ACCT 2020 1nd Edition Exam 3 Study Guide Chapters 7 9 10 Chapter 7 Master Budgets I Are costs benefits are relevant irrelevant for a decision Which costs and benefits are relevant or irrelevant for a decision o Relevant cost is something that is different between alternative and irrelevant costs are the same between alternatives If something is unavoidable than it is irrelevant Fixed costs Sunk costs and future costs that we cannot change are irrelevant We ve touched on this a bit we only want to evaluate things that are different between the two to help simplify to two Differential costs benefits are relevant o Make sure you are evaluating costs for current decision at hand II Using this differential approach saves us time instead of organizing a whole income statement Should we add or drop a segment This will look similar to chapter 5 but we will compare fixed cost savings to the contribution margin we will lose from that segment We need to be saving enough money to make up for the lost contribution margin for the segment to be dropped o Depreciation is a sunk cost unless relevant Regardless of what method we will still see depreciation as irrelevant o Why should we keep a segment if showing a loss Common costs when allocated can alter the finding and amount of profitability III Should we make or buy a component Sometimes they need to decide if they should manufacture a component or outsource this component Is it worth their while to make the component When evaluating we want to compare costs we could avoid by buying it We compare avoidable and opportunity cost to the purchase price o We only want to consider costs that we would NOT need to pay if we don t make the component ONLY VARIABLE depreciation will not go away unless it had a resale value IV Do we accept the opportunity to make a special order Lets say a bike company could sell their product in bulk to another company at a lower offer 5000 for 200 bikes is that worth it to us and will it cover our costs WE want to compare the sales price for the special order to the incremental cost of supplying this order We want to ignore unavoidable costs so do not consider FIXED costs only incremental o Opportunity cost is considered Not actually cash outlays not in accounting information For apple it makes more sense to buy so that they can devote more money to design V How do we want to use a constrained resource VI Company has a very large demand for its products given the current level of resource there s no way we can saturate the demand So which products do we emphasis Whichever is most profitable per constrained resource and produce that product Say employee resource is constrained which product will employees work on first Produce the product with the highest contribution margin per unit of the constrained resource So for example we would look at contribution margin per labor hours Focus on this product UP TO DEMAND FOR THAT PRODUCT and then focus on the next most profitable Increase the constrained resource At what cost One obvious option is to allow overtime is it worth it though Is the money they will bring in greater than the increased cost We should be willing to pay up to the contribution margin per unit of the constrained resource VII 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 VIII 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 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 IX 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 X 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 XI Sell or continue to produce a component of joint product This is