)
– Output measures tracks the volume of resource use
– Costs are segregated into proportional (change with
volume in resource use) and fixed
– Practical capacity is used for estimated allocation rate
volumes
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 22
Q5: Capacity Definitions
• Theoretical capacity – maximum assuming
continuous, uninterrupted operations 365 days/year
• Practical capacity – typical operating conditions
• Budgeted capacity – expected volume for the
upcoming time period
• Idle/excess capacity – difference between activity
capacity used and one of the above measures of
capacity
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 23
Q5: What are GPK and RCA?
• Resource Consumption Accounting (RCA)
• Builds on GPK and ABC principles
• Each cost is assigned to a resource cost pool
– Labor and machinery are often placed in different cost
pools since they are different types of resources
– RCA involves a significantly larger number of cost pools
than traditional accounting
– Like GPK, segregates proportional and fixed costs
– Utilizes theoretical rather than practical capacity for
allocating fixed costs
• More likely to focus manager attention on reducing idle and nonproductive resource time
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 24
Q5: Benefits/Drawbacks to GPK/RCA
• Benefits
– Generates multi-level internal income statements useful
for short terms decisions because it focuses on marginal
cost
– Increases cause & effect awareness among managers
– Categorizes costs (and generates profit margin) at the
product, product group, division, and company level
– Avoids arbitrary allocations of fixed costs
• Drawbacks
– Can be costly to implement
– Can result in a large number of variances to analyze
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 25
Q5: Comparison of ABC, GPK, and RCA
ABC
GPK
RCA
Character of cost
accounting system
Full costing
Marginal costing
Full and marginal
costing
Location of data
Database separate
from general ledger
Comprehensive
accounting system
Comprehensive
accounting system
Primary decision
relevance
Mid- to long-term
Short-term
Short-, Mid-, and
Long term
Allocation of
overhead based on
Activities
Cost Centers
Resources and/or
activities
Cost Drivers
Activity –Based
Resource Output
related
Resource output or
activity related
Fixed cost
allocation rate
denominator
Actual, budgeted,
or practical
capacity
Budgeted or
practical capacity
Theoretical
capacity
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 26
Q6: Decision Making with ABC, GPK, and RCA
• Benefits
• more accurate and relevant product cost information
• employees focus attention on activities
• measurement of the costs of activities and business
processes
• identify non-value-added activities and reduce costs
• Costs
• systems can be difficult to design and maintain
• more information must be captured
• decision makers may not use the information
appropriately
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 27
Q6: Uncertainties in ABC and ABM
Implementation
• Judgment is required when determining
activities.
• Judgment is required when selecting cost
drivers.
• Denominator levels for cost drivers are
estimates.
• ABC information includes unitized fixed
costs, so decision makers must use ABC
information correctly.
© John Wiley & Sons, 2011
Chapter 7: Activity-Based Costing and Management
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 28
Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 4
Relevant Information for Decision Making
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 4: Relevant Costs for Nonroutine
Operating Decisions
Learning objectives
•
•
•
•
•
•
Q1: What is the process for identifying and using relevant
information in decision making?
Q2: How is relevant quantitative and qualitative information
used in special order decisions?
Q3: How is relevant quantitative and qualitative information
used in keep or drop decisions?
Q4: How is relevant quantitative and qualitative information used in
outsourcing (make or buy) decisions?
Q5: How is relevant quantitative and qualitative information used in
product emphasis and constrained resource decisions?
Q6: What factors affect the quality of operating decisions?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Nonroutine Operating Decisions
• Routine operating decisions are those made on a
regular schedule. Examples include:
• annual budgets and resource allocation decisions
• monthly production planning
• weekly work scheduling issues
• Nonroutine operating decisions are not made on a
regular schedule. Examples include:
• accept or reject a customer’s special order
• keep or drop business segments
• insource or outsource a business activity
• constrained (scarce) resource allocation issues
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Nonroutine Operating Decisions
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Process for Making Nonroutine
Operating Decisions
1. Identify the type of decision to be made.
2. Identify the relevant quantitative analysis
technique(s).
3. Identify and analyze the qualitative factors.
4. Perform quantitative and/or qualitative analyses
5. Prioritize issues and arrive at a decision.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Identify the Type of Decision
•
•
Special order decisions
•
determine the pricing
•
accept or reject a customer’s proposal for order quantity
and pricing
•
identify if there is sufficient available capacity
Keep or drop business segment decisions
•
•
examples of business segments include product lines,
divisions, services, geographic regions, or other distinct
segments of the business
eliminating segments with operating losses will not
always improve profits
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q1: Identify the Type of Decision
•
•
•
Outsourcing decisions
•
make or buy production components
•
perform business activities “in-house” or pay another
business to perform the activity
Constrained resource allocation decisions
•
determine which products (or business segments)
should receive allocations of scarce resources
•
examples include allocating scarce machine hours or
limited supplies of materials to products
Other decisions may use similar analyses
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q1: Identify and Apply the Relevant
Quantitative Analysis Technique(s)
•
•
Regression, CVP, and linear programming are
examples of quantitative analysis techniques.
Analysis techniques require input data.
•
Data for some input variables will be known and for
other input variables estimates will be required.
•
Many nonroutine decisions have a general
decision rule to apply to the data.
•
The results of the general rule need to be
interpreted.
•
The quality of the information used must be considered
when interpreting the results of the general rule.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2-Q5 : Identify and Analyze Qualitative Factors
•
Qualitative information cannot easily be valued in
dollars.
•
•
•
can be difficult to identify
can be every bit as important as the quantitative
information
Examples of qualitative information that may be
relevant in some nonroutine decisions include:
•
quality of inputs available from a supplier
•
effects of decision on regular customers
•
effects of decision on employee morale
•
effects of production on the environment or the
community
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q1: Consider All Information and Make a Decision
•
Before making a decision:
•
Consider all quantitative and qualitative information.
• Judgment is required when interpreting the effects of
qualitative information.
•
Consider the quality of the information.
• Judgment is also required when user lower-quality
information.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2: Special Order Decisions
•
•
A new customer (or an existing customer) may
sometimes request a special order with a lower
selling price per unit.
The general rule for special order decisions is:
•
•
accept the order if incremental revenues exceed
incremental costs,
subject to qualitative considerations.
Price >=
•
Relevant
Variable Costs +
Relevant
Fixed Costs +
Opportunity
Cost
If the special order replaces a portion of normal
operations, then the opportunity cost of accepting
the order must be included in incremental costs.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Special Order Decisions
RobotBits, Inc. makes sensory input devices for robot manufacturers.
The normal selling price is $38.00 per unit. RobotBits was approached
by a large robot manufacturer, U.S. Robots, Inc. USR wants to buy
8,000 units at $24, and USR will pay the shipping costs. The per-unit
costs traceable to the product (based on normal capacity of 94,000
units) are listed below. Which costs are relevant to this decision?
yes$6.20 Relevant?
Direct materials
yes 8.00 Relevant?
Direct labor
Variable mfg. overhead yes 5.80 Relevant?
no 3.50 Relevant?
Fixed mfg. overhead
yes
Shipping/handling
no 2.50 Relevant?
Fixed administrative costs no 0.88 Relevant?
no 0.36 Relevant?
Fixed selling costs
$27.24
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
$20.00
Slide # 12
Q2: Special Order Decisions
Suppose that the capacity of RobotBits is 107,000 units and projected
sales to regular customers this year total 94,000 units. Does the
quantitative analysis suggest that the company should accept the
special order?
First determine if there is sufficient idle capacity to accept this
order without disrupting normal operations:
Projected sales to regular customers
Special order
94,000 units
8,000 units
102,000 units
RobotBits still has 5,000 units of idle capacity if the order is
accepted. Compare incremental revenue to incremental cost:
Incremental profit if accept special order =
($24 selling price – $20 relevant costs) x 8,000 units = $32,000
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q2: Qualitative Factors in
Special Order Decisions
What qualitative issues, in general, might RobotBits consider before
finalizing its decision?
• Will USR expect the same selling price per unit on future
orders?
• Will other regular customers be upset if they discover the
lower selling price to one of their competitors?
• Will employee productivity change with the increase in
production?
• Given the increase in production, will the incremental costs
remain as predicted for this special order?
• Are materials available from its supplier to meet the increase
in production?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q2: Special Order Decisions and Capacity Issues
Suppose instead that the capacity of RobotBits is 100,000 units and
projected sales to regular customers this year totals 94,000 units.
Should the company accept the special order?
Here the company does not have enough idle
capacity to accept the order:
Projected sales to regular customers
Special order
94,000 units
8,000 units
102,000 units
If USR will not agree to a reduction of the order to 6,000
units, then the offer can only be accepted by denying sales
of 2,000 units to regular customers.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q2: Special Order Decisions and Capacity Issues
Suppose instead that the capacity of RobotBits is 100,000 units and
projected sales to regular customers this year total 94,000 units. Does
the quantitative analysis suggest that the company should accept the
special order?
Direct materials
Direct labor
Variable mfg. overhead
Fixed mfg. overhead
Shipping/handling
Fixed administrative costs
Fixed selling costs
$6.20
8.00
5.80
3.50
2.50
0.88
0.36
$27.24
Variable cost/unit for
regular sales = $22.50.
CM/unit on regular sales
= $38.00 – $22.50 = $15.50.
The opportunity cost of accepting this
order is the lost contribution margin
on 2,000 units of regular sales.
Incremental profit if accept special order =
$32,000 incremental profit under idle capacity – opportunity cost =
$32,000 – $15.50 x 2,000 = $1,000
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q2: Qualitative Factors in
Special Order Decisions
What additional qualitative issues, in this case of a capacity constraint,
might RobotBits consider before finalizing its decision?
• What will be the effect on the regular customer(s) that do not
receive their order(s) of 2,000 units?
• What is the effect on the company’s reputation of leaving
orders from regular customers of 2,000 units unfilled?
• Will any of the projected costs change if the company
operates at 100% capacity?
• Are there any methods to increase capacity? What effects do
these methods have on employees and on the community?
• Notice that the small incremental profit of $1,000 will probably
be outweighed by the qualitative considerations.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q3: Keep or Drop Decisions
•
Managers must determine whether to keep or
eliminate business segments that appear to be
unprofitable.
•
The general rule for keep or drop decisions is:
•
•
keep the business segment if its contribution margin
covers its avoidable fixed costs,
subject to qualitative considerations.
Drop if: Contribution < Relevant Margin Fixed Costs • + Opportunity Cost If the business segment’s elimination will affect continuing operations, the opportunity costs of its discontinuation must be included in the analysis. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 18 Q3: Keep or Drop Decisions Starz, Inc. has 3 divisions. The Gibson and Quaid Divisions have recently been operating at a loss. Management is considering the elimination of these divisions. Divisional income statements (in 1000s of dollars) are given below. According to the quantitative analysis, should Starz eliminate Gibson or Quaid or both? Revenues Variable costs Contribution margin Traceable fixed costs Division operating income Unallocated fixed costs Operating income Gibson Quaid Russell $390 $433 $837 247 335 472 143 98 365 166 114 175 ($23) ($16) $190 Breakdown of traceable fixed costs: Avoidable $154 Unavoidable 12 $166 © John Wiley & Sons, 2011 $96 18 $114 Total $1,660 1,054 606 455 151 81 $70 $139 36 $175 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 19 Q3: Keep or Drop Decisions Revenues Variable costs Contribution margin Traceable fixed costs Division operating income Unallocated fixed costs Operating income Gibson Quaid Russell $390 $433 $837 247 335 472 143 98 365 166 114 175 ($23) ($16) $190 Breakdown of traceable fixed costs: Avoidable $154 Unavoidable 12 $166 $96 18 $114 Total $1,660 1,054 606 455 151 81 $70 $139 36 $175 Contribution margin Avoidable fixed costs Effect on profit if keep Use the general rule to determine if Gibson and/or Quaid should be eliminated. Gibson Quaid $143 $98 154 96 ($11) $2 The general rule shows that we should keep Quaid and drop Gibson. © John Wiley & Sons, 2011 Chapter 4: Relevant Costs for Nonroutine Operating Decisions Eldenburg & Wolcott’s Cost Management, 2e Slide # 20 Q3: Keep or Drop Decisions Revenues Variable costs Contribution margin Traceable fixed costs Division operating income Unallocated fixed costs Operating income Gibson Quaid Russell $390 $433 $837 247 335 472 143 98 365 166 114 175 ($23) ($16) $190 Breakdown of traceable fixed costs: Avoidable $154 Unavoidable 12 $166 $96 18 $114 Total $1,660 1,054 606 455 151 81 $70 $139 36 $175 Using the general rule is easier than recasting the income statements: Gibson Quaid Russell Total Revenues $390 $433 $837 $1,270 Variable costs 247 335 472 807 Contribution margin 143 98