Description

Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 4
Relevant Information for Decision Making
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 1
Chapter 4: Relevant Costs for Nonroutine
Operating Decisions
Learning objectives






Q1: What is the process for identifying and using relevant
information in decision making?
Q2: How is relevant quantitative and qualitative information
used in special order decisions?
Q3: How is relevant quantitative and qualitative information
used in keep or drop decisions?
Q4: How is relevant quantitative and qualitative information used in
outsourcing (make or buy) decisions?
Q5: How is relevant quantitative and qualitative information used in
product emphasis and constrained resource decisions?
Q6: What factors affect the quality of operating decisions?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 2
Q1: Nonroutine Operating Decisions
• Routine operating decisions are those made on a
regular schedule. Examples include:
• annual budgets and resource allocation decisions
• monthly production planning
• weekly work scheduling issues
• Nonroutine operating decisions are not made on a
regular schedule. Examples include:
• accept or reject a customer’s special order
• keep or drop business segments
• insource or outsource a business activity
• constrained (scarce) resource allocation issues
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 3
Q1: Nonroutine Operating Decisions
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 4
Q1: Process for Making Nonroutine
Operating Decisions
1. Identify the type of decision to be made.
2. Identify the relevant quantitative analysis
technique(s).
3. Identify and analyze the qualitative factors.
4. Perform quantitative and/or qualitative analyses
5. Prioritize issues and arrive at a decision.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 5
Q1: Identify the Type of Decision


Special order decisions

determine the pricing

accept or reject a customer’s proposal for order quantity
and pricing

identify if there is sufficient available capacity
Keep or drop business segment decisions


examples of business segments include product lines,
divisions, services, geographic regions, or other distinct
segments of the business
eliminating segments with operating losses will not
always improve profits
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 6
Q1: Identify the Type of Decision



Outsourcing decisions

make or buy production components

perform business activities “in-house” or pay another
business to perform the activity
Constrained resource allocation decisions

determine which products (or business segments)
should receive allocations of scarce resources

examples include allocating scarce machine hours or
limited supplies of materials to products
Other decisions may use similar analyses
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 7
Q1: Identify and Apply the Relevant
Quantitative Analysis Technique(s)


Regression, CVP, and linear programming are
examples of quantitative analysis techniques.
Analysis techniques require input data.

Data for some input variables will be known and for
other input variables estimates will be required.

Many nonroutine decisions have a general
decision rule to apply to the data.

The results of the general rule need to be
interpreted.

The quality of the information used must be considered
when interpreting the results of the general rule.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 8
Q2-Q5 : Identify and Analyze Qualitative Factors

Qualitative information cannot easily be valued in
dollars.



can be difficult to identify
can be every bit as important as the quantitative
information
Examples of qualitative information that may be
relevant in some nonroutine decisions include:

quality of inputs available from a supplier

effects of decision on regular customers

effects of decision on employee morale

effects of production on the environment or the
community
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 9
Q1: Consider All Information and Make a Decision

Before making a decision:

Consider all quantitative and qualitative information.
• Judgment is required when interpreting the effects of
qualitative information.

Consider the quality of the information.
• Judgment is also required when user lower-quality
information.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 10
Q2: Special Order Decisions


A new customer (or an existing customer) may
sometimes request a special order with a lower
selling price per unit.
The general rule for special order decisions is:


accept the order if incremental revenues exceed
incremental costs,
subject to qualitative considerations.
Price >=

Relevant
Variable Costs +
Relevant
Fixed Costs +
Opportunity
Cost
If the special order replaces a portion of normal
operations, then the opportunity cost of accepting
the order must be included in incremental costs.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 11
Q2: Special Order Decisions
RobotBits, Inc. makes sensory input devices for robot manufacturers.
The normal selling price is $38.00 per unit. RobotBits was approached
by a large robot manufacturer, U.S. Robots, Inc. USR wants to buy
8,000 units at $24, and USR will pay the shipping costs. The per-unit
costs traceable to the product (based on normal capacity of 94,000
units) are listed below. Which costs are relevant to this decision?
yes$6.20 Relevant?
Direct materials
yes 8.00 Relevant?
Direct labor
Variable mfg. overhead yes 5.80 Relevant?
no 3.50 Relevant?
Fixed mfg. overhead
yes
Shipping/handling
no 2.50 Relevant?
Fixed administrative costs no 0.88 Relevant?
no 0.36 Relevant?
Fixed selling costs
$27.24
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
$20.00
Slide # 12
Q2: Special Order Decisions
Suppose that the capacity of RobotBits is 107,000 units and projected
sales to regular customers this year total 94,000 units. Does the
quantitative analysis suggest that the company should accept the
special order?
First determine if there is sufficient idle capacity to accept this
order without disrupting normal operations:
Projected sales to regular customers
Special order
94,000 units
8,000 units
102,000 units
RobotBits still has 5,000 units of idle capacity if the order is
accepted. Compare incremental revenue to incremental cost:
Incremental profit if accept special order =
($24 selling price – $20 relevant costs) x 8,000 units = $32,000
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 13
Q2: Qualitative Factors in
Special Order Decisions
What qualitative issues, in general, might RobotBits consider before
finalizing its decision?
• Will USR expect the same selling price per unit on future
orders?
• Will other regular customers be upset if they discover the
lower selling price to one of their competitors?
• Will employee productivity change with the increase in
production?
• Given the increase in production, will the incremental costs
remain as predicted for this special order?
• Are materials available from its supplier to meet the increase
in production?
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 14
Q2: Special Order Decisions and Capacity Issues
Suppose instead that the capacity of RobotBits is 100,000 units and
projected sales to regular customers this year totals 94,000 units.
Should the company accept the special order?
Here the company does not have enough idle
capacity to accept the order:
Projected sales to regular customers
Special order
94,000 units
8,000 units
102,000 units
If USR will not agree to a reduction of the order to 6,000
units, then the offer can only be accepted by denying sales
of 2,000 units to regular customers.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 15
Q2: Special Order Decisions and Capacity Issues
Suppose instead that the capacity of RobotBits is 100,000 units and
projected sales to regular customers this year total 94,000 units. Does
the quantitative analysis suggest that the company should accept the
special order?
Direct materials
Direct labor
Variable mfg. overhead
Fixed mfg. overhead
Shipping/handling
Fixed administrative costs
Fixed selling costs
$6.20
8.00
5.80
3.50
2.50
0.88
0.36
$27.24
Variable cost/unit for
regular sales = $22.50.
CM/unit on regular sales
= $38.00 – $22.50 = $15.50.
The opportunity cost of accepting this
order is the lost contribution margin
on 2,000 units of regular sales.
Incremental profit if accept special order =
$32,000 incremental profit under idle capacity – opportunity cost =
$32,000 – $15.50 x 2,000 = $1,000
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 16
Q2: Qualitative Factors in
Special Order Decisions
What additional qualitative issues, in this case of a capacity constraint,
might RobotBits consider before finalizing its decision?
• What will be the effect on the regular customer(s) that do not
receive their order(s) of 2,000 units?
• What is the effect on the company’s reputation of leaving
orders from regular customers of 2,000 units unfilled?
• Will any of the projected costs change if the company
operates at 100% capacity?
• Are there any methods to increase capacity? What effects do
these methods have on employees and on the community?
• Notice that the small incremental profit of $1,000 will probably
be outweighed by the qualitative considerations.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 17
Q3: Keep or Drop Decisions

Managers must determine whether to keep or
eliminate business segments that appear to be
unprofitable.

The general rule for keep or drop decisions is:


keep the business segment if its contribution margin
covers its avoidable fixed costs,
subject to qualitative considerations.
Drop if: Contribution 0
Not
150,000 $B$10>=$C$10 Binding
150,000
Cell
Name
$B$9 DL hr
© John Wiley & Sons, 2011
Slack
The nonnegativity
constraints for R and D
are not binding; the slack
is 50,000 and 150,000
units respectively.
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 54
Q5: Excel Solver Sensitivity Report
Microsoft Excel 9.0 Sensitivity Report
Refer to the problem on Slide #50.
Adjustable Cells
Final Reduced Objective Allowable Allowable
Cell Name Value
Cost Coefficient Increase Decrease
$B$2 Regular 150,000
0
20
2
6.8
$C$2 Deluxe
50000
0
66
34
6
Constraints
Final Shadow Constraint Allowable Allowable
Cell Name Value
Price R.H. Side Increase Decrease
$B$9 DL hr
600,000
9
600000
200000
120000
$B$8 mach hr 160,000
8
160000
40000
40000
$B$11 D>0
50,000
0
0
50000
1E+30
$B$10 R>0
150,000
0
0
150000
1E+30
This shows
how much the
slope of the
total CM line
can change
before the
optimal
production
plan will
change.
The CM per unit for Regular can drop to $13.20 or increase to $22 (all else equal)
before the optimal plan will change. The CM per unit for Deluxe can drop to $60 or
increase to $100 (all else equal) before the optimal plan will change.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 55
Q5: Excel Solver Sensitivity Report
Microsoft Excel 9.0 Sensitivity Report
Refer to the problem on Slide #50.
Adjustable Cells
Final Reduced Objective Allowable Allowable
Cell Name Value
Cost Coefficient Increase Decrease
$B$2 Regular 150,000
0
20
2
6.8
$C$2 Deluxe
50000
0
66
34
6
Constraints
Final Shadow Constraint Allowable Allowable
Cell Name Value
Price R.H. Side Increase Decrease
$B$9 DL hr
600,000 8.50
600000
200000
120000
$B$8 mach hr 160,000 7.50
160000
40000
40000
$B$11 D>0
50,000 0.00
0
50000
1E+30
$B$10 R>0
150,000 0.00
0
150000
1E+30
This shows
how much the
RHS of each
constraint can
change
before the
shadow price
will change.
The available DL hours could decrease to 480,000 or increase to 800,000 (all
else equal) before the shadow price for DL would change. The available
machine hours could decrease to 120,000 or increase to 200,000 (all else
equal) before the shadow price for machine hours would change.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 56
Q5: Excel Solver Sensitivity Report
Microsoft Excel 9.0 Sensitivity Report
Refer to the problem on Slide #50.
Adjustable Cells
Final Reduced Objective Allowable Allowable
Cell Name Value
Cost Coefficient Increase Decrease
$B$2 Regular 150,000
0
20
2
6.8
$C$2 Deluxe
50000
0
66
34
6
Constraints
Final Shadow Constraint Allowable Allowable
Cell Name Value
Price R.H. Side Increase Decrease
$B$9 DL hr
600,000 8.50
600000
200000
120000
$B$8 mach hr 160,000 7.50
160000
40000
40000
$B$11 D>0
50,000 0.00
0
50000
1E+30
$B$10 R>0
150,000 0.00
0
150000
1E+30
The shadow
price shows
how much a
one unit
increase in
the RHS of a
constraint will
improve the
total
contribution
margin.
Urban would be willing to pay up to $8.50 to obtain one more DL hour and up
to $7.50 to obtain one more machine hour.
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 57
Q7: Impacts to Quality of
Nonroutine Operating Decisions
• The quality of the information used in nonroutine
operating decisions must be assessed.
• There may be more information quality issues (and more
uncertainty) in nonroutine decisions because of the
irregularity of the decisions.
• Three aspects of the quality of information
available can affect decision quality.
• Business risk (changes in economic condition, consumer
demand, regulation, competitors, etc.)
• Information timeliness
• Assumptions in the quantitative and qualitative analyses
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 58
Q7: Impacts to Quality of
Nonroutine Operating Decisions
• Short term decision must align to company’s overall
strategic plans
• Must watch for decision maker bias
– Predisposition for specific outcome
– Preference for one type of analysis without considering
other options
• Opportunity costs are often overlooked
• Performing sensitivity analysis can help assess and
minimize business risk
• Established control system incentives (performance
bonuses, etc.) can encourage sub-obtimal decision
making
© John Wiley & Sons, 2011
Chapter 4: Relevant Costs for Nonroutine Operating Decisions
Eldenburg & Wolcott’s Cost Management, 2e
Slide # 59
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