ACCT 2020 1st Edition Lecture 13 Outline of Last Lecture I Are costs benefits are relevant irrelevant for a decision II Should we add or drop a segment III Should we make or buy a component IV Do we accept the opportunity to make a special order V How do we want to use a constrained resource VI Increase the constrained resource At what cost VII Sell or continue to produce a component of joint product Outline of Current Lecture I Special Order Sales II Constrained resources III Constrained Resource Increase IV Sell or continue to produce a component of joint product Current Lecture I Special Order Sales Special order sales need to assume that by lowering the sales to one person we do NOT lower the sales price to another person Doesn t affect the number or any other profits These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best Used as a supplement to your own notes not as a substitute Fixed expenses will exist regardless of special orders Need to make sure they are in their current capacity if not than the fixed expenses will also increase All we want to look at is the incremental cost because fixed costs will not change So look at the variable cost per unit compared to the price per unit offered by the customer Variable expenses extra fixed expenses of units minimum price unit o 100 000 50 000 10 000 15 unit o Can also be variable expense per unit cost of extra fixed expenses per unit II Constrained resources A constraint or bottleneck is a limited resource of some type that limits production could be anything A certain machine that has a max amount of hours or workers time etc allocation of the constrained resource is unaffected by fixed costs o We are interested on the amount of time each product requires of the constraint So in the example we see that in one minute we can produce one unit of product one and 2 units of product two What generates more profit Well if product two produces twice the units at a 15 than just one unit of product at 24 so makes more sense to produce more of product 2 We first want to focus on product two Make as many of product 2 as the demand will sustain o So we produce 2200 units the demand for product 2 and the remaining minutes are used for product 1 This is how you maximize profit III Constrained Resource Increase In the previous problem the constraint was machine A1 so should we increase the constraint to have more minutes available Increased capacity of a constrained resource should lead to increased production and sales this is all assuming that demand is there o In the last problem we saw that we had some demand left for product 1 The additional time would be used to make these So we should be willing to pay UP TO the contribution margin for that product o Always be willing to pay additionally for more increase of constraint equal to the contribution margin per unit of the product It is often possible to increase capacity by working overtime on the bottleneck If the bottleneck is direct labor than we can ask employees to work overtime to increase capacity We can also contract out some of that product to increase capacity If the constraint is machines maybe we just buy another machine We can shift workers from non bottleneck processes to bottleneck processes Also we can focus on business processes that could improve the capacity and decrease defective units to create a more effective system A bottleneck could be the amount of surgeries a doctor can perform in a hospital or the people getting on plane ahead of you that delay your arrival at your seat IV Sell or continue to produce a component of joint product This is about the option of using a raw material to produce both products or produce one What s the current selling price compared to the incremental profit of that product once again not taking into consideration fixed costs o Incremental revenue incremental cost There is a split off point when they can be separated For petroleum refining there are common production costs but at some point we are able to separate these raw materials and we decide if we sell it now as a raw material or continue producing Costs that occur up to the split off point are not relevant to the system Joint costs are irrelevant unless Relative sales values are being used for financial statement purposes Compare the incremental revenue of processes to the incremental cost of producing o Saw mill incorporation cuts logs from which unfinished lumber and sawdust are immediate products Can be processes into finished into lumber or sold as sawdust o Allocated joint product costs are NOT CONSIDERED FOR THIS DECISION o The cost of further processing incremental so L 50 S 20 Right now we could sell the sawdust for 40 with no work for 20 more dollars we can get 10 more dollars so not a good deal just sell unfinished In ABC we allocated May types of cost Those fixed costs are not differential If it s an ABC system we exclude ANY fixed costs Some variable costs might not change depending on the option Make sure only compare things that are different between the options