Management Accounting
Fundamentals
Module 9
Relevant costs for decision
making and inventory
management
Lectures and handouts by:
Shirley Mauger, HB Comm, CGA
Module 9 - Table of Contents
Part
1
2
3
N/A
3
4
5
6
7
8
9
10
11
12
Content
9.1 Cost concepts for decision making
9.2 Adding and dropping product lines
9.3 The make or buy decision
9.4 Computer illustration 9-1: Relevant costs
9.5 Special orders
9.6 Utilization of a constrained resource
9.7 Joint product costs and the contribution approach
9.8 Economic order quantity (EOQ) and the reorder point
Review question: Relevant cost analysis
Review question: Retain or drop a department, make or buy
decision
Review question: Economic order quantity and safety stock
Review question: Sell or process further
Review question: Economic order quantity
Review question: Multiple choice questions
2
MA1 – MODULE 9
Part 1
Cost concepts for
decision making
Topic 9.1
3
Part 1 – Cost concepts for decision making (Topic 9.1)
Identify sunk costs and explain why they are not relevant in
decision making based on a general rule for distinguishing
between relevant and irrelevant costs, including decisions about
whether to keep or replace old equipment. (Level 1)
Formulating longand short-term
plans (Planning)
Comparing actual
to planned
performance
(Controlling)
Implementing
plans (Directing
and Motivating)
Decision
Making
Measuring
performance
(Controlling)
Garrison, Noreen, Chesley, Carroll, Managerial Accounting, 6 th Canadian edition, 2004 p. 6
4
Part 1 – Cost concepts for decision making (Topic 9.1)
Short term
decisions
• Adding and dropping product lines or segments
• Make or buy
• Special orders
• Utilization of a constrained resource
• Sell or process further
5
Part 1 – Cost concepts for decision making (Topic 9.1)
Short term
decisions
• Adding and dropping product lines or segments
• Make or buy
• Special orders
• Utilization of a constrained resource
• Sell or process further
Relevant costs
A cost that differs between
alternatives
Irrelevant costs
A cost that can be ignored
in the analysis
6
Part 1 – Cost concepts for decision making (Topic 9.1)
Avoidable/differential cost
Relevant
Irrelevant
Future costs that don’t
differ between alternatives
Sunk cost
Opportunity cost
Different costs for different purposes
Whether a cost is relevant or irrelevant depends on
the circumstances
7
Part 1 – Cost concepts for decision making (Topic 9.1)
Avoidable/differential cost
Relevant
Irrelevant
Future costs that don’t
differ between alternatives
Sunk cost
Opportunity cost
Can be eliminated in whole or in part by
choosing one alternative over another.
• Department manager’s salary if the department is eliminated
• Savings in direct materials cost because of the purchase of a
new machine
8
Part 1 – Cost concepts for decision making (Topic 9.1)
Avoidable/differential cost
Relevant
Irrelevant
Future costs that don’t
differ between alternatives
Sunk cost
Opportunity cost
Any cost which will continue in the future no
matter which alternative is chosen
• Lease cost on the building which will continue to be
used whether or not you install the new equipment.
• Depreciation cost of existing equipment that will be
kept whether or not the new product line is
manufactured.
9
Part 1 – Cost concepts for decision making (Topic 9.1)
Avoidable/differential cost
Relevant
Irrelevant
Future costs that don’t
differ between alternatives
Sunk cost
Opportunity cost
Any cost that has already been incurred and
cannot be changed
• Money that a corporation spent last year to
investigate the site for a new office, expensed those
funds and now is deciding whether or not to go
forward with the project.
• Book value of old equipment that cannot be resold
10
Part 1 – Cost concepts for decision making (Topic 9.1)
Avoidable/differential cost
Relevant
Irrelevant
Future costs that don’t
differ between alternatives
Sunk cost
Opportunity cost
The potential benefit foregone when one
alternative is chosen over another
• Revenue lost because the retail outlet closes early
on the weekends.
• Potential loss of investment income due to
stockpiling inventory
• Seldom recognized on financial reports
11
MA1 – MODULE 9
Part 2
Adding and dropping
product lines
Topic 9.2
12
Part 2 – Adding and dropping product lines (Topic 9.2)
Prepare an analysis showing whether a product line or other
organizational segment should be dropped or retained. (Level 1)
Adding and dropping product lines
Two approaches to the cost analysis:
1. Compare all costs
2. Compare only differential costs
(those that differ between alternatives)
13
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services
Exercise 13-3, page 646
First classify the costs:
Variable costs
Depreciation on van
Liability insurance
Program administrators’ salary
General administrative overhead
Relevant/
Irrelevant
Avoid./diff.
R
Sunk
I
Avoid./diff.
R
Avoid./diff.
R
Future cost
I
Stop the audio, turn to exercise 13-3, page 646,
and the handout, page 1 then come back to
listen to the solution.
14
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services
Exercise 13-3, page 646, requirement 1
Compare all costs
Revenues
Less variable expenses
Contribution margin
Current House-keeping
Total
Dropped Difference
$900,000
$660,000 $(240,000)
490,000
330,000
160,000
410,000
330,000
(80,000)
Variable costs
are avoidable
15
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services
Exercise 13-3, page 646, requirement 1
Compare all costs
Revenues
Less variable expenses
Contribution margin
Less fixed expenses:
Depreciation
Liability insurance
Current House-keeping
Total
Dropped Difference
$900,000
$660,000 $(240,000)
490,000
330,000
160,000
410,000
330,000
(80,000)
68,000
42,000
68,000
27,000
0
15,000
Depreciation is based
on the van which is a
sunk cost.
Liability insurance is
an avoidable cost
16
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services
Exercise 13-3, page 646, requirement 1
Compare all costs
Current House-keeping
Total
Dropped Difference
Cost of administrator’s
Revenues
$900,000 salary$660,000 $(240,000)
Less variable expenses is avoidable
490,000
330,000
160,000
Contribution margin General administrative
410,000
330,000
(80,000)
overhead is not unavoidable.
Less fixed expenses:
Depreciation
Liability insurance
Program admin. salaries
General administrative
overhead
Total fixed expenses
Net operating income/loss
68,000
42,000
115,000
180,000
405,000
$ 5,000
68,000
27,000
78,000
0
15,000
37,000
180,000
0
353,000
52,000
$(23,000) $ (28,000)
17
Part 2 – Adding and dropping product lines (Topic 9.2)
the housekeeping service is dropped,
Jackson County SeniorIfServices
netrequirement
income will
Exercise 13-3, page 646,
1 be reduced by $28,000
Compare all costs
Revenues
Less variable expenses
Contribution margin
Less fixed expenses:
Depreciation
Liability insurance
Program admin. salaries
General administrative
overhead
Total fixed expenses
Net operating income/loss
Current House-keeping
Total
Dropped Difference
$900,000
$660,000 $(240,000)
490,000
330,000
160,000
410,000
330,000
(80,000)
68,000
42,000
115,000
180,000
405,000
$ 5,000
68,000
27,000
78,000
0
15,000
37,000
180,000
0
353,000
52,000
$(23,000) $ (28,000)
18
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services Compare lost contribution margin
Exercise 13-3, page 646, requirement
1
to costs
that can be avoided.
(Relevant costs)
Compare all costs
Revenues
Less variable expenses
Contribution margin
Less fixed expenses:
Depreciation
Liability insurance
Program admin. salaries
General administrative
overhead
Total fixed expenses
Net operating income/loss
Current House-keeping
Total
Dropped Difference
$900,000
$660,000 $(240,000)
490,000
330,000
160,000
410,000
330,000
(80,000)
68,000
42,000
115,000
180,000
405,000
$ 5,000
68,000
27,000
78,000
0
15,000
37,000
180,000
0
353,000
52,000
$(23,000) $ (28,000)
19
Part 2 – Adding and dropping product lines (Topic 9.2)
Ignoring the irrelevant costs,
Jackson County Senior Services
will give the same answer.
Exercise 13-3, page 646, requirement 1
Compare differential costs
Difference
Contribution margin lost if housekeeping is dropped
Less fixed costs that can be avoided
Liability insurance
Program admin. salaries
Total traceable fixed expenses
Net annual cost increase
(80,000)
15,000
37,000
52,000
$ (28,000)
20
Part 2 – Adding and dropping product lines (Topic 9.2)
Segment reporting format
Sales
(Variable costs)
= Contribution margin
(Traceable fixed costs)
= Segment margin
Segmented
statements –
module 8
(Common costs)
= Net income
Corporate wide income
21
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services
Exercise 13-3, page 646, req. 2
Revenues
Less variable expenses
Contribution margin
Home Meals on
Total
Nursing Wheels
$900,000 $260,000 $400,000
490,000 120,000 210,000
410,000 140,000 190,000
Housekeeping
$240,000
160,000
80,000
Deduct variable expenses
Housekeeping has a 33%
contribution margin
($80,000/$240,000)
22
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services
Exercise 13-3, page 646, req.2
Home Meals on HouseTotal
Nursing Wheels keeping
Revenues
$900,000 $260,000 $400,000 $240,000
Less variable expenses
490,000 120,000 210,000 160,000
Contribution margin
410,000 140,000 190,000
80,000
Less traceable fixed expenses:
Depreciation
68,000
8,000
40,000
20,000
Liability insurance
42,000
20,000
7,000
15,000
Program administrators’
salaries
115,000
40,000
38,000
37,000
Total traceable fixed
expenses
225,000
68,000
85,000
72,000
Program segment margins $185,000 $ 72,000 $105,000 $ 8,000
Deduct fixed costs that can be
traced to the department
23
Part 2 – Adding and dropping product lines (Topic 9.2)
Jackson County Senior Services
Exercise 13-3, page 646, req.2
Home Meals on HouseTotal
Nursing Wheels keeping
Revenues
$900,000 $260,000 $400,000 $240,000
Less variable expenses
490,000 120,000 210,000 160,000
Contribution margin
410,000 140,000 190,000
80,000
Less traceable fixed expenses:
Depreciation
68,000
8,000
40,000
20,000
Liability insurance
42,000
20,000
7,000
15,000
Program administrators’
salaries
115,000
40,000
38,000
37,000
Total traceable fixed
expenses
225,000
68,000
85,000
72,000
Program segment margins
185,000 $ 72,000 $105,000 $ 8,000
General administrative
Deduct common
overhead
180,000
costs from the
Net operating income/loss $ 5,000
corporate wide total.
24
Part 2 – Adding and dropping product lines (Topic 9.2)
Qualitative factors to consider:
• Is the line necessary to the sale of other products?
• Does the line serve as a ‘magnet’ to attract customers?
25
MA1 – MODULE 9
Part 3
The make or buy
decision
Special orders
Topics 9.3 & 9.5
26
Part 3 – The make or buy decision (Topic 9.3)
Explain what is meant by a make or buy decision and prepare a
well-organized make or buy analysis. (Level 1)
• Vertical integration:
• When a company is involved in the production of
more than one or more steps in the production and
distribution of the product. (value chain)
• Make or buy decision:
• Decision as to whether a product should be made
internally or purchased from an outside supplier
Common steps in an organization’s value chain
R&D
Product
Design
Customer
Manufacturing Marketing Distribution Service
© M cGraw-Hill Ryerson Limited., 2004
27
Part 3 – The make or buy decision (Topic 9.3)
• Advantages of integration:
• Less dependence on suppliers
• Smoother flow of parts and materials
• More control over quality
• Disadvantages of integration
• Suppliers may be able to benefit from economies of
scale resulting in higher quality and lower cost.
• Contact with suppliers may be necessary if there is an
emergency and parts cannot be produced in-house.
Product
Design
R&D
Customer
Manufacturing Marketing Distribution Service
© M cGraw-Hill Ryerson Limited., 2004
28
Part 3 – The make or buy decision (Topic 9.3)
Climate Control Inc.
Exercise 13-4, page 647 – requirement 1
First classify the costs:
Direct materials
Direct labour
Variable manufacturing OH
Fixed manufacturing OH salaries
Fixed manufacturing OH equipment
Fixed manufacturing OH common
Cost of component from outside supplier
Avoid./diff.
Avoid./diff.
Avoid./diff.
Avoid./diff.
Sunk
Future cost
Avoid./diff.
Relevant/
Irrelevant
R
R
R
R
I
I
R
Stop the audio, turn to exercise 13-4, page 647,
and the handout, page 2, then come back to
listen to the solution.
29
Part 3 – The make or buy decision (Topic 9.3)
Climate Control Inc.
Exercise 13-4, page 647 – requirement 1
Per unit
Total-15,000 units
Make Buy
Make
Buy
Direct materials
$6
Direct labour
8
1
Variable manufacturing OH
2
Fixed manufacturing salaries
-Fixed manufacturing OH equipment
-Fixed manufacturing OH common
TOTAL
$17
Exclude irrelevant costs
30
Part 3 – The make or buy decision (Topic 9.3)
Climate Control Inc.
Exercise 13-4, page 647 – requirement 1
Per unit
Total-15,000 units
Make Buy
Make
Buy
Direct materials
$6
Direct labour
8
1
Variable manufacturing OH
2
Fixed manufacturing salaries
-Fixed manufacturing OH equipment
-Fixed manufacturing OH common
Purchase price of components
$20
TOTAL
$17 $20
It will cost $3 per unit
more to purchase the
thermostats.
31
Part 3 – The make or buy decision (Topic 9.3)
Climate Control Inc.
Exercise 13-4, page 647 – requirement 1
Per unit
Total-15,000 units
Make Buy
Make
Buy
$6
$ 90,000
Direct materials
8
120,000
Direct labour
Variable manufacturing OH
1
15,000
Fixed manufacturing salaries
2
30,000
-Fixed manufacturing OH equipment
-Fixed manufacturing OH common
$20
$300,000
Purchase price of components
TOTAL
$17 $20 $255,000 $300,000
A total difference
of $45,000
32
Part 3 – The make or buy decision (Topic 9.3)
Climate Control Inc.
Exercise 13-4, page 647 – requirement 2
First classify the costs:
Direct materials:
Direct labour
Variable manufacturing OH
Fixed manufacturing OH salaries
Fixed manufacturing OH equipment
Fixed manufacturing OH common
Cost of component from outside supplier
Opportunity cost: segment margin
foregone on a new product line
Relevant/
Irrelevant
Avoid./diff.
Avoid./diff.
Avoid./diff.
Avoid./diff.
Sunk
Future cost
Avoid./diff.
R
Opportunity cost
R
R
R
R
I
I
R
33
Part 3 – The make or buy decision (Topic 9.3)
Climate Control Inc.
Exercise 13-4, page 647 – requirement 2
Total-15,000 units
Make
Buy
$ 90,000
Direct materials
120,000
Direct labour
Variable manufacturing OH
15,000
Fixed manufacturing salaries
30,000
-Fixed manufacturing OH equipment
-Fixed manufacturing OH common
$300,000
Purchase price of components
Segment margin foregone
65,000
TOTAL
$320,000 $300,000
A difference of $20,000 in favor of
buying the new thermostat and
implementing the new product line.
34
Part 3 – Special orders (Topic 9.5)
Prepare an analysis showing whether a special order should be
accepted. (Level 1)
Special order
• One-time order that is not considered part of the
company’s normal ongoing business
• Only incremental costs are considered
• Should not affect normal sales
• Idle capacity should be available
35
Part 3 – Special orders (Topic 9.5)
Vicario Jewellers
Exercise 13-5, page 647
First classify the costs:
Materials
Direct labour
Fixed manufacturing OH
Variable manufacturing OH
Additional materials (for filigree)
Cost of special tool
Relevant/
Irrelevant
Avoid./diff.
Avoid./diff.
Future cost
Avoid./diff.
Avoid./diff.
Avoid./diff.
R
R
I
R
R
R
Stop the audio, turn to exercise 13-5, page 647,
and the handout, page 3 then come back to
listen to the solution.
36
Part 3 – Special orders (Topic 9.5)
Vicario Jewellers
Exercise 13-5, page 647
37
Part 3 – Special orders (Topic 9.5)
Vicario Jewellers
Exercise 13-5, page 647
Incremental revenue ($389.95 x 10)
Incremental cost
Variable costs:
Materials
Direct labour
Variable manufacturing OH
Additional materials (for filigree)
Total variable cost
Fixed costs:
Per bracelet 10 bracelets
$349.95
$3,499.50
143.00
86.00
7.00
6.00
$242.00
1,430,00
860.00
70.00
60.00
$2,420.00
Total incremental cost
Incremental operating income
38
Part 3 – Special orders (Topic 9.5)
Vicario Jewellers
Exercise 13-5, page 647
The special order adds $614,50 to the
company’s net operating income and
should be accepted.
Incremental revenue ($389.95 x 10)
Incremental cost
Variable costs:
Materials
Direct labour
Variable manufacturing OH
Additional materials (for filigree)
Total variable cost
Fixed costs:
Fixed manufacturing OH
Cost of special tool
Total incremental cost
Incremental operating income
Per bracelet 10 bracelets
$349.95
$3,499.50
143.00
86.00
7.00
6.00
$242.00
1,430,00
860.00
70.00
60.00
$2,420.00
465.00
$2,885.00
$ 614.50
39
MA1 – MODULE 9
Part 4
Utilization of a
constrained resource
Topic 9.6
40
Part 4 – Utilization of a constrained resource (Topic 9.6)
Make appropriate computations to determine the most profitable
utilization of scarce resources. (Level 1)
Constraint
• A limitation under which a company must operate that
restricts its ability to satisfy demand
• i.e. – a machine already operating 24/7 cannot
produce any more units.
• When this constraint is narrowly focused it’s called a
bottleneck.
• How can a company maximize its profits under these
conditions?
• Focus on maximizing total contribution margin
41
Part 4 – Utilization of a constrained resource (Topic 9.6)
Banner Company
Exercise 13-6, page 648 – requirement 1
Selling price
Less variable costs:
Direct materials
Direct labour
Variable manufacturing OH
Total variable cost
Contribution margin
A
$60
Product
B
$90
C
$80
27
12
3
42
$18
14
32
8
54
$36
40
16
4
60
$20
Maximize contribution margin when there is a
constraint on direct labour: 3,000 hours at $8 per hour
Stop the audio, turn to exercise 13-6, page 648,
and the handout, page 4, then come back to
listen to the solution.
42
Part 4 – Utilization of a constrained resource (Topic 9.6)
Banner Company
Exercise 13-6, page 648 – requirement 1
Selling price
Less variable costs:
Direct materials
Direct labour
Variable manufacturing OH
Total variable cost
Contribution margin
Amount of direct labour hours required
Direct labour cost per unit/$8
Product A: $12/$8=1.5 hours
Product B: $32/$8=4.0 hours
Product C: $16$/8=2.0 hours
A
$60
Product
B
$90
C
$80
27
12
3
42
$18
14
32
8
54
$36
40
16
4
60
$20
1.5
4.0
2.0
43
Part 4 – Utilization of a constrained resource (Topic 9.6)
Banner Company
Exercise 13-6, page 648 – requirement 1
Selling price
Less variable costs:
Direct materials
Direct labour
Variable manufacturing OH
Total variable cost
Contribution margin
Amount of direct labour hours required
Contribution margin per direct labour hour
A
$60
Product
B
$90
C
$80
27
12
3
42
$18
14
32
8
54
$36
40
16
4
60
$20
1.5
$12
4.0
$9
2.0
$10
Contribution margin per direct labour hour
Product A: $18/1.5= $12/hour
Product B: $36/4.0= $9/hour
Product C: $20/2.0= $10/hour
44
Part 4 – Utilization of a constrained resource (Topic 9.6)
Banner Company
Exercise 13-6, page 648 – requirement 2
A
$60
Product
B
$90
C
Selling price
$80
Less variable costs:
Direct materials
27
14
40
Direct labour
12
32
16
Variable manufacturing OH
3
8
4
Total variable cost
42
54
60
Contribution margin
$18
$36
$20
Contribution margin ratio
30%
40%
25%
Amount of direct labour hours required
1.5
4.0
2.0
Contribution margin per direct labour hour
$12
$9
$10
Times 3,000 direct labour hours available
3,000
3,000 3,000
Total contribution margin
$36,000 $27,000 $30,000
Focus production on product A
45
Part 4 – Utilization of a constrained resource (Topic 9.6)
Utilizing constraints
• Focus on the constraint by relaxing (or elevating) it
• add more hours by paying overtime
• add another machine
• subcontract bottleneck processing
• move shift workers from a non-bottleneck process
• perform business process reengineering or total
quality management techniques on the bottleneck
process
• reduce defective units
How much would you be willing to pay to relax
a constraint?
Not more than the additional
contribution margin will generate.
46
Part 4 – Utilization of a constrained resource (Topic 9.6)
Banner Company
Exercise 13-6, page 648 – requirement 3
Contribution margin
Amount of direct labour hours required
Contribution margin per direct labour hour
Times 3,000 direct labour hours available
Total contribution margin
A
$18
Product
B
$36
C
$20
1.5
4
2
$12
$9
$10
3,000
3,000
3,000
$36,000 $27,000 $30,000
Up to how much should the
company be willing to pay per hour
in overtime wages if 3,000
additional hours are made available?
47
Part 4 – Utilization of a constrained resource (Topic 9.6)
Banner Company
Exercise 13-6, page 648 – requirement 3
Contribution margin
Amount of direct labour hours required
Contribution margin per direct labour hour
Times 3,000 direct labour hours available
Total contribution margin
Contribution margin per direct labour hour
Current direct labour rate
Maximum overtime rate:
A
$18
Product
B
$36
C
$20
1.5
4
2
$12
$9
$10
3,000
3,000
3,000
$36,000 $27,000 $30,000
$12
8
$20
They would be willing to pay an additional
$12 per hour or $20 in total in overtime pay
to produce Product A.
48
Part 4 – Utilization of a constrained resource (Topic 9.6)
Banner Company
Exercise 13-6, page 648 – requirement 3
A
$18
Contribution margin
Amount of direct labour hours required
Contribution margin per direct labour hour
Times 3,000 direct labour hours available
Total contribution margin
Product
B
$36
C
$20
1.5
4
2
$12
$9
$10
3,000
3,000 3,000
$36,000 $27,000 $30,000
Contribution margin per direct labour hour
Current direct labour rate
Maximum overtime rate:
$12
8
$20
$9
8
$17
$10
8
$18
They would be willing to spend up to $17 in
overtime pay for product B and up to $18 in
overtime for product C.
49
MA1 – MODULE 9
Part 5
Joint product costs and
the contribution
approach
Topic 9.7
50
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Prepare an analysis showing whether joint products should be
sold at the split-off point or processed further. (Level 1)
Joint product
costs
Cream
Raw
milk Purchasing
and
separating
Split-off
point
Skim
Joint
products
51
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Prepare an analysis showing whether joint products should be
sold at the split-off point or processed further. (Level 1)
Joint product
costs
Raw Purchasing
and
milk
Sales value
Cream
$28,000
10,000
litres
1.Based on relative sales value
2.Based on physical measure
separating
$30,000
Skim
$25,000
30,000
Split-off litres
point
How are the costs of the raw
milk and the further processing
allocated to cream and liquid
milk?
Joint
products
Stop the audio, turn to the
handout, page 5, then come
back to listen to the solution.
52
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Prepare an analysis showing whether joint products should be
sold at the split-off point or processed further. (Level 1)
Based on relative sales value
Sales value
% of total
Cream
$28,000
56%
Skim
Total
$22,000 $50,000
44%
100%
Allocate $30,000 processing costs
$16,800
$13,200 $30,000
Contribution margin
$11,200
$8,800 $20,000
53
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Prepare an analysis showing whether joint products should be
sold at the split-off point or processed further. (Level 1)
Based on relative sales value
Sales value
% of total
Cream
$28,000
56%
Skim
Total
$22,000 $50,000
44%
100%
Allocate $30,000 processing costs
$16,800
$13,200 $30,000
Contribution margin
$11,200
$8,800 $20,000
Based on physical measure
Litres
% of total
Allocate $30,000 processing costs
Contribution margin
10,000
30,000
40,000
25%
75%
100%
$7,500
$22,500 $30,000
$20,500
($500) $20,000
54
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Prepare an analysis showing whether joint products should be
sold at the split-off point or processed further. (Level 1)
Joint product
costs
Separate product costs
Cream
Manufacture
ice
cream
Skim
Pasteurize
homogenize
and bottle
Raw
milk Purchasing
and
separating
Split-off
point
Ice
cream
Packaged
skim milk
Joint
products
55
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Prepare an analysis showing whether joint products should be
sold at the split-off point or processed further. (Level 1)
Sell or process further decision.
Cream
Manufacture
ice
cream
Skim
Pasteurize
homogenize
and bottle
Raw
milk Purchasing
and
separating
Ice
cream
Packaged
skim milk
Joint
products
56
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Solex Company
Exercise 13-7, page 648
Input
Stop the audio, turn to exercise 13-8, page 648,
and the handout, page 6, then come back to
listen to the solution.
57
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Solex Company
Exercise 13-7, page 648
Joint product
costs
X
$50,000
Input Processing
$100,000
Y
$90,000
Z
$60,000
Split-off
Joint
point
products
58
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Solex Company
Exercise 13-7, page 648
Joint product
Separate
costs
product costs
Additional
X
processing
$50,000
$35,000
Input Processing
$100,000
New
product X
$80,000
Y
$90,000
Additional
processing
$40,000
New
product Y
$150,000
Z
$60,000
Additional
processing
$12,000
New
product Z
$75,000
Split-off
Joint
point
products
59
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Solex Company
Exercise 13-7, page 648
Joint product
Separate
costs
product costs
Additional
X
processing
$50,000
$35,000
Input Processing
$100,000
New
product X
$80,000
Y
$90,000
Additional
processing
$40,000
New
product Y
$150,000
Z
$60,000
Additional
processing
$12,000
New
product Z
$75,000
Split-off
Joint
point
products
60
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Solex Company
Exercise 13-7, page 648
Classify the costs:
Relevant/
Irrelevant
Joint processing costs
Further processing costs
Sunk
Avoid./diff.
I
R
61
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Solex Company
Exercise 13-7, page 648
Sales value after further processing
Sales value at split-off point
Incremental revenue
Cost of further processing
Incremental profit/loss
Product
X
Y
Z
$80,000 $150,000 $75,000
50,000 90,000 60,000
30,000 60,000 15,000
62
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Solex Company
Exercise 13-7, page 648
Sales value after further processing
Sales value at split-off point
Incremental revenue
Cost of further processing
Incremental profit/loss
Product
X
Y
Z
$80,000 $150,000 $75,000
50,000 90,000 60,000
30,000 60,000 15,000
35,000 40,000 12,000
($5,000) $20,000 $3,000
Sell product X at split-off and
process product Y and Z further.
63
Part 5 – Joint product costs and the contribution
approach (Topic 9.7)
Joint product
costs
Input Processing
W
By-products
X
joint product with a
relatively low sales value
(wood chips, molasses)
Y
Z
Split-off
Joint
point products
64
MA1 – MODULE 9
Part 6
Economic order quantity
(EOQ) and the reorder
point
Topic 9.8
65
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Compute the optimum inventory level and order size. (Level 1)
• Ordering cost
• Clerical costs
• Transportation costs
• Carrying cost
Inventory
• Storage space costs
• Handling costs
Costs
• Property taxes
• Insurance
• Obsolescence losses
• Interest on capital invested in inventory
• Costs of not carrying sufficient inventory (stock outs)
• Customer ill will
• Quantity discounts forgone
• Erratic production
• Inefficiency of production runs
• Added transportation charges
• Lost sales
66
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Compute the optimum inventory level and order size. (Level 1)
Inventory Control
• ABC analysis
• Break inventory items into three categories based on
value. Control is focused on ‘A’ items which have the
highest value and are usually the smallest in number.
• Economic order quantity
• Determining an order size that minimizes costs of
ordering and carrying inventory
67
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity
Total cost
Annual carrying
cost: C
Annual ordering cost: P
Exhib it 13-9, Reading 9-1, CGA lesson notes, module 968
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity
EOQ – Total cost is
minimized
(reading 9-1 page 2)
Exhib it 13-8,Reading 9-1, CGA lesson notes, module 9 69
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity
formula
E = order size in units
Q = annual quantity used
in units
P = cost of placing an order
C = annual cost of carrying
one unit in stock
70
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity
formula
E=?
Q = 3,000
P = $10
C = $.80
71
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Total annual cost
T = P(Q/E)+C(E/2)
Order cost
Carrying cost
E = order size in units
Q = annual quantity used
in units
P = cost of placing an order
C = annual cost of carrying
one unit in stock
72
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Total annual cost
T = P(Q/E)+C(E/2)
Order cost
Carrying cost
T = P(Q/E) +C(E/2)
=$10(3,000/274)+$.80*(274/2)
=
$109
+
$110
=
$219
73
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Economic order quantity
formula for production
O
O = optimal production lot
size
Q = annual production
quantity
P = setup costs for each run
C = annual cost of carrying
one unit in stock
74
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about
rising costs and wants to determine the economic order
quantity. After doing some research, the manager has
determined the following costs:
•
•
Cost to place an order
Cost to carry one Deluxe-2M in inventory
for 1 year
$25
$2
What is the EOQ for the Deluxe-2M?
Stop the audio, turn to the handout, page
7, then come back to listen to the solution.
75
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about
rising costs and wants to determine the economic order
quantity. After doing some research, the manager has
determined the following costs:
•
•
Cost to place an order
Cost to carry one Deluxe-2M in inventory
for 1 year
$25
$2
What is the EOQ for the Deluxe-2M?
= 775 units
per order
76
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about
rising costs and wants to determine the economic order
quantity. After doing some research, the manager has
determined the following costs:
•
•
Cost to place an order
Cost to carry one Deluxe-2M in inventory
for 1 year
$25
$2
What is the total annual cost for Deluxe-2M?
T = P ( Q / E) + C( E / 2)
T=25(24,000/775)+2(775/2)
T = $1,549 per year
77
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about
rising costs and wants to determine the economic order
quantity. After doing some research, the manager has
determined the following costs:
•
•
Cost to place an order
Cost to carry one Deluxe-2M in inventory
for 1 year
$35
$2
What will happen to EOQ if ordering costs
increase to $35 per order?
= 917 units
per order
78
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Bakerview products sells 24,000 units of the Deluxe-2M each
year. The inventory control manager is concerned about
rising costs and wants to determine the economic order
quantity. After doing some research, the manager has
determined the following costs:
•
•
Cost to place an order
Cost to carry one Deluxe-2M in inventory
for 1 year
$25
$2.50
What will happen to EOQ if carrying costs
increase to $2.50 per unit?
= 693 units
per order
79
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Original costs
$25
Annual
carrying
cost/unit
$2.00
Increased order costs
$35
$2.00
917
Increased carrying costs
$25
$2.50
693
Summary of requirements
Order
cost
EOQ
775
As order costs increase, EOQ increases. The
manager will want to order larger quantities
resulting in fewer orders
As carrying costs increase, EOQ decreases.
The manager will want to order smaller
quantities, resulting in less storage and
handling.
80
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
JIT focuses on
reducing the order
cost (P).
81
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Reorder point
• Time when an order is placed to replenish stock
= (lead time x average demand) + safety stock
Lead time
• Time between order and receipt of stock
Safety stock
• Additional units kept on hand to satisfy maximum
demand that can be reasonably expected during the
lead time
82
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Time (weeks)
Average
usage
EOQ
Safety
stock
Adapted from Exhib it 13-10, Reading 9-2, CGA lesson notes, module 9
83
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Time (weeks)
Average
usage
EOQ
Safety
stock
Maximum
expected
usage
Adapted from Exhib it 13-10, Reading 9-2, CGA lesson notes, module 9
84
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Time (weeks)
Average
usage
EOQ
Reorder
point
Safety
stock
Lead
time
Maximum
expected
usage
Adapted from Exhib it 13-10, Reading 9-2, CGA lesson notes, module 9
85
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Aegean distributors sells building materials
throughout western Canada. The following
information relates to a line of metal doors carried by
the company:
Economic order quantity
Lead time
Average weekly usage
650 units
4 weeks
65 units
What is the reorder point? (assuming no safety stock)
= (lead time x average demand) + safety stock
= ( 4 weeks x
65
)+0
=
260
+0
= 260 units
Stop the audio, turn to the handout, page
8, then come back to listen to the solution.
86
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Aegean distributors sells building materials
throughout western Canada. The following
information relates to a line of metal doors carried by
the company:
Economic order quantity
650 units
Lead time
4 weeks
Average weekly usage
65 units
Maximum weekly usage
78 units
What is the reorder point? (with safety stock)
Safety stock is additional stock required to satisfy
maximum demand during the lead time.
Maximum weekly usage
78 units
Average weekly usage
65 units
Safety stock
13 units
Lead time
x 4 weeks
Safety stock
52 units
87
Part 6 – Economic order quantity (EOQ) and the reorder
point (Topic 9.8)
Aegean distributors sells building materials
throughout western Canada. The following
information relates to a line of metal doors carried by
the company:
Economic order quantity
Lead time
Average weekly usage
Maximum weekly usage
650 units
4 weeks
65 units
78 units
What is the reorder point? (with safety stock)
= (lead time x average demand) + safety stock
= ( 4 weeks x
65
) + 52
=
260
+ 52
= 312 units
88
MA1 – MODULE 9
Part 7
Review question:
Relevant cost analysis
(download the additional questions handout:
ma1_mod9_handout1.pdf)
89
Part 7 – Review question: Relevant cost analysis
Problem 13-22 pages 656-657
Handout pages 9 and 10
1.
Would the increased fixed expenses be justified?
2.
Compute the per unit break-even price on this order
3.
What would be the dollar advantage or
disadvantage of closing the plant for the threemonth period?
4.
What unit cost figure is relevant for setting a
minimum selling price?
5.
Compute the unit cost figure that is relevant for
comparison to the quoted price
Stop the audio, read and attempt the
question in the textbook then come back to
listen to the solution.
90
Part 7 – Review question: Relevant cost analysis
Problem 13-22 pages 656-657
Handout pages 9 and 10
1.
Would the increased fixed expenses be justified?
2.
Compute the per unit break-even price on this order
3.
What would be the dollar advantage or
disadvantage of closing the plant for the threemonth period?
4.
What unit cost figure is relevant for setting a
minimum selling price?
5.
Compute the unit cost figure that is relevant for
comparison to the quoted price
91
Part 7 – Review question: Relevant cost analysis
Problem 13-22 pages 656-657
Handout pages 9 and 10
1.
Would the increased fixed expenses be justified?
2.
Compute the per unit break-even price on this order
3.
What would be the dollar advantage or
disadvantage of closing the plant for the threemonth period?
4.
What unit cost figure is relevant for setting a
minimum selling price?
5.
Compute the unit cost figure that is relevant for
comparison to the quoted price
92
MA1 – MODULE 9
Part 8
Review questions:
Retain or drop a department
Make or buy decision
(download the additional questions handout:
ma1_mod9_handout1.pdf)
93
Part 8 – Review question: Retain or drop a department;
make or buy decision
Question 8 March 2006
Handout page 11
Prepare an analysis to determine whether the shoe
department should be dropped, and make a
recommendation.
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
94
Part 8 – Review question: Retain or drop a department;
make or buy decision
Question 7 June 2007
Handout page 12
State whether Green’s should make or buy the game
boards from the competitor.
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
95
MA1 – MODULE 9
Part 9
Review question:
EOQ and safety stock
(download the additional questions handout:
ma1_mod9_handout1.pdf)
96
Part 9 – Review question: EOQ and safety stock
Handout question
Handout pages 13 thru 14
1.
Compute the EOQ
2.
At 18% risk of a stock out what would be the safety
stock? The reorder point?
3.
At 6% risk of a stock out what would be the safety
stock? The reorder point?
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
97
Part 9 – Review question: EOQ and safety stock
Handout question
Handout pages 13 thru 14
4.
At a 6% stock out risk what would be the total cost
of ordering and carrying inventory for one year?
5.
a) Using a JIT purchasing policy compute the new
EOQ
b) How frequently would the company be placing
an order?
98
MA1 – MODULE 9
Part 10
Review question:
Sell or process further
(download the additional questions handout:
ma1_mod9_handout1.pdf)
99
Part 10 – Review question: Sell or process further
Question 3 December, 2005 exam
Handout pages 15 thru 16
a.
Compute the profit if all 3 products are sold at the
split-off point
b.
Compute the profit if all 3 products are processed
further before being sold
c.
Compute the profit at the optimum mix of sales
either at, or after split-off
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
100
Part 10 – Review question: Sell or process further
Question 3 December, 2005 exam
Handout pages 15 thru 16
a.
Compute the profit if all 3 products are sold at the
split-off point
b.
Compute the profit if all 3 products are processed
further before being sold
c.
Compute the profit at the optimum mix of sales
either at, or after split-off
101
Part 10 – Review question: Sell or process further
Question 3 December, 2005 exam
Handout pages 15 thru 16
a.
Compute the profit if all 3 products are sold at the
split-off point
b.
Compute the profit if all 3 products are processed
further before being sold
c.
Compute the profit at the optimum mix of sales
either at, or after split-off
102
MA1 – MODULE 9
Part 11
Review question:
Economic order quantity
(download the additional questions handout:
ma1_mod9_handout1.pdf)
103
Part 11 – Review question: Economic order quantity
Question 2 June, 1989 exam
Handout page 17
a.
How many bottles should Quality Produce request
in each order?
b.
If Koala Products offers Quality Produce a 10%
discount off the delivered price for minimum orders
of 50,000 bottles what should Quality Produce do?
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
104
Part 11 – Review question: Economic order quantity
Question 2 June, 1989 exam
Handout page 17
a.
How many bottles should Quality Produce request
in each order?
b.
If Koala Products offers Quality Produce a 10%
discount off the delivered price for minimum orders
of 50,000 bottles what should Quality Produce do?
105
Part 11 – Review question: Economic order quantity
Question 2 June, 1989 exam
Handout page 17
a.
How many bottles should Quality Produce request
in each order?
b.
If Koala Products offers Quality Produce a 10%
discount off the delivered price for minimum orders
of 50,000 bottles what should Quality Produce do?
106
MA1 – MODULE 9
Part 12
Review questions:
Multiple Choice Questions
(download the additional questions handout:
ma1_mod9_handout1.pdf)
107
Part 12 – Review questions: Multiple choice
Multiple choice questions
Handout pages 18 thru 20
Now working on page 18
Q1 What is the affect of the decision on EOQ?
Q2 If the division were discontinued how much would
IPM’s income increase?
Q3 What is the EOQ for Popcorn Co.
Q4 Which would not be relevant to the closure decision?
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
108
Part 12 – Review questions: Multiple choice
Multiple choice questions
Handout pages 18 thru 20
Now working on page 19
Q5 What type of cost is machine amortization?
Q6 Which is not a relevant cost?
Q7 Which is the appropriate decision and related cost?
109
Part 12 – Review questions: Multiple choice
Multiple choice questions
Handout pages 18 thru 20
Now working on page 20
Q8 How many units of the standard and deluxe models
should be produced?
Q9 What should be considered when deciding whether to
accept or reject the order?
110