Prepared by Debby Bloom-Hill CMA, CFM CHAPTER CHAPTER 77 The Use of Cost Information in Management Decision Making Slide 7-2 Incremental Incremental Analysis 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 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-3 Incremental Incremental Analysis Analysis  Incremental Revenue   Incremental Cost   Additional revenue received by selecting one alternative over another Additional cost incurred by selecting one alternative over another Incremental Profit  Difference between incremental revenue and incremental cost Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-4 Incremental Incremental Analysis 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 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-5 Incremental Incremental Analysis Analysis Example 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 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-6 Incremental Incremental Analysis Analysis Example Example Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-7 Incremental Incremental Analysis 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 the profit for this alternative and the profit of any other alternative is the incremental profit Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-8 “What “What Does Does This This Product Product Cost?” 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 Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-9 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 b c d Set-up costs Depreciation of equipment Inspection costs Material costs Answer: d Material costs are variable costs and usually incremental Learning objective 1: Explain the role of incremental analysis (analysis of incremental costs and revenues) in management decisions, and define sunk cost, avoidable cost, and opportunity cost and understand how to use these concepts in analyzing decisions Slide 7-10 Joint Joint Cost Cost Allocation Allocation Example Example Slide 7-44 Joint Joint Cost Cost Allocation Allocation Methods Methods Relative   sales value Joint costs allocated to product A = Joint costs allocated to product B = Slide 7-45 Joint Joint Cost Cost Allocation Allocation Example Example Slide 7-46 Additional Additional Processing Processing Decisions Decisions and and Joint Joint Costs Costs  Joint costs not relevant to decisions made after the split-off point because they are not incremental  Joint costs incurred prior to the split-off point are sunk costs and have no effect on what happens after the split-off point Learning objective 2: Analyze decisions involving joint costs, and discuss the importance of Slide 7-47 qualitative considerations in management decisions Test Your Knowledge The joint costs incurred in a joint product situation: a b c d Are incurred before the split-off point Are incurred after the split-off point Should only be allocated based on physical attributes Should never be allocated Answer: a Are incurred before the split-off point Learning objective 2: Analyze decisions involving joint costs, and discuss the importance of Slide 7-48 qualitative considerations in management decisions Qualitative Qualitative Considerations Considerations in in Decision Decision Analysis 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 Qualitative Qualitative Considerations Considerations in in Decision Decision Analysis Analysis Slide 7-50 Qualitative Qualitative Factors Factors Learning objective 2: Analyze decisions involving joint costs, and discuss the importance of Slide 7-51 qualitative considerations in management decisions Appendix Appendix –– The The Theory Theory of of Constraints 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 Appendix –– The The Theory Theory of of Constraints 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 Appendix –– The The Theory Theory of of Constraints 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 loosen 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 Appendix –– The The Theory Theory of of Constraints 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) Implications Implications of of The The Theory Theory of of Constraints Constraints  Inspections   Should take place before work is transferred to a constrained department Batch sizes  When a production process is a binding constraint, it may be better to have large batch sizes  The time of the constrained department is not wasted setting up equipment for numerous batches  Across the board cuts  Cuts in bottleneck departments may make sense, but across the board cuts can have a serious negative impact on profits Slide 7-56 Learning objective A1: Understand the five-step approach to the Theory of Constraints (TOC) You You Get Get What What You You Measure Measure and and The The Theory Theory of of Constraints Constraints Slide 7-57 Learning objective A1: Understand the five-step approach to the Theory of Constraints (TOC) Copyright Copyright © 2016 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 7-58 .. .CHAPTER CHAPTER 77 The Use of Cost Information in Management Decision Making Slide 7-2 Incremental Incremental