CHAPTER 7 MANAGERIAL ACCOUNTING Power Point Presentation by

CHAPTER 7 MANAGERIAL ACCOUNTING Power. Point Presentation by Gail B. Wright Professor Emeritus of Accounting Bryant University © Copyright 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South. Western are trademarks used herein under license. 10 TH EDITION BY MAHER, STICKNEY & WEIL DIFFERENTIAL COST ANALYSIS FOR OPERATING DECISIONS

Managerial Decision Making LEARNING OBJECTIVES 1. Explain differential principle & know how to identify costs for differential analysis. 2. Explain relation between costs & prices. 3. Explain how to base target costs on target prices. 4. Describe how to use differential analysis to measure customer profitability. Continued 2

Managerial Decision Making LEARNING OBJECTIVES 5. Explain how businesses apply differential analysis to product choice decisions. 6. Explain theory of constraints. 7. Identify factors underlying make-or-buy decisions. 8. Explain how to identify costs of producing joint products & relevant costs for decisions to sell or process further. Continued 3

Managerial Decision Making LEARNING OBJECTIVES 9. Explain use of differential analysis to determine when to add or drop parts of operations. 10. Identify factors of inventory management decisions. 11. Explain how linear program optimizes use of scarce resources (Appendix 7. 1). 12. Identify use of economic order quantity model (Appendix 7. 2). 4

☼ CHAPTER GOAL ☼ This chapter explains how managers can use differential analysis to examine the effects on profits. Differential analysis helps managers answer relevant questions such as: Managerial Decision Making ¯What activities differ between the alternatives? ¯How does that difference affect costs & profits? 5

LO 1 DIFFERENTIAL ANALYSIS: Definition Managerial Decision Making Is the analysis of differences among particular alternative actions. 6

LO 1 CASH FLOW Differential analysis focuses on cash flow because Managerial Decision Making ¯Cash is the medium of exchange in business ¯Cash is a common objective measure of the costs & benefits of alternatives 7

U E M MANAGERS WANT TO KNOW! LO 2 SPECIAL ORDERS Managerial Decision Making Ullman has an opportunity for a 1 time only special order to sell 100 units at $25 each. The regular price is $28. Should they take it? Continued 8

LO 2 U E M Managerial Decision Making Yes! Since normal operations should be used to cover FC, not special orders, this special order adds $300 to the bottom line. EXHIBIT 7. 3 9

U E M MANAGERS WANT TO KNOW! LO 2 Managerial Decision Making What is UEM’s minimum selling price? The minimum selling price in the short run must cover variable costs. For UEM, the minimum selling price is $22. 10

LO 2 PRICING DECISIONS Managerial Decision Making Use of full cost in pricing decisions is justified because ¯In the long run, prices must cover all costs to survive ¯Long term contractual agreements must cover all costs ¯Prices in regulated industries are often based on full cost ¯Although full cost + profit may be used initially, short term adjustments may reflect market conditions. 11

LO 6 THEORY OF CONSTRAINTS Managerial Decision Making The theory of constraints (TOC) acknowledges that businesses often have constraints or limits on what can be done. TOC encourages managers to identify where constraints arise and to develop methods to manage them. 3 factors predominate: 1. Throughput contribution 2. Investments 3. Other operating costs 12

LO 6 BOTTLENECK: Definition Managerial Decision Making Is an operation in which the work to be performed equals or exceeds the available capacity. 13

MANAGING THE BOTTLENECK LO 6 ¯ Recognize that the bottleneck resource determines throughput contribution of product ¯ Search for, find bottleneck Managerial Decision Making ¯Resource with large quantities of inventory waiting to be worked on ¯ Subordinate all non-bottleneck resources to the bottleneck resource ¯ Increase bottleneck efficiency, capacity ¯ Repeat 4 steps for any new bottleneck 14

P P C LO 6 EXAMPLE: Pete’s Pizza Co. (PPC) is a pizza delivery company that will only accept orders that can be delivered within 30 minutes. This policy creates a bottleneck in delivery totaling 60 hours per month, resulting in orders being turned away. VC is $6; SP is $15. Preparation Cooking Delivery 15 units 12 units 10 units Monthly capacity (60 hours) 900 units 720 units 600 units Monthly possible production (60 hours) 600 units Managerial Decision Making Hourly capacity Continued 15

P P C MANAGERS WANT TO KNOW! LO 6 PPC: Solution Alternatives Examine differential costs for each alternative 1. Eliminate bottleneck idle time Hiring 1 employee for cooking & prep work will increase delivery capacity by 120 units per month. Throughput contribution increases by $1, 080 but extra employee will cost $1, 200. Managerial Decision Making 2. Shift from bottleneck to non-bottleneck production Selling pizzas for pickup will increase production during bottleneck by 120 units, reducing SP to $12 & VC to $5 but increasing labor costs by $600. Throughput contribution increases by $240. Continued 16

P P C MANAGERS WANT TO KNOW! LO 6 PPC: Solution Alternatives Examine differential costs for each alternative 3. Increase capacity of bottleneck process Managerial Decision Making Hiring 1 driver for bottleneck hours will increase delivery capacity by 120 units and cost $900. Throughput contribution will increase by $1, 080. 17

LO 7 MAKE-OR-BUY Managerial Decision Making The make-or-buy decision is one where the firm must decide whether to meet its needs internally or to acquire goods or services externally. Both cost & nonquantitative factors are considered. 18

B & J LO 7 EXAMPLE: Ben & Jerry’s Ben & Jerry Cookie Co. (B&J) produces & sells cookies. B&J has an opportunity to buy some product for $12 per unit. The affect on current conditions follows: Buy Unit SP Volume $ 30 800 / mo. Make $ 30 800 / mo. Managerial Decision Making Unit VC $ 11 $ 22 Purchased ingredients/unit $ 12 $ 0 Total FC $3, 840 $4, 800 19

MANAGERS WANT TO KNOW! LO 8 Managerial Decision Making JOINT PRODUCTS In some circumstances, multiple products can be produced from a single production process. The question for management is: What is the effect of additional processing/production on profits? 20

LO 8 SPLITOFF POINT: Definition Managerial Decision Making Is the point up to which all costs are joint and after which additional processing costs are identified with other products. 21

H D LO 8 EXAMPLE: Hanson Dairy (HD) produces 7, 000 gallons of whole milk (SP $1) & 3, 000 gallons of cream at a joint cost of $11, 000. Processing the milk further into 6, 500 gallons of skim milk would cost $0. 20 & be sold for $1. 25 per gallon. Process Revenue Managerial Decision Making Less additional processing costs CM before splitoff Sell $ 8, 125 $7, 000 1, 300 0 $ 6, 825 $7, 000 22

MANAGERS WANT TO KNOW! LO 9 ADD OR DROP Managerial Decision Making Managers must decide when to add or drop products; when to open or abandon sales territories. The differential principle involved can be stated: If differential revenue from selling exceeds differential costs of product, the product is profitable & firm should continue production. 23

MANAGERS WANT TO KNOW! LO 10 INVENTORY MANAGEMENT Managerial Decision Making Inventory has a direct affect on profit and must be carefully managed. Key questions for managers are: 1. How many units should be on hand for use or sale? 2. How often should the firm order an item and what is the optimal order size? 24

LO 10 Managerial Decision Making JUST-IN-TIME (JIT) JIT is a philosophy, not a tool, that dovetails with total quality management (TQM) in that TQM requires reliable processing systems & disallows defective units. Flexible manufacturing that reduces both setup & inventory levels also enhances JIT. 25

Managerial Decision Making CHAPTER 7 THE END 26