Chapter 13 - Cost Management and Decision Making

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Cost Management and
Decision Making
Chapter 13
Decision making process
Step 1: Goal setting
Provides guidance
Goals
Tangible
Quantifiable
Target profit, market share, enrollment, etc.
Decision making process
Step 2: Gather information
Relevant information
Capable of influencing a decision
Differs among alternatives
Occurs now or in the future
Sunk costs are never relevant
Decision making process
Tradeoffs
Qualitative vs. quantitative
Objective vs. subjective
Accuracy vs. timeliness
Quality vs. cost
Decision making process
Step 3: Identify and evaluate
alternatives
Stay as is or change?
Consider the domino effect
What other changes will this alternative
necessitate?
Decision making process
Costs and benefits of each
Qualitative vs. quantitative
Numbers may not tell the whole story
The past may be a guide
Prototype or pilot project may be
appropriate
Common decisions
Make or buy?
Retain or drop?
Keep or replace?
Accept or reject?
Make or buy?
Make
Qualitative factors
Buy
Qualitative factors
Control
Dependence
Worker morale
Time and distance
Reputation
Greater risk
Reduced risk
Cultural
differences
Make or buy?
Material
Labor
Variable overhead
Fixed overhead
Total
Unit cost
based on
100,000 units
$
18.00
3.00
2.00
8.00
$
31.00
Purchase price
Shipping
Inspection
Unit cost
based on
100,000 units
$
22.50
0.50
0.25
Total
$
23.25
100,000 units are required each year. Some special-purpose equipment can be eliminated, along
with its operators, if the part is purchased, reducing fixed overhead by $80,000 per year. If
purchased, the capacity freed up could be used to "insource" another component, saving the
company $18,000 per year.
Make or buy?
Assume you chose to buy. Subsequent to your decision you discover you will need an interpreter
($30,000 per year) due to language differences. In addition, you incur travel costs ($60,000 per
year) for your engineers to travel to the supplier to solve problems.
Retain or drop?
Retain
Drop
Profitable?
Revenue lost
Support other
products, locations?
Costs avoided
Maintain image?
Shift to other
products, locations
Impact on
remaining workers,
community
Retain or drop?
Sales revenue
Cost of goods sold
Gross margin
Operating costs
Wages
Utilities
Rent
Fixture depreciation
Insurance
Operating profit
Store A
$ 7,800,000
6,240,000
1,560,000
Store B
$ 3,800,000
3,040,000
760,000
530,000
63,000
210,000
114,000
75,000
568,000
300,000
47,000
115,000
87,000
60,000
151,000
$
$
Store C
$ 1,700,000
1,360,000
340,000
$
Total
$ 13,300,000
10,640,000
2,660,000
230,000
1,060,000
14,000
124,000
80,000
405,000
52,000
253,000
40,000
175,000
(76,000) $
643,000
If store C is eliminated, 10% of its sales will migrate to the other two locations.
In addition, one manager, paid $50,000, will be moved to another store.
Should Store C be closed?
Keep or replace?
Keep
Replace
Serviceability
Cost
Operating costs
Available financing
Capacity
Operating costs
Obsolescence
Capacity
Useful life
Market value of old
asset
Keep or replace?
Existing
machine
Annual operating costs
Materials
Labor
Utilities
Maintenance
Depreciation
Total annual operating costs
Other information
Cost
Accumulated depreciation
Current resale value
Remaining useful life - years
$
$
$
Proposed
machine
38,000
17,000
3,000
4,000
4,500
66,500
$
50,000
22,500
18,000
5
$
$
$
38,000
6,000
1,400
500
18,000
63,900
95,000
5
What costs are relevant? Should the machine be replaced?
Accept or reject?
Accept
Does incremental
revenue exceed
incremental cost?
Unit/batch
Product/facility
Impact on other
products
Impact on other
customers
Reject
Not profitable
Negative impact
on current sales
Discriminatory
Negative impact
on image
Accept or reject?
Annual capacity
Current production, sales level
Selling price per unit
Cost per unit
Materials
Labor
Variable overhead
Fixed overhead
Total fixed overhead
Current production level
Fixed overhead per unit
Total cost per unit
$
$
$
200,000
170,000
25.00
12.00
3.50
1.80
391,000
170,000
$
2.30
19.60
A potential new customer asks the company to produce 50,000 units in special
packaging and offers to pay $20.00 per unit. The special packaging will increase
material cost by $0.10 per unit. Due to capacity limitations, the company will have
to reduce its current sales by 20,000 units if the special order is accepted. Should
the order be accepted? What is the minimum acceptable unit price for the special
order?
Life cycle costing
At some point, all costs must be
recovered
Previous examples only considered
incremental costs
Life cycle costing considers all of the
costs related to owning and using the
asset
Costs are then charged to customers
Life cycle costing
Ownership costs
Net cost consumed (cost – salvage value)
Opportunity cost or cost of capital
Ongoing fixed costs (insurance, taxes, etc.)
Operating costs
Utilities, repairs, maintenance, etc. related
to using the asset