Resource Allocation Decisions Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 9

Production Constraints Constraints occur when the capacity to manufacture a product or provide a service is limited in some manner  Examples  Labor  Skilled craftspeople  Facilities  Special machinery  Limited factory space  Materials  Limited availability 2

Influence of Constraints  Limited resources may cause management to focus on the constraint instead of the contribution margin per unit  Goal  Determine the most profitable allocation of resources  i.e., which product will contribute the most to profit 3

Decisions When Resources are Limited  If products are mutually exclusive  Occurs when events do not occur at the same time  i.e., a customer will buy one product instead of the other; does not insist that both be purchased  If products are not mutually exclusive  Occurs when customers insist on having more than one product available 4

Limited Resource Decisions When Products are Mutually Exclusive How to select products to produce/sell Step 1: Determine contribution margin per unit per constrained resource of each product or service Step 2: Choose the product/service with the highest CM per constrained resource to produce; Produce zero of the other products 5

Limited Resource Decisions When Multiple Product Production Required How to select products to produce/sell Step 1: Determine contribution margin per unit per constrained resource Step 2: Choose the product/service with the lowest CM per constrained resource to produce the product with the minimum quantity required Step 3: Determine the resource used for the product with minimum units Step 4: Subtract the resource to be used for the product with minimum units from the total resource available Step 5: Allocate the remaining resource to the second product 6

Mutually Exclusive Allocation WatCo manufactures and sells two products. Customers will buy either product with no demand on other products. There are 1,200 machine hours available. X21R45 Selling price$55$88 Variable costs$30$48 Machine hours Step 1: Contribution margin per unit of limited resource X21: ($55 - $30) / 2.5 hours = $10 /machine hour R45: ($88 - $48) / 4.2 hours = $9.52 /machine hour Step 2: Produce only the product with the best use of the resource. Product X21: 1,200/2.5 = 480 units Product R45: 0 units Product X21: 1,200/2.5 = 480 units Product R45: 0 units

Non-Mutually Exclusive Allocation WatCo must produce a minimum of 100 of each product. There are 1,200 machine hours available. X21R45 Selling price$55$88 Variable costs$30$48 Machine hours Step 1: Contribution margin per unit of limited resource X21: ($55 - $30) / 2.5 hours = $10 /machine hour R45: ($88 - $48) / 4.2 hours = $9.52 /machine hour Step 2: Produce minimum units of the least profitable product Product R45: 100 units Usage = 100 * 4.2 = 420 hours Product R45: 100 units Usage = 100 * 4.2 = 420 hours Step 3: Use all remaining resources on the most profitable product. Remaining hours: 1,200 – 420 = 780 Product X21: = 780/2.5 = 312 units Remaining hours: 1,200 – 420 = 780 Product X21: = 780/2.5 = 312 units

9 The End