EXAM 2 STUDY GUIDE CHAPTER 8 10 questions 2 are conceptual questions Section 8 1 1 To focus on the facts that make a difference in decisions managers must know how to sort through irrelevant information Information Overload 2 3 Relevant Information being overwhelmed by the huge amount of information meets 2 criteria Differential The differences will occur in the future differs between alternatives occur only with the implementation of a particular alternative incurred no matter what using any alternative thus they are irrelevant a cost that has been incurred in the past they are irrelevant because they occurred in the difference between the 2 alternatives calculations that show the additional impact of one alternative over 4 Avoidable Costs 5 Unavoidable Costs 6 Sunk Costs the past not future Incremental additional Revenues Incremental Analysis another 7 8 Helps to understand the impact of a decision 9 5 Steps to a Decision Model 1 What is the decision to be made other steps 2 What are the available alternatives Make sure they are relevant to step 1 3 What are the relevant revenues costs Must be differential future occurring Without understanding the decision context you can t satisfactorily complete any 4 What are the qualitative issues that must be considered Just as important as quantitative 5 Which alternative offers the greatest benefit or least cost Must go through all steps to provide an accurate answer Section 8 2 1 Robinson Patman Act of 1936 2 Sometimes accepting a special order at a loss is worth the future potential gain 3 Even if the gain is small if it generates numerous future cash flows it is a good idea prohibits companies from engaging in price discrimination EXAMPLE Jersey costs 6 85 in direct materials New jersey for special project is 2 less The alternative jersey will sell at 10 On a 10 sale commission is 0 50 and shipping is 0 40 Calculate the gain or loss on 1000 jerseys REGULAR JERSEY Direct Materials Direct Labor Variable Overhead Fixed Overhead TOTAL 6 85 1 95 1 05 1 29 11 14 NEW JERSEY Direct Materials Direct Labor Variable Overhead Commission Shipping TOTAL 4 85 1 95 1 05 0 50 0 40 8 75 PROFIT LOSS Sale Price Total Costs for NEW Jersey x Number of Jerseys PROFIT LOSS 10 8 75 x 1000 PROFIT LOSS 1 25 x 1000 1250 00 1 250 MUST ALSO CONSIDER QUALITATIVE ISSUES i e overtime consequences of alternative methods profit that could have been made on regular products demand increases causing contribution margin to decrease Section 8 3 1 Outsourcing organization to a provider outside the organization moving the production of goods or the delivery of services from within the Example cleaning services answering services etc 2 Offshoring moving a company s business processes to a foreign country Only when products are made or services performed by an unrelated company is offshoring 3 When the outsourcing decision refers to the components of a manufactured product it is called a considered outsourcing make or buy decision Make or buy Decision something internally or buy it externally 4 Basic Outsourcing Decision Model when a company indicates they are choosing whether to make Direct Materials Direct Labor Variable Overhead Total Unit Cost x Letters Required TOTAL RELEVANT COSTS Relevant Cost to Produce Internally 0 78 0 48 0 26 1 52 18 000 27 360 Outsource 1 65 18 000 29 700 use It is 2 340 LESS to produce internally ADVANTAGE OF 2 340 Since fixed overhead is unavoidable and occurs regardless it is omitted Even though variable costs are usually avoidable and fixed costs are usually unavoidable that is NOT always the case 5 When the production of an item is outsourced resources that are freed up can be put to another Considered an opportunity cost Opportunity Cost contribution margin of the next best alternative use of the facilities Direct Materials Direct Labor Variable Overhead Total Unit Cost x Letters Required Additional contribution margin from alternative use of resources TOTAL RELEVANT COSTS Relevant Cost to Produce Internally 0 78 0 48 0 26 1 52 18 000 27 360 Outsource 1 65 18 000 15 000 14 700 In this case it is 12 660 ADVANTAGE to Outsource 6 Quantitative and qualitative issues must BOTH be considered in order to outsource 7 Consider quality stability of price potential theft of intellectual property Section 8 4 1 Contribution Margin per Constrained Resource Contribution Margin per unit Constrained 2 Theory of Constraints Resource per unit focusing on constraints that limit an organization s output developed by Eli Goldratt to maximize the performance of a value chain by 5 Steps required to maximize and improve the performance of a value chain Identify the constraint 1 2 Decide how to exploit the constraint 3 Subordinate and synchronize everything else to the first 2 decisions 4 Elevate the performance of the constraint 5 If during any of these steps the constraint has shifted go back to step 1 3 Bottleneck Process 4 Throughput Contribution Sales Revenue Direct Materials Cost the process that limits total output Theory of Constraints seeks to maximize throughput contribution Section 8 5 1 Before managers make a decision to close they must be certain they are evaluating the information properly 2 Allocated fixed costs are not generally relevant to decision making 3 To better analyze costs managers can split operations in segments Segments business units i e north division south division etc 4 Allocated Assigned and Common indicates that costs are not directly caused by the cost object Makes the irrelevant 5 The key to a segment margin income statement is the calculation of the segment margin Segment Margin Contribution Margin Direct Fixed Costs CHAPTER 5 14 questions 5 are conceptual questions Section 5 1 1 Strategic Planning 2 Tactical Planning 3 Budget very broad helps to identify the overall focus of an organization develops concrete actions that turn strategic plan into reality an operating plan that is expressed primarily in financial terms dollars Helps to communicate commitment of funds throughout the organization 4 Information flows in two directions 1 Top Down Budget pushed down through the rest of the organization executive management creates the budget and then that budget is then Imposed method Most efficient 2 Bottom Up Budget up through the organizations budgeting process begins at the lowest levels of management and filters As it goes up in levels it is reviewed and altered if needed Also referred to as participative budgeting when employees
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