Managerial Accounting for Business Professionals ACC 330 UNIT 5 Dr. Doug Letsch I am online waiting for the live session to begin. If you have a general question, please ask it in the chat window. The only talking you will here is when I welcome someone who has just signed in. If you don’t hear me welcoming everyone, please adjust your speakers. Let me know if you have problems. Thanks, Dr. Doug

Clean Up Incremental Analysis & Costs Types of Analysis Questions

CLEAN UP When you are an instructor, you get used to excuses! To see a couple of the excuses I have seen click on the link below and have a little fun! What is your favorite excuse?

INCREMENTAL ANALYSIS Review possible scenarios, the financial impact of each, and then make a decision !

INCREMENTAL ANALYSIS – COSTS TO CONSIDER Relevant, Sunk, or Opportunity Cost Relevant: Only those costs or revenues that change between alternatives are relevant. Sunk: Prior costs or cash outlays that will not change between alternatives are NOT relevant. Opportunity: What you give up when you choose one alternative.

INCREMENTAL ANALYSIS – COSTS TO CONSIDER Relevant, Sunk, or Opportunity Cost Relevant: Only those costs or revenues that change between alternatives are relevant. Sunk: Prior costs or cash outlays that will not change between alternatives are NOT relevant. Opportunity: What you give up when you choose one alternative. Type an example of each in your chat area If you are buying shoes how would you apply these terms to the picture?

Incremental analysis is the process of identifying the financial data that: a.Do not change under alternative courses of action. b. Change under alternative courses of action. c. Are mixed under alternative courses of action. d. No correct answer is given. Poll Question Select your answer on the poll question. Remember to get credit you must answer all poll questions during a session.

Incremental analysis is the process of identifying the financial data that: a.Do not change under alternative courses of action. b. Change under alternative courses of action. c. Are mixed under alternative courses of action. d. No correct answer is given. Poll Question Select your answer on the poll question. Remember to get credit you must answer all poll questions during a session.

TYPES OF INCREMENTAL ANALYSIS Accept an order at a special price. Make or buy components or finished products. Sell products or process further. Retain or replace equipment. Eliminate an unprofitable business segment. Allocate limited resources

TYPES OF INCREMENTAL ANALYSIS-SPECIAL PRICE ORDER Price concessions to a specific customer. Sales of the product would not be affected. Company has capacity.

TYPES OF INCREMENTAL ANALYSIS- SPECIAL PRICE ORDER Big-Lots Co. offers to buy a special order of 3,000 pairs of shoes at $510 per pair from Jimmy Choo. Current fixed manufacturing costs = $1,600,000 or $200/Unit at 8,000 units Variable manufacturing cost = $400 per unit. Normal selling price = $750 per unit. Based strictly on total cost of $600 per unit ($200 + $400), reject offer as cost exceeds selling price of $510. However, what costs are relevant to this decision?

TYPES OF INCREMENTAL ANALYSIS- SPECIAL PRICE ORDER BigLotts Co. offers to buy a special order of 3,000 pairs of shoes at $510 per pair from Jimmy Choo. Current fixed manufacturing costs = $1,600,000 or $200/Unit at 8,000 units Variable manufacturing cost = $400 per unit. Normal selling price = $750 per unit. Based on assumed capacity there would be no change in fixed costs, so FC not relevant for this decision. Based on relevant costs of $400 per unit, accept offer as selling price of $510 exceeds relevant variable cost of $400. Profit of $330k on revenue of $1.53million! What could become a problem for the company?

TYPES OF INCREMENTAL ANALYSIS- MAKE OR BUY Management must decide whether to make or buy components. The decision to buy parts or services rather than making them is called outsourcing. Example: Costs to produce 25,000 heals for Choo Shoes at the company. Quantity to Make/Buy 25,000 Choo Soles Direct materials $ 375,000 Direct Labor $ 100,000 Variable manufacturing costs $ 25,000 Fixed manufacturing costs $ 75,000 Total manufacturing costs $ 575,000 Total Cost Per sole $575/25 $ 23.00

TYPES OF INCREMENTAL ANALYSIS- MAKE OR BUY Soles can be outsourced for $22.40 each (25,000 × $22.40 = $560,000). At first look, the soles should be purchased; thus saving $.60 per unit. Decision is to Outsource or Buy Quantity to M/B 25,000 Choo Soles Direct materials $ 375,000 Direct Labor $ 100,000 Variable manufacturing costs $ 25,000 Fixed manufacturing costs $ 75,000 Total manufacturing costs $ 575,000 Total Cost Per sole $ $22.4 vs $23.00 Save the $.60/sole or $15,000

TYPES OF INCREMENTAL ANALYSIS- MAKE OR BUY However, upon further investigation, all variable costs would be saved in outsourcing BUT some of the fixed cost would remain. In this case $40,000 of the original $75,000 of FC would remain; making $40k relevant and $35k NOT relevant! How does this change our analysis or decision? Quantity to M/B 25,000 Choo Soles Relevant fixed manuf. costs $ 40,000 Outsourced Price $22.4 $ 560,000 Total manufacturing costs $ 600,000 Total Cost Per sole $600/25 $ $22.4 vs $24.0 Make!! If you outsource, the relevant fixed costs increase by $40,000

TYPES OF INCREMENTAL ANALYSIS- OPPORTUNITY COSTS BigLotts Co. offers to buy a special order of 3,000 pairs of shoes at $510 per pair from Jimmy Choo. Current fixed manufacturing costs = $1,600,000 or $200/Unit at 8,000 units Variable manufacturing cost = $400 per unit. Normal selling price = $750 per unit. Now however, assume that there are choices for the use of excess capacity. That choice gives you opportunity cost. Making 3,000 additional shoes takes capacity!

TYPES OF INCREMENTAL ANALYSIS- OPPORTUNITY COSTS BigLotts Co. offers to buy a special order of 3,000 pairs of shoes at $510 per pair from Jimmy Choo. Current fixed manufacturing costs = $1,600,000 or $200/Unit at 8,000 units Variable manufacturing cost = $400 per unit. Normal selling price = $750 per unit. Question: What use of capacity makes the most return? Quantity to Make/Buy 3,000 Choo Shoes Direct materials $ 750,000 Direct Labor $ 450,000 Cur. Fixed manufacturing costs $ 600,000Capacity is: $1,600,00038% Total manufacturing costs $1,800,000 Total Cost per pair shoes $

TYPES OF INCREMENTAL ANALYSIS- SELL OR PROCESS Many manufacturers have the option of selling a product now or continuing to process hoping to sell at a higher price. Decision Rule: Process further as long as the incremental revenue from such processing exceeds the incremental processing costs. To see this in action, open up a new Internet Explorer window and enter the following hyperlink. View the video (5 minutes) and then return to answer a poll question. This question must be answered correctly to earn points for this seminar – so pay close attention.

In the video on YouTube Susan Crosson explained the concept of sale or process further. Which statement is true about that video? a.The pizza should be processed further b. The calzone should be processed further Poll Question Select your answer on the poll question. Remember to get credit you must answer all poll questions during a session.

In the video on YouTube Susan Crosson explained the concept of sale or process further. Which statement is true about that video? a.The pizza should be processed further b. The calzone should be processed further Poll Question Select your answer on the poll question. Remember to get credit you must answer all poll questions during a session.

TYPES OF INCREMENTAL ANALYSIS-RETAIN OR REPLACE Replace the equipment - Lower variable manufacturing costs more than offset cost of new equipment. The book value of the old machine does not affect the decision – it is a sunk cost. However, any trade-in allowance or cash disposal value of the old asset is relevant.

TYPES OF INCREMENTAL ANALYSIS-UNPROFITABLE SEGMENT Should the company eliminate an unprofitable segment? Key: Focus on relevant costs. Consider effect on related product lines. Fixed costs allocated to the unprofitable segment must be absorbed by the other segments. Net income may decrease when an unprofitable segment is eliminated. Decision Rule: Retain the segment unless eliminated fixed costs exceed the lost contribution margin.

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