ACCT 2020 1st Edition Lecture 12 Outline of Last Lecture I Terminology Review II Terminology Review III Exam Review Outline of Current 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 Current Lecture 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 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 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 Using this differential approach saves us time instead of organizing a whole income statement II 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 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 VI 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