FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Managerial Accounting
Profit Planning : Setting Standard in
Decision Making
Assoc. Prof. Dr. Mohd Fuad Mohd Salleh
fuadsalleh@unisel.edu.my
019-332 6629
1st. Sept. 2012
1
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
1. Standard
2. Profit Planning
3. Decision Making
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Nurturing professionals with high moral and ethical values
Standard
Standards are benchmarks or “norms”
for measuring performance. Two types
of standards are commonly used.
Quantity standards
specify how much of an
input should be used to
make a product or
provide a service.
Cost (price)
standards specify
how much should be
paid for each unit
of the input.
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Standard Costs
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Amount
Deviations from standards deemed significant
are brought to the attention of management, a
practice known as management by exception.
Standard
Direct
Labor
Direct
Material
Manufacturing
Overhead
Type of Product Cost
Exhibit
FACULTY OF BUSINESS
10-1
Nurturing professionals with high moral and ethical values
Variance Analysis Cycle
Identify
questions
Receive
explanations
Take
corrective
actions
Conduct next
period’s
operations
Analyze
variances
Prepare standard
cost performance
report
Begin
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Setting Standard Costs
Accountants, engineers, purchasing
agents, and production managers
combine efforts to set standards that encourage
efficient future production.
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Setting Standard Costs
Should we use
ideal standards that
require employees to
work at 100 percent
peak efficiency?
Engineer
I recommend using practical
standards that are currently
attainable with reasonable and
efficient effort.
Managerial
Accountant
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Setting Standards
Price
Standards
Quantity
Standards
Final, delivered
cost of materials,
net of discounts.
Summarized in
a Bill of Materials.
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Setting Standards
Six Sigma advocates have sought to
eliminate all defects and waste, rather than
continually build them into standards.
As a result allowances for waste and
spoilage that are built into standards
should be reduced over time.
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Setting Direct Labor Standards
Rate
Standards
Time
Standards
Often a single
rate is used that reflects
the mix of wages earned.
Use time and
motion studies for
each labor operation.
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Setting Variable Overhead Standards
Rate
Standards
Activity
Standards
The rate is the
variable portion of the
predetermined overhead
rate.
The activity is the
base used to calculate
the predetermined
overhead.
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A standard cost card for one unit of
product might look like this:
Inputs
Direct materials
Direct labor
Variable mfg. overhead
Total standard unit cost
A
B
AxB
Standard
Quantity
or Hours
Standard
Price
or Rate
Standard
Cost
per Unit
3.0 lbs.
2.5 hours
2.5 hours
$ 4.00 per lb.
$
14.00 per hour
3.00 per hour
$
12.00
35.00
7.50
54.50
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Standards vs. Budgets
Are standards the
same as budgets?
A budget is set for
total costs.
A standard is a per
unit cost.
Standards are often
used when
preparing budgets.
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Price and Quantity Standards
Price and and quantity standards are
determined separately for two reasons:
The purchasing manager is responsible for raw
material purchase prices and the production manager
is responsible for the quantity of raw material used.
The buying and using activities occur at different times.
Raw material purchases may be held in inventory for a
period of time before being used in production.
FACULTY OF BUSINESS
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A General Model for Variance Analysis
Variance Analysis
Price Variance
Quantity Variance
Difference between
actual price and
standard price
Difference between
actual quantity and
standard quantity
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A General Model for Variance Analysis
Variance Analysis
Price Variance
Quantity Variance
Materials price variance
Labor rate variance
VOH spending variance
Materials quantity variance
Labor efficiency variance
VOH efficiency variance
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A General Model for Variance Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
A General Model for Variance Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
Actual quantity is the amount of direct
materials, direct labor, and variable
manufacturing overhead actually used.
FACULTY OF BUSINESS
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A General Model for Variance Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
Standard quantity is the standard quantity
allowed for the actual output of the period.
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A General Model for Variance Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
Actual price is the amount actually
paid for the input used.
FACULTY OF BUSINESS
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A General Model for Variance Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
Standard price is the amount that should
have been paid for the input used.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
A General Model for Variance Analysis
Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Price Variance
Standard Quantity
×
Standard Price
Quantity Variance
(AQ × AP) – (AQ × SP)
(AQ × SP) – (SQ × SP)
AQ = Actual Quantity
AP = Actual Price
SP = Standard Price
SQ = Standard Quantity
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Material Variances Example
Glacier Peak Outfitters has the following direct material
standard for the fiberfill in its mountain parka.
0.1 kg. of fiberfill per parka at $5.00 per kg.
Last month 210 kgs of fiberfill were purchased and used to
make 2,000 parkas. The material cost a total of $1,029.
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Material Variances Summary
Actual Quantity
×
Actual Price
210 kgs.
×
$4.90 per kg.
= $1,029
Actual Quantity
×
Standard Price
210 kgs.
×
$5.00 per kg.
= $1,050
Price variance
$21 favorable
Standard Quantity
×
Standard Price
200 kgs.
×
$5.00 per kg.
= $1,000
Quantity variance
$50 unfavorable
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Actual Quantity
×
Actual Price
210 kgs.
×
$4.90 per kg.
= $1,029
Actual Quantity
×
Standard Price
210 kgs.
× 210 kgs =
$1,029 ÷
$5.00
$4.90 per
perkg.
kg
= $1,050
Price variance
$21 favorable
Standard Quantity
×
Standard Price
200 kgs.
×
$5.00 per kg.
= $1,000
Quantity variance
$50 unfavorable
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Actual Quantity
×
Actual Price
Actual Quantity
×
Standard Price
Standard Quantity
×
Standard Price
210 kgs.
210 kgs.
200 kgs.
×
× × 2,000 parkas = ×
0.1 kg per parka
$4.90 per kg.
$5.00
per
kg.
$5.00 per kg.
200
kgs
= $1,029
= $1,050
Price variance
$21 favorable
= $1,000
Quantity variance
$50 unfavorable
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Material Variances:
Using the Factored Equations
Materials price variance
MPV = AQ (AP - SP)
= 210 kgs ($4.90/kg - $5.00/kg)
= 210 kgs (-$0.10/kg)
= $21 F
Materials quantity variance
MQV = SP (AQ - SQ)
= $5.00/kg (210 kgs-(0.1 kg/parka× 2,000 parkas))
= $5.00/kg (210 kgs - 200 kgs)
= $5.00/kg (10 kgs)
= $50 U
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Isolation of Material Variances
I need the price variance
sooner so that I can better
identify purchasing problems.
You accountants just don’t
understand the problems that
purchasing managers have.
I’ll start computing
the price variance
when material is
purchased rather than
when it’s used.
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Material Variances
High Hill purchased and
used 1,700 pounds. How
are the variances
computed if the amount
purchased differs from
the amount used?
The price variance is
computed on the entire
quantity purchased.
The quantity variance
is computed only on
the quantity used.
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Responsibility for Material Variances
Materials Quantity Variance
Production Manager
Materials Price Variance
Purchasing Manager
The standard price is used to compute the quantity variance
so that the production manager is not held responsible for
the purchasing manager’s performance.
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Responsibility for Material Variances
I am not responsible for
this unfavorable material
quantity variance.
You purchased cheap
material, so my people
had to use more of it.
Your poor scheduling
sometimes requires me to
rush order material at a higher
price, causing unfavorable
price variances.
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Zippy
Exercise
High Hill Bhd. has the following direct material standard
to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week, 1,700 pounds of material were purchased and
used to make 1,000 Zippies. The material cost a total of
$6,630.
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Zippy
Exercise
High Hill’s material price variance (MPV)
for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
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Zippy
Exercise
High Hill’s material price variance (MPV)
for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable. MPV = AQ(AP - SP)
MPV = 1,700 lbs. × ($3.90 - 4.00)
MPV = $170 Favorable
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Zippy
Exercise
High Hill’s material quantity variance (MQV)
for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
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Zippy
Exercise
High Hill’s material quantity variance (MQV)
for the week was:
a. $170 unfavorable.
b. $170 favorable.
c. $800 unfavorable.
d. $800 favorable.
MQV = SP(AQ - SQ)
MQV = $4.00(1,700 lbs - 1,500 lbs)
MQV = $800 unfavorable
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Zippy
Exercise
Actual Quantity
×
Actual Price
1,700 lbs.
×
$3.90 per lb.
= $6,630
Actual Quantity
×
Standard Price
1,700 lbs.
×
$4.00 per lb.
= $ 6,800
Price variance
$170 favorable
Standard Quantity
×
Standard Price
1,500 lbs.
×
$4.00 per lb.
= $6,000
Quantity variance
$800 unfavorable
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Zippy
High Hill Bhd. has the following material standard to
manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Last week, 2,800 pounds of material were purchased at a
total cost of $10,920, and 1,700 pounds were used to make
1,000 Zippies.
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Zippy
Actual Quantity
Purchased
×
Actual Price
2,800 lbs.
×
$3.90 per lb.
= $10,920
Actual Quantity
Purchased
×
Standard Price
2,800 lbs.
×
$4.00 per lb.
= $11,200
Price variance
$280 favorable
Price variance increases
because quantity
purchased increases.
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Zippy
Actual Quantity
Used
Standard Quantity
×
×
Standard Price
Standard Price
1,700 lbs.
×
$4.00 per lb.
= $6,800
Quantity variance is
unchanged because actual
and standard quantities
are unchanged.
1,500 lbs.
×
$4.00 per lb.
= $6,000
Quantity variance
$800 unfavorable
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Understanding the
processes of profit
planning.
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Planning and Control
Planning –
involves developing
objectives and preparing
various budgets to achieve
these objectives.
Control –
involves the steps taken by
management that attempt
to ensure the objectives are
attained.
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The Basic Framework of Budgeting
A budget is a detailed quantitative plan for
acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activity is known as
budgetary control.
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Advantages of Budgeting
Define goal
and objectives
Communicate
plans
Think about and
plan for the future
Advantages
Coordinate
activities
Means of allocating
resources
Uncover potential
bottlenecks
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Responsibility Accounting
Managers should be held responsible for those items —
and only those items — that
the manager can actually control
to a significant extent.
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Self-Imposed Budget
Top Management
Middle
Management
Supervisor
Supervisor
Middle
Management
Supervisor
Supervisor
A budget is prepared with the full cooperation and
participation of managers at all levels. A participative
budget is also known as a self
self--imposed budget.
budget.
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Advantages of Self-Imposed Budgets
1. Individuals at all levels of the organization are viewed as
members of the team whose judgments are valued by top
management.
2. Budget estimates prepared by frontfront-line managers are
often more accurate than estimates prepared by top
managers.
3. Motivation is generally higher when individuals
participate in setting their own goals than when the goals
are imposed from above.
4. A manager who is not able to meet a budget imposed
from above can claim that it was unrealistic. SelfSelf-imposed
budgets eliminate this excuse.
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Self-Imposed Budgets
Most companies do not rely exclusively upon
self--imposed budgets in the sense that top
self
managers usually initiate the budget process by
issuing broad guidelines in terms of overall
profits or sales.
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Human Factors in Budgeting
The success of budgeting depends upon three important
factors:
1. Top management must be enthusiastic and committed
to the budget process.
2. Top management must not use the budget to pressure
employees or blame them when something goes wrong.
3. Highly achievable budget targets are usually preferred
when managers are rewarded based on meeting budget
targets.
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The Budget Committee
A standing committee responsible for
overall policy matters relating to the
budget
coordinating the preparation of the
budget
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The Master Budget: An Overview
Ending
Finished Goods
Budget
Direct
Materials
Budget
Sales
Budget
Production
Budget
Selling and
Administrative
Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget
Cash
Budget
Budgeted Financial Statements
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Learning Objective 2
Preparing a sales budget
and schedule of expected
cash collections.
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Budgeting Example
Royal Company is preparing budgets for the
quarter ending June 30.
Budgeted sales for the next five months are:
April
20,000 units
May
50,000 units
June
30,000 units
July
25,000 units
August 15,000 units.
The selling price is $10 per unit.
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The Sales Budget
The individual months of April, May, and June are
summed to obtain the total projected sales in units and
dollars for the quarter ended June 30th
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Expected Cash Collections
All sales are on account.
Royal’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% uncollectible.
The March 31 accounts receivable balance of
$30,000 will be collected in full.
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Expected Cash Collections
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Expected Cash Collections
From the Sales Budget for April.
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Expected Cash Collections
From the Sales Budget for May.
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Exercise What will be the total cash collections for the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
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Exercise What will be the total cash collections for the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
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Expected Cash Collections
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Relevant and irrelevant
costs and benefits in
decision making process.
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Cost Concepts for Decision Making
A relevant cost is a cost that differs between
alternatives.
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Identifying Relevant Costs
An avoidable cost can be eliminated, in whole or in part,
by choosing one alternative over another. Avoidable
costs are relevant costs. Unavoidable costs are
irrelevant costs.
Two broad categories of costs are never relevant in any
decision. They include
include::
Sunk costs.
Future costs that do not differ between the alternatives.
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Relevant Cost Analysis: A Two-Step Process
Step 1 Eliminate costs and benefits that do not differ
between alternatives.
Step 2 Use the remaining costs and benefits that differ
between alternatives in making the decision. The
costs that remain are the differential, or avoidable,
costs.
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Different Costs for Different Purposes
Costs that are
relevant in one
decision situation
may not be relevant
in another context.
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Identifying Relevant Costs
Veronica, a Penang student, is considering visiting her friend in Kuala
Lumpur. She can drive or take the train. By car, it is 230 miles to her
friend’s apartment. She is trying to decide which alternative is less
expensive and has gathered the following information:
Automobile Costs (based on 10,000 miles driven per year)
1
2
3
4
5
6
Annual straight-line depreciation on car
Cost of gasoline
Annual cost of auto insurance and license
Maintenance and repairs
Parking fees at school
Total average cost
$45 per month × 8 months
Annual Cost
of Fixed Items
$
2,800
1,380
360
Cost per
Mile
$
0.280
0.050
0.138
0.065
0.036
$
0.569
$1.60 per gallon ÷ 32 MPG
$18,000 cost – $4,000 salvage value ÷ 5 years
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Identifying Relevant Costs
Automobile Costs (based on 10,000 miles driven per year)
1
2
3
4
5
6
Annual straight-line depreciation on car
Cost of gasoline
Annual cost of auto insurance and license
Maintenance and repairs
Parking fees at school
Total average cost
7
8
9
10
11
12
13
Annual Cost
of Fixed Items
$
2,800
1,380
360
Cost per
Mile
$
0.280
0.050
0.138
0.065
0.036
$
0.569
Some Additional Information
Reduction in resale value of car per mile of wear
Round-tip train fare
Benefits of relaxing on train trip
Cost of putting dog in kennel while gone
Benefit of having car in New York
Hassle of parking car in New York
Per day cost of parking car in New York
$ 0.026
$
104
????
$
40
????
????
$
25
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Identifying Relevant Costs
Which costs and benefits are relevant in Veronica’s
decision?
The cost of the
car is a sunk cost
and is not
relevant to the
current decision.
The annual cost of
insurance is not
relevant. It will remain
the same if she drives or
takes the train.
However, the cost of gasoline is clearly relevant
if she decides to drive. If she takes the train, the
cost would now be incurred, so it varies
depending on the decision.
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Identifying Relevant Costs
Which costs and benefits are relevant in Veronica’s
decision?
The cost of
maintenance and
repairs is relevant. In
the long-run these
costs depend upon
miles driven.
The monthly
school parking
fee is not relevant
because it must
be paid if
Veronica drives or
takes the train.
At this point, we can see that some of the average cost
of $0.569 per mile are relevant and others are not.
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Identifying Relevant Costs
Which costs and benefits are relevant in Veronica’s
decision?
The decline in resale
value due to additional
miles is a relevant cost.
The round-trip train
fare is clearly relevant.
If she drives the cost
can be avoided.
Relaxing on the train is
relevant even though it
is difficult to assign a
dollar value to the
benefit.
The kennel cost is not
relevant because
Veronica will incur the
cost if she drives or
takes the train.
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Identifying Relevant Costs
Which costs and benefits are relevant in Veronica’s
decision?
The cost of parking is
relevant because it can
be avoided if she takes
the train.
The benefits of having a car in Kuala Lumpur
and the problems of finding a parking space
are both relevant but are difficult to assign a
dollar amount.
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Identifying Relevant Costs
From a financial standpoint, Veronica would be
better off taking the train to visit her friend. Some of
the non-financial factor may influence her final
decision.
Relevant Financial Cost of Driving
Gasoline (460 @ $0.050 per mile)
Maintenance (460 @ $0.065 per mile)
Reduction in resale (460 @ $0.026 per mile)
Parking in New York (2 days @ $25 per day)
Total
$ 23.00
29.90
11.96
50.00
$ 114.86
Relevant Financial Cost of Taking the Train
Round-trip ticket
$ 104.00
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Total and Differential Cost Approaches
The management of a company is considering a new labor saving machine
that rents for $3,000 per year. Data about the company’s annual sales and
costs with and without the new machine are:
Sales (5,000 units @ $40 per unit)
Less variable expenses:
Direct materials (5,000 units @ $14 per unit)
Direct labor (5,000 units @ $8 and $5 per unit)
Variable overhead (5,000 units @ $2 per unit)
Total variable expenses
Contribution margin
Less fixed expense:
Other
Rent on new machine
Total fixed expenses
Net operating income
Current
Situation
$
200,000
Situation
With New
Machine
$
200,000
Differential
Costs and
Benefits
-
70,000
40,000
10,000
120,000
80,000
70,000
25,000
10,000
105,000
95,000
15,000
15,000
62,000
62,000
18,000
62,000
3,000
65,000
30,000
(3,000)
(3,000)
12,000
$
$
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Total and Differential Cost Approaches
As you can see, the only costs that differ between the
alternatives are the direct labor costs savings and the increase
in fixed rental costs.
Current
Situation
$
200,000
Situation
With New
Machine
$
200,000
Differential
Costs and
Benefits
-
70,000
40,000
10,000
120,000
80,000
70,000
25,000
10,000
105,000
95,000
15,000
15,000
We can efficiently analyze the decision by 62,000
62,000
looking at the different costs and revenues
$
18,000
and arrive at the same solution.
62,000
3,000
65,000
30,000
(3,000)
(3,000)
12,000
Sales (5,000 units @ $40 per unit)
Less variable expenses:
Direct materials (5,000 units @ $14 per unit)
Direct labor (5,000 units @ $8 and $5 per unit)
Variable overhead (5,000 units @ $2 per unit)
Total variable expenses
Contribution margin
Less fixed expense:
Other
Rent on new machine
Total fixed expenses
Net operating income
Net Advantage to Renting the New Machine
Decrease in direct labor costs (5,000 units @ $3 per unit)
Increase in fixed rental expenses
Net annual cost saving from renting the new machine
$
$
15,000
(3,000)
12,000
$
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of Constrained /
Scare / Limited Resources
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
When a constraint exists, a company should select
a product mix that maximizes the total
contribution margin earned since fixed costs
usually remain unchanged.
A company should not necessarily promote those
products that have the highest unit contribution
margin.
Rather, it should promote those products that earn
the highest contribution margin in relation to the
constraining resource.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
Design Company produces two products and selected
data are shown below:
Product
2
1
Selling price per unit
Less variable expenses per unit
Contribution margin per unit
Current demand per week (units)
Contribution margin ratio
Processing time required
on machine A1 per unit
$
60
36
$ 24
2,000
40%
1.00 min.
$
50
35
$ 15
2,200
30%
0.50 min.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
Machine A1 is the constrained resource and is
being used at 100% of its capacity.
There is excess capacity on all other machines.
Machine A1 has a capacity of 2,400 minutes per
week.
Should Design focus its efforts on
Product 1 or Product 2?
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Exercise How many units of each product can be processed
through Machine A1 in one minute?
Product 1
a.
b.
c.
d.
1 unit
1 unit
2 units
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
How many units of each product can be
processed through Machine A1 in one minute?
Product 1
a.
1 unit
b.
1 unit
c.
2 units
d.
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
How many units of each product can be
processed through Machine A1 in one minute?
Product 1
a.
1 unit
b.
1 unit
c.
2 units
d.
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
I was just checking to make sure you
are with us.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
What generates more profit for the company, using one
minute of machine A1 to process Product 1 or using one
minute of machine A1 to process Product 2?
a. Product 1
b. Product 2
c. They both would generate the same profit.
d. Cannot be determined.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
With one minute of machine A1, we could make 1
unit of Product 1, with a contribution margin of
or 2 more
units profit
of Product
each with
a one
What $24,
generates
for the2,
company,
using
minute of machine
A1 to process
Product
1 or using one
contribution
margin
of $15.
minute of machine A1 to process Product 2?
2 × $15 = $30 > $24
a. Product 1
b. Product 2
c. They both would generate the same profit.
d. Cannot be determined.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
The key is the contribution margin per unit of the
constrained resource.
Product
1
Contribution margin per unit
Time required to produce one unit
Contribution margin per minute
2
$
÷
24
$
15
1.00 min. ÷
0.50 min.
$
24
$
30
Product 2 should be emphasized. Provides more
valuable use of the constrained resource machine A1,
yielding a contribution margin of $30 per minute as
opposed to $24 for Product 1.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
The key is the contribution margin per unit of the
constrained resource.
Product
1
Contribution margin per unit
Time required to produce one unit
Contribution margin per minute
2
$
÷
24
$
15
1.00 min. ÷
0.50 min.
$
24
$
30
If there are no other considerations, the best plan
would be to produce to meet current demand for
Product 2 and then use remaining capacity to
make Product 1.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Utilization of a Constrained Resource
According to the plan, we will produce 2,200 units
of Product 2 and 1,300 of Product 1. Our
contribution margin looks like this.
Production and sales (units)
Contribution margin per unit
Total contribution margin
Product 1
1,300
$
24
$ 31,200
Product 2
2,200
$
15
$ 33,000
The total contribution margin for Design is $64,200.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Interior Design makes reproduction colonial furniture
from select hardwoods.
C hairs
Selling price per unit
$80
$30
Variable cost per unit
Board feet per unit
2
M onthly dem and
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only be able
to supply 2,000 board feet this month. Is this enough
hardwood to satisfy demand?
a. Yes
b. No
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Interior Design makes reproduction colonial furniture
from select hardwoods.
C hairs
Selling price per unit
$80
$30
Variable cost per unit
Board feet per unit
2
M onthly dem and
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only be able
to supply 2,000 board feet this month. Is this enough
hardwood to satisfy demand?
a. Yes
b. No
(2 × 600) + (10 × 100 ) = 2,200 > 2,000
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
C hairs
S elling price per unit
$80
V ariable cost per unit
$30
B oard feet per unit
2
M onthly dem and
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only be
able to supply 2,000 board feet this month. What
plan would maximize profits?
a. 500 chairs and 100 tables
b. 600 chairs and 80 tables
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Chairs Tables
Selling price
$ 80 $ 400
C hairs Tables
200
Variable
S elling price per
unit cost$80
$400 30
$30
V ariable cost Contribution
per unit
margin $200
$ 50 $ 200
B oard feet perBoard
unit feet
2
10 2
10
M onthly dem and
600
100
CM per board foot
$ 25 $ 20
The company’s supplier of hardwood will only be
Production
of chairs
600What
able to supply 2,000
board feet
this month.
Board
feet required
1,200
plan would maximize
profits?
Board
feet remaining
800
a. 500 chairs and 100
tables
Board feet per table
10
b. 600 chairs and Production
80 tables of tables
80
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
As before, Interior Design’s supplier of hardwood will only
be able to supply 2,000 board feet this month. Assume the
company follows the plan we have proposed. Up to how
much should Interior Design be willing to pay above the
usual price to obtain more hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
As before, Interior Design’s supplier of hardwood will only
The
additional
wood
would
bemonth.
used to
make
be
able
to supply 2,000
board
feet this
Assume
the
company
follows
weeach
have proposed.
Up to
tables.
In the
thisplan
use,
board foot
ofhow
much shouldwood
Interior
Design
be willing
to pay above
additional
will
allow
the company
to the
earn
usual
price to obtain
hardwood?
an
additional
$20more
of contribution
margin and
a. $40 per board foot profit.
b. $25 per board foot
c. $20 per board foot
d. Zero
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Managing Constraints
Finding ways to
process more units
through a resource
bottleneck
At the bottleneck itself:
• Improve the process
• Add overtime or another shift
• Hire new workers or acquire
more machines
• Subcontract production
• Reduce amount of defective
units produced
• Add workers transferred from
non--bottleneck departments
non
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Decision Making: SplitSplit-off
Point or Processed Further.
urther.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Joint Costs
In some industries, a number of end
products are produced from a single raw
material input.
Two or more products produced from a
common input are called joint products.
products
The point in the manufacturing process
where each joint product can be
recognized as a separate product is called
the split
split--off point
point.
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Nurturing professionals with high moral and ethical values
Joint Products
Oil
Joint
Input
Common
Production
Process
Gasoline
Chemicals
Split-Off
SplitPoint
FACULTY OF BUSINESS
Joint Products
Joint
Costs
Joint
Input
Common
Production
Process
Nurturing professionals with high moral and ethical values
Oil
Gasoline
Chemicals
Split-Off
SplitPoint
Separate
Processing
Final
Sale
Final
Sale
Separate
Processing
Separate
Product
Costs
Final
Sale
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
The Pitfalls of Allocation
Joint costs are often allocated
to end products on the basis
of the relative sales value of
each product or on some
other basis.
Allocation is needed for some
purpose such as balance sheet
inventory valuation, but
allocations of this kind are very
dangerous for decision making.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Sell or Process Further
Joint costs are irrelevant in decisions regarding
what to do with a product from the splitsplit-off
point forward.
It will always be profitable to continue processing
a joint product after the splitsplit-off point so long
as the incremental revenue exceeds the
incremental processing costs incurred after the
split--off point
split
point..
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Nurturing professionals with high moral and ethical values
Sell or Process Further
Timberland Bhd. cuts logs from which
unfinished lumber and sawdust are the
immediate joint products.
Unfinished lumber is sold “as is” or processed
further into finished lumber.
Sawdust can also be sold “as is” to gardening
wholesalers or processed further into “presto“prestologs.”
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Nurturing professionals with high moral and ethical values
Sell or Process Further
Data about Timberland’s joint products includes:
Sales value at the split-off point
Sales value after further processing
Allocated joint product costs
Cost of further processing
Per Log
Lumber
Sawdust
$
140
$
40
270
176
50
50
24
20
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Sell or Process Further
Analysis of Sell or Process Further
Per Log
Lumber
Sales value after further processing
Sales value at the split-off point
Incremental revenue
$
270
140
130
Sawdust
$
50
40
10
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Sell or Process Further
Analysis of Sell or Process Further
Per Log
Lumber
Sales value after further processing
Sales value at the split-off point
Incremental revenue
Cost of further processing
Profit (loss) from further processing
$
$
270
140
130
50
80
Sawdust
$
$
50
40
10
20
(10)
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Sell or Process Further
Analysis of Sell or Process Further
Per Log
Lumber
Sales value after further processing
Sales value at the split-off point
Incremental revenue
Cost of further processing
Profit (loss) from further processing
$
$
270
140
130
50
80
Sawdust
$
$
Should we process the lumber further
and sell the sawdust “as is?”
50
40
10
20
(10)
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Ends of Discussion