1. Cost Management ACCOUNTING AND CONTROL
HANSEN & MOWEN

2. Activity Resource Usage Model And Tactical Decision Making
CHAPTER 18
Activity Resource Usage Model And Tactical Decision Making

3. The Tactical Decision-Making Process
OBJECTIVE 1
The Tactical Decision-Making Process
1. Recognize and define the problem.
2. Identify alternatives as possible solutions to the problem, and eliminate alternatives that are not feasible.
3. Identify the predicted costs and benefits associated with each feasible alternative. Eliminate the costs and benefits that are not relevant to the decision.
Continued

4. The Tactical Decision-Making Process
OBJECTIVE 1
The Tactical Decision-Making Process
4. Compare the relevant costs and benefits for each alternative, and then relate each alternative to the overall strategic goals of the firm and other important qualitative factors.
5. Select the alternative with the greatest benefit which also supports the organization’s strategic objectives.

5. 1 Tactical Decision Making Step 1: Define the Problem
OBJECTIVE 1
Step 1: Define the Problem
Each year 25 percent of the harvest by an apple processor is small and odd-shaped. These apples cannot be sold in the normal distribution channels and have simply been dumped in the orchards for fertilizer. What should the firm do with these apples?

6. 1 Tactical Decision Making Step 2: Identify Feasible Alternatives
OBJECTIVE 1
Step 2: Identify Feasible Alternatives
1. Sell the apples to pig farmers.
2. Bag the apples in five-pound bags and sell them to local supermarkets as seconds.
3. Rent a local canning facility and convert the apples to applesauce.
4. Rent a local canning facility and convert the apples to pie filling.
5. Continue with the current dumping practice.

7. 1 Tactical Decision Making
OBJECTIVE 1
Step 3: Predicting Costs and Benefits and Eliminating Irrelevant Costs
Labor and materials (bags and ties) for the bagging option would cost $0.05 per pound. A five-pound bag of apple could be sold for $1.30 to local supermarkets.
Making applesauce would cost $0.40 per pound for rent, labor, apples, cans, and other materials. It takes six pounds of apples to produce five, 16-ounce cans of applesauce. Each can sells for $0.78.

8. 1 Tactical Decision Making
OBJECTIVE 1
Step 4: Comparing Relevant Costs and Relating to Strategic Goals.
The bagging alternative costs $0.25 to produce a five-pound bag ($0.05 x 5 pounds). The revenue is $1.30 per bag, or $0.26 per pound. The net benefit is $0.21 per pound ($0.26 – $0.05).
The net benefit of converting the apples into applesauce is $0.25 per pound ($0.65 – $0.40).

9. 1 Tactical Decision Making Step 5: Select Best Alternative.
OBJECTIVE 1
Step 5: Select Best Alternative.
Since the apple producer is reluctant to follow a forward integration strategy, the bagging alternative should be chosen.

10. Decision Model: Tactical Decision-Making Process
OBJECTIVE 1
Decision Model: Tactical Decision-Making Process
Step 1
Example
What to do with small, ill-shaped apples.
Step 2
1. Sell to pig farmers.
2. Sell bagged apples (feasible).
3. Make applesauce (feasible).
4. Make pie filling.
5. Continue dumping.
Continued

11. 1 Tactical Decision Making Bagged alternative: Step 3
OBJECTIVE 1
Bagged alternative:
a. Revenue $1.30 per bag ($0.26 per pound)
b. Cost $0.05 per pound
Applesauce alternative:
a. Revenue: $0.78 per can ($0.65 per pound)
b. Cost: $0.40 per pound
Step 3
Step 4
Bagged Applesauce
Revenue $0.26 $0.65
Cost
Net benefit $0.21 $0.25
Bagged: Differentiation
Applesauce: Forward integration
Continued

12. 1 Tactical Decision Making Step 5
OBJECTIVE 1
Step 5
Select bagging alternative because it is profitable and is more consistent with strategic positioning desired by producer.

13. 2 Relevant Costs and Revenues
OBJECTIVE 2
Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but must also differ between alternatives.

14. 2 Relevant Costs and Revenues Sunk costs are past costs.
OBJECTIVE 2
Sunk costs are past costs.
Example: The original cost of a building is a sunk cost when you are trying to decide whether or not to sell the business five years later.

15. Relevancy, Cost Behavior, and the Activity Resource Usage Model
OBJECTIVE 3
Flexible resources can be easily purchased in the amount needed and at the time of use… like electricity.

16. 3 Flexible Resources a. Demand Changes Relevant
Relevancy, Cost Behavior, and the Activity Resource Usage Model
OBJECTIVE 3
Flexible Resources
a. Demand Changes
Relevant
b. Demand Constant Not Relevant

17. Relevancy, Cost Behavior, and the Activity Resource Usage Model
OBJECTIVE 3
Committed resources are purchased before they are used, such as salaried employees.

18. Supply – Demand = Unused Capacity
Relevancy, Cost Behavior, and the Activity Resource Usage Model
OBJECTIVE 3
Committed Resources
Supply – Demand = Unused Capacity
a. Demand Increase < Unused Capacity Not relevant
b. Demand Increase > Unused Capacity Relevant
c. Demand Decease (Permanent)
Activity Capacity Reduced Relevant
Activity Capacity Unchanged Not Relevant

19. 3 Relevancy, Cost Behavior, and the Activity Resource Usage Model
OBJECTIVE 3
A company has five manufacturing engineers who supply a capacity of 10,000 engineering hours (2,000 hours each). The cost of this activity capacity is $250,000, or $25 per hour. The firm expects to use 9,000 hours. If the firm decides to reject a special order requiring 500 hours, the cost of engineering would be irrelevant.

20. Relevancy, Cost Behavior, and the Activity Resource Usage Model
OBJECTIVE 3
The firm can purchase a component that will drop the demand from engineering hours from 9,000 to 7,000. Since engineering activity capacity is acquired in chunks of 2,000, the company can lay off one engineer or reassign the engineer to another plant.

21. Resource demand and Supply
Relevancy, Cost Behavior, and the Activity Resource Usage Model
OBJECTIVE 3
Resource demand and Supply

22. Assumptions of C-V-P Analysis
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Assumptions of C-V-P Analysis
1. The analysis assumes a linear revenue function and a linear cost function.
2. The analysis assumes that price, total fixed costs, and unit variable costs can be accurately identified and remain constant over the relevant range.
3. The analysis assumes that what is produced is sold.
4. For multiple-product analysis, the sales mix is assumed to be known.
5. The selling price and costs are assumed to be known with certainty.

23. 4 Make or Buy Keep or Drop Special Order Sell or Process Further
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Make or Buy
Keep or Drop
Special Order
Sell or Process Further
Important: Short-term Perspective

24. Make-or-Buy Decisions
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Make-or-Buy Decisions
Talmage Company produces a mechanical part used in one of its engines. (Talmage produces engines for snowblowers.) An outside supplier has offered to sell a part (Part 34B) for $ The company normally produces 100,000 units of the part each year.

25. ABC Make-or-Buy Analysis: Talmage Company
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
ABC Make-or-Buy Analysis: Talmage Company
Buy the part!

26. 4 Make the part! Illustrative Examples of Tactical Decision Making
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Functional-Based Make-or-Buy Analysis: Talmage Company
Make the part!

27. 4 Illustrative Examples of Tactical Decision Making
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
ABC Segmented Income Statement
DROP?

28. Dropping the product saves $45,000!
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
ABC Keep-or-Drop Analysis
Dropping the product saves $45,000!

29. 4 Special-Order Cost Illustrative Examples of Tactical Decision Making
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Special-Order Cost
Polarcreme, Inc., an ice-cream company, is operating at 80 percent of its 20 million half-gallon capacity. A distributor from another geographically area offered to buy 2 million units of premium ice cream at $1.75 per unit. They have agreed to provide their own label and pay transportation costs. This sale would avoid a sales commission.

30. Which costs are irrelevant?
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Special-Order Cost
Variable costs:
Dairy ingredients $0.70
Sugar 0.10
Flavoring 0.15
Direct labor 0.25
Packaging 0.20
Commissions 0.02
Distribution 0.03
Other
Total unit-level costs $1.50
Which costs are irrelevant?
$1.45

31. OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Special-Order Cost
The nonunit-level variable costs will also be incurred, producing a total increment cost of $304,000 or $0.152 per unit (for an order of 2 million units). Revenue per unit of $1.75, less the unit-level variable cost ($1.45) plus the nonunit-level variable cost ($0.152) provides a net benefit of $0.148 per unit. Thus Polarcreme’s profit would increase by $296,000 ($0.148 x 2,000,000).

32. Sell or Process Further
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Sell or Process Further
Joint products have common processes and costs of production up to a split-off point.
The point of separation is called the split-off point.
Assume that Delrio can sell hot sauce for $1.50 per bottle. Also, assume that additional processing costs amount to $1,000. The total revenue at split-off for Grade A tomatoes are $400 ($0.40 x 1,000 pounds). If the Grade A tomatoes are processed into hot sauce, the total revenues are $1,500 ($1.50 per bottle).

33. Decision: Further Process
OBJECTIVE 4
Illustrative Examples of Tactical Decision Making
Sell or Process Further
Differential Amount
Sell Process Further to Process Further
Revenues $400 $1,500 $1,100
Processing costs , ,000
Total $400 $ $ 100
Decision: Further Process

34. End of Chapter 18