Prepared by Debby Bloom-Hill CMA, CFM CHAPTER Use of Cost Information in Management Decision Making Slide 7-2 Incremental Analysis  Incremental analysis  All decisions involve a choice among alternative courses of action  The solution to business problems involves incremental analysis  Incremental analysis is the analysis of the incremental revenue and incremental costs incurred when one alternative is chosen over another Slide 7-3 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions Incremental Analysis  Incremental Revenue  Additional revenue received by selecting one alternative over another  Incremental Cost  Additional cost incurred by selecting one alternative over another  Incremental Profit  Difference between incremental revenue and incremental cost Slide 7-4 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions Incremental Analysis  An alternative that yields an incremental profit should be selected  Incremental costs are referred to as relevant costs  Also called differential costs because they are the costs that differ between decision alternatives Slide 7-5 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions Incremental Analysis Example  Jensen’s Rapid Copy is considering extending its hours  Alternative is the status quo  Alternative involved the company extending their hours from pm to midnight  The next slide shows the incremental costs and revenues associated with choosing one alternative over another Slide 7-6 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions Incremental Analysis Example Slide 7-7 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions Incremental Analysis  Incremental Analysis can be extended to more than two alternatives  Calculate profit for each alternative  The alternative with the highest profit is the best alternative  Difference between its profit and the profit of any other alternative is its incremental profit Slide 7-8 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions “What Does This Product Cost?”  Answer: Why you want to know?  No single cost number is relevant for all decisions  Must find incremental information that is applicable to the decision  Some costs will change due to the decision, some will not  Only costs that change are relevant Slide 7-9 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions Test Your Knowledge Which of the following is likely to be an incremental cost associated with increasing planned production run of 1,000 units to 1,010 units? a Set-up costs b Depreciation of equipment c Inspection costs d Material costs Answer: d Material costs are variable costs and usually incremental Slide 7-10 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions Relative sales value Joint costs allocated to product A = Joint costs allocated to product B = Slide 7-42 Learning objective 3: Analyze decisions involving joint costs Joint costs of $620 allocated using physical quantity of output Process results in 500 feet of grade A lumber that sells for $1 per foot, and 500 feet of grade B lumber that sells for $0.50 per foot Joint costs allocated to product A = Slide 7-43 Learning objective 3: Analyze decisions involving joint costs Joint costs of $620 allocated using physical quantity of output Process results in 500 feet of grade A lumber that sells for $1 per foot, and 500 feet of grade B lumber that sells for $0.50 per foot Joint costs allocated to product B = Slide 7-44 Learning objective 3: Analyze decisions involving joint costs Joint costs of $620 allocated using sales value Process results in 500 feet of grade A lumber that sells for $1 per foot, sales value 500 * = $500, and 500 feet of grade B lumber that sells for $0.50 per foot, sales value 500 * 0.50 = $250 Joint costs allocated to product A = Slide 7-45 Learning objective 3: Analyze decisions involving joint costs Joint costs of $620 allocated using sales value Process results in 500 feet of grade A lumber that sells for $1 per foot, sales value 500 * = $500, and 500 feet of grade B lumber that sells for $0.50 per foot, sales value 500 * 0.50 = $250 Joint costs allocated to product B = Slide 7-46 Learning objective 3: Analyze decisions involving joint costs Additional Processing Decisions and Joint Costs  Joint costs not relevant to decisions made after the split-off point because they are not incremental  Joint costs incurred prior to the splitoff point are sunk costs and must be incurred no matter what happens after the split-off point Slide 7-47 Learning objective 3: Analyze decisions involving joint costs Test Your Knowledge The joint costs incurred in a joint product situation: a Are incurred before the split-off point b Are incurred after the split-off point c Should only be allocated based on physical attributes d Should never be allocated Answer: a Are incurred before the split-off point Slide 7-48 Learning objective 3: Analyze decisions involving joint costs Qualitative Considerations in Decision Analysis  Many decisions have one or more features that are difficult to quantify but should be given careful consideration  Examples include, but are not limited to      Slide 7-49 Swings in the economy Loss of control Quality of the product Quality of service Company morale Learning objective 4: Discuss the importance of qualitative considerations to management decisions Slide 7-50 Learning objective 4: Discuss the importance of qualitative considerations to management decisions Qualitative Factors Slide 7-51 Learning objective 4: Discuss the importance of qualitative considerations to management decisions Appendix – The Theory of Constraints  The Theory of Constraints is an approach to production and constraint management developed by Eli Goldratt  Five step process  Large increases in profit can be achieved by elimination of bottlenecks in production processes Slide 7-52 Learning objective A1: Understand the five-step approach to the Theory of Constraints (TOC) Appendix – The Theory of Constraints  Goldratt specified a five step process for dealing with constraints Identify the Binding Constraint The binding constraint is the process that limits throughput Optimize Use of the Constraint Produce products with the highest contribution margin per unit of the constraint Slide 7-53 Learning objective A1: Understand the five-step approach to the Theory of Constraints (TOC) Appendix – The Theory of Constraints  Goldratt specified a five step process for dealing with constraints Subordinate Everything Else to the Constraint Managers should focus their attention on trying to loosed the constraint and not on process improvements Slide 7-54 Learning objective A1: Understand the five-step approach to the Theory of Constraints (TOC) Appendix – The Theory of Constraints  Goldratt specified a five step process for dealing with constraints Break the Constraint This can be done many ways including cross training workers, outsourcing, purchasing additional equipment or hiring new workers Identify a New Binding Constraint Identify the additional bottlenecks If there are no bottlenecks and excess capacity, focus on building demand Slide 7-55 Learning objective A1: Understand the five-step approach to the Theory of Constraints (TOC) Copyright  © 2010 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Slide 7-56