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These costs are relevant costs in decision-making. Examples of avoidable costs include departmental salaries and other costs that could be avoided by not operating the specific department. Opportunity Costs and Capacity Considerations – An opportunity cost is the forgone benefit of choosing to do one thing instead of another. We all face opportunity costs anytime we make a choice about what to do with limited time and money. The relevant costing can only be used to calculate the incremental costs of distinct projects. Therefore, results of different projects cannot be compared to make sensible decision, because each project will have its own relevant cost which may or may not affect the other project. For example, a business has to determine whether to terminate or continue production of a specific product.
Allocate joint costs to each product using the physical quantities method . Although Grade B lumber appears to be unprofitable, elimination of Grade B lumber sales would not increase overall https://accountingcoaching.online/ profit for Oregon Lumber. Grade B lumber contributes $60,000 to covering joint costs. Thus elimination of Grade B lumber sales would result in a decrease in overall profit of $60,000.
Cost
A company sells three types of bicycles , all of which are profitable. The company faces a labor-hour bottleneck and plans to eliminate the cruiser product because it has the lowest contribution margin per labor hour. If production is outsourced, all variable production costs and 70 percent of fixed production costs will be eliminated. Make-or-Buy Decision and Qualitative Factors. Soda Bottling, Inc., currently bottles its own soda drinks. Management is interested in outsourcing the production of bottles to a reputable manufacturing company that can supply the bottles for $0.04 each. Soda Bottling incurs the following monthly production costs to produce 1,000,000 bottles internally.
- As a result of reducing production capacity, Keyboard’s total fixed manufacturing costs will decrease 30 percent.
- Differential revenues and costs represent the difference in revenues and costs among alternative courses of action.
- The goal in this step is to shift nonbottleneck resources to the bottleneck in department 4.
- Fresh Veggies sells Grade A apples for $0.80 per pound and Grade B apples for $0.50 per pound.
- That means you need to reconcile it to the general ledger or the accounting system.
- At this point, improving efficiencies in other departments does little to alleviate the bottleneck in department 4.
Avoidable costs are those costs that are avoided by choosing to eliminate the home design branch versus keeping it. If we choose to eliminate the division, we will no longer have the costs of the employees’ salaries, trucks to move materials, and licenses for home design software. We assume the units in inventory will not be used—the selling price at $13. ABC Company wants to introduce a self-care portal which will reduce the number of customer service personnel by five.
Results
Total variable manufacturing costs will decrease since only 4,000 pianos will be produced rather than 6,000. Total variable marketing and administrative costs will remain unchanged. Consulting Group LLC has two customers. Customer One generates $150,000 in income after direct fixed costs are deducted, and Customer Two generates $200,000 in income after direct fixed costs are deducted. Allocated fixed costs total $300,000 and are assigned 30 percent to Customer One and 70 percent to Customer Two based on several different cost drivers. Total allocated fixed costs remain the same regardless of how these costs are assigned to customers.
Summarize the result of dropping the tools product line using the format presented in Figure 7.7 “Summary of Differential Analysis for Barbeque Company”. Perform differential analysis using the format presented in Figure 7.2 “Make-or-Buy Differential Analysis for Best Boards, Inc.”. Assume making the product internally is Alternative 1, and buying the product from an outside manufacturer is Alternative 2. Summarize the result of dropping the Apple LLP account using the format presented in Figure 7.12 “Summary of Differential Analysis for Colony Landscape Maintenance”. Explain what happened to the profitability of the furniture product line as a result of dropping the computers product line. Summarize the result of dropping the computer product line using the format presented in Figure 7.7 “Summary of Differential Analysis for Barbeque Company”.
Variable Costs And Decision
Fresh Catch can sell salmon for $3 per pound and halibut for $6 per pound. Product Line Decision and Qualitative Factors. The following annual segmented income statement is for Wax, Inc., a maker of wax for cars, boats, and floors. The following monthly segmented income statement is for Hal’s Hardware. For each of the following independent scenarios, identify at least one qualitative factor that should be considered before making the decision. The following segmented annual income statement is for Office Express.
Monthly basis to reconcile it with your actual cost. You must reconcile; too many businesses don’t do this when Relevant Cost of Labor using standard costing–what they call to “true up the costs”–and don’t adjust the cost to make them true again.
Relevant & Irrelevant Costs For Decision
Opportunity costs can also be included in the differential analysis format presented in Figure 7.6 “Product Line Differential Analysis for Barbeque Company”. Panel C of Figure 7.6 “Product Line Differential Analysis for Barbeque Company” is simply modified to reflect the opportunity cost, as shown. As another example, if ABC wants to close its medieval book division entirely, the only relevant costs will be those costs specifically eliminated as a result of the decision. Once again, the cost of corporate overhead is not a relevant cost when making this decision, since it will not change if the division is sold. A large clothing store is considering rebranding itself into a smaller luxury boutique store. They currently have 50 stores across the nation and want to consolidate to 10 stores.
If a machine breakdown, what are the alternative courses of action? The machine can be repaid or replaced, or a replacement can be leased. But perhaps repair will turn out to be more costly than replacement. Determining the possible alternatives is a critical step in the decision process. As part of this step, the company eliminates alternatives that are not feasible. In relation to a decision or project, relevant costs are those costs that only affect that particular decision or project and those costs are irrelevant or unnecessary for any other project. It means that if any cost arises due to taking up of a certain decision or undertaking a project and that cost will not occur otherwise can be called its relevant costs.
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Since the relevant costs of making are less than the costs of buying the firm should reject the offer and continue to make the parts. This will have the effect of reducing total fixed marketing and administrative costs by 5 percent. As a result of reducing production capacity, Keyboard’s total fixed manufacturing costs will decrease 30 percent.
The second assumption is that this is a one-time order, and therefore represents a short-run pricing decision. If Tony’s T-shirts expects future orders from the high school at the $17 per shirt price, the company must consider the impact this might have on long-run pricing with other customers. That is, regular customers may hear of this special price and demand the same price, particularly those customers who have been loyal to Tony’s T-shirts for many years. Tony’s might be forced to lower prices for regular customers, thereby eroding the company’s profits over time. The key point is that companies evaluating special orders can drop prices in the short run to cover differential variable and fixed costs. But in the long run, prices must cover all variable and fixed costs.
Allocated fixed costs are typically not eliminated if a product line is eliminated, and are not differential costs. Managers compare sales revenue and costs for each alternative , and select the alternative with the highest profit. Are fixed costs that cannot be traced directly to a product line, and therefore are assigned to product lines using an allocation process. Allocated fixed costs are typically not differential costs. For example, rent paid for Barbeque Company’s retail store is allocated to all three product lines because it is not easily traced to each product line.
The incremental costs usually do not include fixed manufacturing costs. Although the fixed costs must be incurred to permit production, the amount of fixed costs incurred by the firm usually will not increase if the special order offer is accepted. For the same reason, other fixed expenses, such as fixed selling and administrative expenses, are usually not relevant in the special order price. Both of these costing techniques are management tools which help management of a company to make well-versed and practical decisions. The management can also consider other options market competitiveness, market share, the timeline of potential projects etc. while making the final decision. Generally speaking, most variable costs are relevant because they depend on which alternative is selected. Fixed costs are irrelevant assuming that the decision at hand does not involve doing anything that would change these stationary costs.
Coursecost And Managerial Accounting Bafmba
Evaluate qualitative factors when using differential analysis. Calculate the contribution margin per unit of constrained resource for each glove. We will look at an example to help explain how the theory of constraints works. Assume Computers, Inc., produces desktop computers using six departments as shown in Figure 7.15 “Production Process at Computers, Inc.”. Computers are assembled in departments 1, 2, and 3 and are then sent to department 4 for quality testing. Once testing is complete, products are packaged in department 5.
Relevant Costing For Short Term Decision Making
At this point, improving efficiencies in other departments does little to alleviate the bottleneck in department 4. Thus Computers, Inc., must try to move resources from other areas to department 4 to reduce the backlog of computers to be tested.
Types Of Irrelevant Costs
Management has asked you to look at the numbers for each product line and make a recommendation on how to increase overall company profit. What course of action would you recommend? Based on your recommendation, describe the qualitative factors that should be considered. Assume keeping all product lines is Alternative 1, and keeping only the soda product line is Alternative 2. Explain what happened to the profitability of the other two customers as a result of dropping the Murray account. Explain what happened to the profitability of the other two customers as a result of dropping the Davis account. Explain what happened to the profitability of the other two customers as a result of dropping the Nguyen account.
