Study Guide Exam 2 Chapter 8 Using accounting information to make managerial decisions o Identifying Relevant Information In order for information such as a revenue or cost to be relevant it has to meet the following two criteria It must occur in the future o The past can t be changed It must differ between the alternative Types of costs Avoidable costs relevant to decision o Costs that are incurred under one alternative but are not incurred they are avoided under the other alternative Unavoidable Costs irrelevant to decision o Costs that are incurred under all alternatives Sunk Costs irrelevant to decisions o Cost that have already been incurred in the past o Example Assume you are trying to decide which island to visit for vacation the Seychelles or the Exumas Pertinent information about the alternative are below relevant costs red Meals Beverages and new bathing suit prices aren t relevant because they are the same for each alternative Travel books aren t relevant because they are already purchased can t changed Flying time worth considering for qualitative analysis Airfare Flying Time Accommodations Meals and Beverages New Bathing Suit Travel Books already purchased Dog sitter for 7 days Total relevant costs Relevant Cost decisions Seychelles 2250 22 hours 0 Hilton point 800 75 25 140 2250 Exumas 750 2 hours 1750 800 75 15 140 2500 o What is the decision to be made o What are the alternatives o What are the relevant revenues and relevant costs o What are the qualitative issues that need to be considered o Which alternative offers the greatest benefit or the least cost Ultimate goal It is 250 cheaper to go to the Seychelles than the Exumas Special Order pricing o With special order decisions a customer offers to purchase a large quantity of the company s product but wants to pay an amount less than the regular sales price The company must then decide whether to accept the special order or to reject it Example Island bistro which is part of the Island Resort Yacht club received a request from a potential customer to provide lunches to a group of 100 at a reduced price of 14 per meal The normal sales price for a conch entr e is 20 Only focus on relevant costs red o Fixed costs normally irrelevant Pay no matter which alternative there are some exceptions o Variable costs are relevant Per meal 20 1 000 meals 20 000 Sales Cost of goods sold Direct material Direct Labor Variable Overhead Fixed overhead Gross Margin Selling Expenses Fixed Selling Expenses Variable Selling Exp Operating Income If accept order Revenue Costs Direct Material Direct Labor Variable Overhead Variable S A Incremental Profits factors Outsourcing 3 3 4 1 9 2 2 5 3 3 4 2 2 Cost per unit relevant 12 Per meal 14 Total 100 meals 1400 o Accept order end up making 2 per meal profit with relevant o Outsourcing transfers production of goods to a provider outside of the company Decisions involving whether to manufacture a good within 3000 3000 4000 1000 9000 2000 2000 5000 300 300 400 200 200 the company or to have someone else do it are often referred to as the make or buy decisions Look at costs of alternatives Example o Assume Island Resort and Yacht club currently produces fresh water that is needed for its business through its reverse osmosis desalination system The following costs were gathered for the previous year when 300 000 gallons of water were needed Direct Material Direct Labor Variable Overhead Fixed Overhead Total Costs Per Gallon 15 05 10 20 50 Total 45 000 15 000 30 000 60 000 150 000 Island Club has been considering purchasing fresh water from another supplier If the other supplier charges 35 per gallon should Island Resort and Yacht club continue to produce the water Assume 300 000 gallons will continue to be needed o To buy 300 000 X 35 105 500 o To make relevant costs 90 000 It makes more sense to make 15 000 o For outsourcing For any outsourcing decision one must also consider qualitative factor as well Quality of the product provide by the supplier Reliability of supplier Theft of intellectual property Stability of the price offered by the supplier Chapter 8 Using accounting information to make managerial decisions o Allocating Constrained Resources Constrained resource anything that limits a company Ability to produce products or provide services Example cash machine hours facilities labor hours Want to maximize profits while working within constraints Bottleneck the most constrained resource that limit the business ability to produce products or provide services Island Excursions a division of Island Resort and Yacht club has gathered the following data about the three different day excursions if offers to its customers Fishing SCUBA diving Island Hopping o Example Sales Price per Excursion Variable Expense Contribution Margin Captain Time Requested per trip Monthly Demand Number of Trips Contribution Margin per Excursion Required Captain Contribution Margin per captain hours hour 250 180 70 8 hours 95 trips Fishing 70 8 8 75 150 120 30 6 hours 55 trips 30 6 5 90 50 40 4 hours 65 trips 40 4 10 If only 1 200 captain hours are available each month how many or each service should be provided to maximize profitability SCUBA diving Island Hopping Limitation constraint captain hours What we can generate per hour o Make best use of hours Contribution margin per o 1 Island Hopping 65 trips demand X 4 hours 260 captain hours o 2 Fishing 95 trips demand X 8 hours 760 captain hours o 260 260 1020 hours left 3 1200 captain hours available 1020 captain hours used 180 captain hours remaining 6 hours per SCUBA trip 30 trips Once we know order then we figure out how to allocate o Can t offer amount of demand based on caption hours Keeping or Eliminating Operations o Segment Margin contribution margin of a particular segment less any direct fixed cost Keep service or eliminate based on profit o Direct Fixed Costs fixed costs that can be attributed to one specific segment Therefore if the segment is eliminated these fixed costs will be eliminated avoidable o Common Fixed Costs fixed costs those are shared by all segments These fixed costs will continue to be incurred even if a segment is eliminated Also called allocated or assigned fixed costs Unavoidable Island Excursions 340 000 95 000 245 000 Island and Health Club 255 000 195 000 60 000 Island Marina 680 000 360 000 320 000 Island Bistro 425 000 185 000 240 000 Total 1 700 000 835 000 865 000 Direct Fixed 70 000 40 000 100 000 80 000 290 000 40 000 50 000
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