0-____ 100000 Profit 320000 4000 224000
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Transcript 0-____ 100000 Profit 320000 4000 224000
Differential Cost Analysis
Chapter 25
Management decisions
Accepting/Rejecting certain orders
Reducing the price of a single order
Making a price cut in a competitive market
Evaluating Make-or-buy alternatives
Expanding or reducing plant capacity
Increasing, curtailing or stopping production
Replacing present equipment
Spending additional amounts for sales promotion
Differential Cost
Difference between cost of alternative choices
Marginal/Incremental cost
Deals with determination of incremental
revenue, costs and margins
Variable costs are significant
Fixed costs might be included
Example
Total cost at 60,000 units = $324,250
Total cost at 80,000 units = $423,400
Calculate total differential cost
Calculate differential cost/unit
Solution
Differential cost = 423,400 – 324,250
= $99,150
Differential cost/unit = 99,150/20,000
= $4.96
Accepting Additional Orders
Differential cost must be considered involving a
change in output
Difference between the cost of producing present
smaller output and that of the planned larger
output
Possibility of selling additional output at a figure
lower or greater than the existing average unit cost
New or additional business can be accepted as long
as the variable cost is recovered
Example
Maximum capacity=100,000 units
Normal capacity = 80,000 units
Variable cost per unit = $5
Fixed cost= $100,000
Sales price per unit= $9
Profit at 80,000 and 81,000 units?
Solution
Present business
Sales
$720,000
Variable cost
Contribution
Additional business
Total
$9,000
$729,000
400,000
5,000
405,000
Margin
320,000
4,000
324,000
Fixed cost
100,000
_-0-____
100,000
Profit
320,000
4,000
224,000
Reducing the Price of a Special Order
At what minimum price the firm can
afford to sell additional goods
Example
Company manufactures 450,000 units using 90% of
its capacity
Fixed factory overhead is $335,000
Variable factory overhead = $0.50/unit
Direct materials = $1.80/unit
Direct labor = $1.40/unit
Each unit sells for $5
Example
Sales
$2,250,000
Cost of goods sold:
Direct materials(450,000*1.80)
810,000
Direct labor(450,000*1.40)
630,000
Variable factory overheads(450,000*0.50)
225,000
Fixed factory overheads(335,000*90%)
301,500
Income from operations
283,500
Unabsorbed fixed factory overheads(335,000*10%]
33,500
Income from operations (adjusted)
250,000
1,966,500
Special Order
Additional fixed cost if special order of
100,000 units is accepted = $10,000
Sales price of a special order=$4.25
Solution
Sales (100,000 [email protected])
Cost of goods sold:
Direct materials(100,000units @1.80)
Direct labor (100,000units @ 1.40)
Variable factory overheads
(100,000 units @0.50)
Additional fixed cost
Gain on the order
$425,000
180,000
140,000
50,000
10,000
380,000
$45,000
Exercise
The wood River plant of the Union Company has a normal
capacity 0f 90,000 units per month. Monthly production
costs are $12 variable cost per unit and $240,000 fixed. By
increasing the fixed cost $10,000 a month, the plant can
produce 95,000 units.
Differential cost of the production between 80% and 90%
of normal capacity.
Differential cost of producing the 5,000 units above the
normal capacity.
Per unit total production cost of the 95,000 units
Per unit differential production cost of the 5,000 units.
Solution
Differential cost of the production between 80%
and 90% of normal capacity.
90,000 units *90%
90,000 units *80%
81,000 units
72,000 units
9,000 units
9,000 units *$12 = $108,000
Solution
Differential cost of producing the 5,000
units above the normal capacity.
5,000 units *12
Differential Fixed cost
$60,000
10,000
70,000
Solution
Per unit total production cost of the
5,000 units
95,000 units *12
$1,140,000
Fixed costs(240,000+10,000) 250,000
1,390,000
Solution
Per unit differential production cost of
the 5,000 units.
=$70,000/5,000 units
= $14
Exercise
Poppycrock,Inc., manufactures large crates of microwavable popcorn that are
typically sold to distributors. Their main factory has the capacity to manufacture
and sell 35,000 crates per month. The following information is available for the
factory:
Sales price per crate
Variable cost per crate:
Direct materials
4.50
Direct labor
10.50
Variable overhead
3.50
Fixed cost per month
$122,000
ABC of Canada offered to pay Poppycrock $20 per crate for the special
batch of 5,000 crates. The additional cost of label is estimated at $1 per
crate. In addition, the variable overhead for these special order crates
would decrease by $0.50 because there would be no distribution costs
for these special order crates .
What is the cost of creating a normal crate of popcorn? What is the
incremental cost of creating a special order crate of popcorn?
$24
Make-Or-Buy Decisions
Compare the cost of making the parts with the
cost of buying them
Costs for each of the alternatives must be
based on the identical product specifications,
quantities and quality standards
Decisions to Shut Down Facilities
In the short run, a firm seems to be better off
operating than not operating if revenue > variable
costs
Shutting down of facilities
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◦
Does not eliminate all costs
Loss of investment spent on training employees
Recruiting and training costs after reopening
Loss of losing established markets & customers
Decisions to Shut Down Facilities
If operations are continued
◦ Certain expenses connected with the shutting down
of the facilities can be saved
◦ Costs that would have to be incurred when a closed
facility is reopened will be saved
Decisions to Discontinue Products
Requires careful analysis of relevant differential cost
and revenue data
Following benefits can be achieved with the correct
decision:
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◦
Expanded sales
Increased profits
Reduced inventory levels
Resources made available for more promising
projects
Decisions to Discontinue Products
Not only the profitability of the products being
analyzed be considered but also the extent to which
sales of other products will be affected when one
product is removed should be evaluated
Decisions to Discontinue Products
Management needs following signals to identify
troubled products:
◦ Declining sales volume
◦ Decreasing market share
◦ Malfunctioning of the product or introduction of a superior
competitive product
◦ Expected future sales and market potential not favorable
◦ Return on investment below minimum acceptable level
◦ Variable costs approaching or exceeding revenue
◦ Price required to be constantly lowered to maintain sales
Other Cost Concepts
Opportunity costs
◦ Measurable value of an opportunity bypassed by rejecting an
alternative use to resources
◦ Measurement of sacrifices associated with alternatives
Imputed costs
◦ Hypothetical costs representing the cost/value of a resource
measured by its use value
◦ Interest on invested capital, rental value of company-owned
properties, salaries of owners of sole proprietors
◦ Do not involve actual cash flows
Other Cost Concepts
Out-Of-Pocket Costs
◦ Involves cash outlays
◦ Often identified as variable costs
◦ Helpful in deciding whether a particular venture will
at least return the cash expenditures
Sunk Costs
◦ Irrecoverable costs
◦ Not included in differential cost analysis