ACCT 210 1st Edition Lecture 9 Outline of Last Lecture I Variable costing II Absorption costing III P S Outline of Current Lecture I 8 1 Identifying relevant information II 8 2 Special order pricing III 8 3 Make or buy decisions Current Lecture 1 8 1 Identifying relevant information a Relevant information i Information directly relevant to making decision ii Information about what happens in the future 1 Sunk costs are irrelevant iii Information that differs between alternatives 1 Example looking for an apartment 2 Apartment 1 500 month 2 bed 2 bath 5 miles from campus 3 Apartment 2 500 month 2 bed 2 bath mile from campus 4 Only information that is relevant is how far it is from campus because everything else is the same b Relevant cost decision model i Identify the decision ii Identify the alternatives iii Identify the relevant revenues and costs iv Identify the qualitative issues to consider v Identify the alternative with the greatest benefit or least cost c Exercise 8 3 from book i Jason McGregor manages an IT department for a large corporation Kelly Preston vice president for marketing has asked him to help her evaluate two statistical packages for monitoring customer purchases Stat Max costs 912 000 requires 2 gigabytes of disk storage space and 80 programmer hours for customization and has no annual license fee The sofware vendor provides 150 hours of user training and offers 24 hour technical support Buy Tracker costs 500 000 requires 2 gigabytes of disk storage space and 125 programmer hours for customization and carries a 10 000 annual license fee The sofware vendor provides 150 hours of user training and offers technical support from 8 00 A M to 5 00 P M Central Standard Time What information is relevant to the decision to purchase one of these statistical packages ii Answer 1 Relevant purchase price programmer hours annual license fee tech support 2 Irrelevant disk storage space hours of user training 3 Note there are no sunk costs d Exercise 8 1 i Cherry Inc currently has a machine that costs 10 000 per year to operate The machine can produce 50 000 units per year In 2006 the company borrowed 200 000 to purchase the machine it still owes 125 000 of that amount Cherry could sell the machine for 70 000 and purchase a new more efficient machine at a cost of 220 000 The new machine can produce 85 000 units per year its annual operating costs would be 12 000 Identify each piece of information in this scenario and indicate whether it is relevant or irrelevant to the decision to purchase the new machine ii Answer 1 Relevant Production of old machine operating cost of old machine market value of old machine cost of new machine production of new machine operating cost of new machine 2 Irrelevant purchase price of old machine loan balance because both are sunk costs 2 Special order pricing a Special order prices getting an order from a customer asking for a special price that is less than stated selling price b Exercise 8 5 i Byways Production has an annual capacity of 80 000 units per year Currently the company is making and selling 78 000 units a year The normal sales price is 100 per unit variable costs are 65 per unit and total fixed expenses are 2 000 000 An out of state distributor has offered to buy 5 000 units at 75 per unit Byways cost structure should not change as a result of this special order By how much will Byways income change if the company accepts this order ii Answer 1 How much contribution margin do I get by fulfilling the order CM Sales Variable costs CM unit 75 65 10 Total CM 10 x 5000 units Gain 50 000 2 How much CM do I lose by fulfilling the order CM unit 100 65 35 Available units 80 000 78 000 2 000 Units lost 5 000 2 000 3 000 Total CM 35 x 3000 units Lose 105 000 3 Should not accept this offer if they do the income change will be 50 000 105 000 55 000 4 Their income will decrease 55 000 c Exercise 8 6 i Lybrand Company is a leading manufacturer of sunglasses One of Lybrand s products protects the eyes from ultraviolet rays An upscale sporting goods store has contacted Lybrand about purchasing 15 000 pairs of these sunglasses Lybrand s unit manufacturing cost based on a full capacity of 100 000 units is as follows Direct materials 6 Direct labor 4 Manufacturing overhead 60 fixed Total manufacturing costs 15 25 Lybrand also incurs selling and administrative expenses of 75 000 plus 2 per pair for sales commissions The company has plenty of excess manufacturing capacity to use in manufacturing the sunglasses Lybrand s normal price for these sunglasses is 40 per pair The sporting goods store has offered to pay 35 per pair Since the special order was initiated by the sporting goods store no sales commission will be paid What would be the effect on Lybrand s income if the special order were accepted ii Answer 1 Variable costs 25 do not count 2 sales because it has not been incurred yet 2 CM unit 35 25 10 3 Total CM 10 x 100 000 units 1 000 000 4 Income increases by 1 000 000 3 8 3 Make or buy decisions a Outsourcing i Moving production outside the organization b Off shoring i Actually moving production facility to another country state wherever ii May or may not be outsourcing as well c Relevant costs i Price we have to pay to buy component ii All avoidable costs we would incur to make component iii Watch out for fixed manufacturing overhead per unit may or may not be avoidable