COST MANAGEMENT
Don R. Hansen
Maryanne M. Mowen
PPT 19 -1
Chapter Nineteen
Activity Resource Usage
Model and Relevant
Costing: Tactical
Decision Making
PPT 19 -2
Learning Objectives
 Describe and explain the tactical decision-
making model.
 Define ad explain the concept of relevant
costs and revenues.
PPT 19 -3
Learning Objectives (continued)
 Explain how the activity resource usage
model is used in assessing relevancy.
 Apply the tactical decision-making concepts
in a variety of business situations.
PPT 19 -4
The Tactical Decision-Making Process
Tactical decision making consists of choosing
among alternatives with an immediate or limited
end in view.
Tactical cost analysis is the use of relevant cost
data to identify the alternative that provides the
greatest benefit to the organization.
PPT 19 -5
The Tactical Decision-Making Process
(continued)
 Recognize and define the problem.
 Identify alternatives as possible solutions to
the problem, and eliminate alternatives that
are not feasible.
 Identify the predicted costs and benefits
associated with each feasible alternative.
Eliminate the costs and benefits that are not
relevant to the decision.
PPT 19 -6
The Tactical Decision-Making Process
(continued)
 Compare the relevant costs and benefits for
each alternative, and relate each alternative
to the overall strategic goals of the firm and
other important qualitative factors.
 Select the alternative with the greatest
benefit which also supports the
organization’s strategic objectives.
PPT 19 -7
Qualitative Factors
How should qualitative factors be handled in the
decision-making process?
1. They must be identified.
2. The decision maker should try to quantify them.
3. True qualitative factors should be taken into
consideration in the final step of the decision-making
process.
PPT 19 -8
Relevant Costs Defined
 Costs that differ across alternatives
 Costs that deal with future courses of action
PPT 19 -9
Irrelevant Cost
Sunk costs are past costs.
Example: The original cost of
a building is a sunk
cost when you are
selling the building
five years later.
PPT 19 -10
Activity Resource Usage Model and
Assessing Relevancy
Flexible Resources
Resources Acquired as Needed
a. Demand Changes
b. Demand Constant
Relevant
Not Relevant
PPT 19 -11
Activity Resource Usage Model and
Assessing Relevancy (continued)
Committed Resources
Acquired in Advance (Short Term)
a. Demand Increase < Unused Capacity
b. Demand Increase > Unused Capacity
c. Demand Decrease (Permanent)
1. Activity Capacity Reduced
2. Activity Capacity Unchanged
Not Relevant
Relevant
Relevant
Not Relevant
PPT 19 -12
Some Types of Decisions Illustrated
 Make or Buy
 Keep or Drop
 Special Order
 Sell or Process Further
Important: Short-term Perspective
PPT 19 -13
Activity and Cost Information
Part
Activity
Expected
34B
Activity Activity
Units of
Activity
Using materials
Cost Driver
Units
Cost Formula Capacity
Y = $0.5X
As needed
Usage
100,000
Usage
100,000
Purchase
1
Using direct labor
Providing
Units
Number of
Y = $2X
Y = $300,000
As needed
15
100,000
15
100,000
3
1
3
supervision
Moving materials
lines
Number of
Y = $250,000
250,000
240,000
40,000
25,000
Providing power
moves
Machine
+ $0.60X
Y = $3X
As needed
30,000
30,000
1
Inspecting
hours
Inspection
Y = $280,000
16,000
14,000
2,000
2,000
products
Setting
hours
Setup hours
+ $1.50X
Y = $600,000
60,000
58,000
6,000
2,000
up equipment
Providing space
Square feet
Y = $1,000,000
50,000
50,000
5,000
50,000
Units
Y = $0.50X
120,000
100,000
100,000
15,000
Equipment
depreciation
PPT 19 -14
Make-or-Buy Decisions
Assume the following cost data related to the decision to produce
12,000 units of a product or buy from an external source:
Total Costs
Unit Cost
Rental of equipment
$15,000
$1.25
Equip. depreciation
3,000
.25
Direct materials
12,000
1.00
Direct labor
24,000
2.00
Variable overhead
9,000
.75
Fixed overhead
36,000
3.00
Total
$99,000
$8.25
======
====
Purchase price from an outside vendor is $5.50 per unit
PPT 19 -15
Make-or-Buy Decision (continued)
Alternatives
Differential
Make
Buy
Cost to Make
Rental of equip.
Direct materials
Direct labor
Variable overhead
Purchase cost
$15,000
5,000
24,000
9,000
------------$66,000
$15,000
5,000
24,000
9,000
($66,000)
Relevant costs
$53,000
======
$66,000
======
($13,000)
======
Decision: Manufacture parts in-house
PPT 19 -16
Keep-or-Drop Decisions
Assume the following:
Sales units
Sales revenue
Less variable expenses:
Variable cost of sales
Variable selling & admin.
Contribution margin
Less direct fixed expenses:
Direct fixed costs
Product margin
Less common fixed costs
Net income
Regular
Deluxe
Total
400
$200,000
200
$150,000
600
$350,000
96,000
10,000
$ 94,000
60,000
7,500
$ 82,500
156,000
17,500
$176,500
30,000
$ 64,000
=======
85,000
$ (2,500)
=======
115,000
$ 61,500
30,000
$ 31,500
=======
Should the Deluxe product line be eliminated?
PPT 19 -17
Keep-or-Drop (continued)
Keep
Sales
$150,000
Variable expenses
(67,500)
Contribution margin $ 82,500
Direct fixed expenses (85,000)
Relevant benefit/loss
Drop
-------------
Differential
Amount to Keep
$150,000
(67,500)
$ 82,500
(85,000)
$ (2,500)
======
Decision: Drop the Deluxe product line but investigate alternative
use of facilities. This analysis provides a benchmark for future
decisions.
PPT 19 -18
Special-Order Decisions
Assume the following price quotation sheet for the XYX Company who
has received an offer buy at $38 per unit.
Direct materials
Direct labor
Variable overhead
Variable selling and administrative
Fixed manufacturing
Total
Markup--50%
Target selling price
$12
14
4
2
20
$52
26
$78
===
Important: XYZ Company has idle capacity and can produce the
special order without affecting its current production.
PPT 19 -19
Special-Order Decisions (continued)
Decision Rule: The “floor” for establishing a price for a special
order is incremental cost(variable cost in this case).
Incremental Costs:
Direct materials
Direct labor
Variable overhead
Variable S & A
Total
$12
14
4
2
$32
===
Sales price
Incremental costs
Additional income
$38
32
$ 6 per unit
===
Question: What impact is this decision likely to have on existing
customers?
PPT 19 -20
Joint Products
Joint products have common processes and
costs of production up to a split-off point.
The point of separation is called the split-off point.
PPT 19 -21
Decisions to Sell or Process Further
Product A
Joint Input
Should the company
process further?
Joint Costs
Split-off
point
Separate
Processing
Product B
Joint
products
Separate
Processing
PPT 19 -22
Decisions to Sell or Process Further
(continued)
Sell or process further decision:
Products
A
Sales value at split-off
Sales value after additional processing
Allocated joint product costs
Cost of further processing
$240,000
320,000
160,000
100,000
B
$300,000
480,000
200,000
120,000
Incremental revenue from processing
$ 80,000
$180,000
Cost of additional processing
100,000
120,000
Profit (loss) from further processing
$(20,000)
$ 60,000
Decision
Sell at split-off Process further
Joint costs are irrelevant
PPT 19 -23
End of Chapter 19
PPT 19 -24