Week 7 - Tactical Decision Making:

1
Week 7 - Tactical Decision Making

• Relevant Costing, The Activity Resource Usage
  Model, and Pricing
• Chapter 10

2
Learning Objectives

• Describe and explain the tactical decision-
  making model.
• Explain how the activity resource usage model is
  used in assessing relevancy.
• Apply the tactical decision-making concepts in a
  variety of business situations.
• Choose the optimal product mix when faced with
  one constrained resource.

3
Learning Objectives(continued)

• Explain the impact of cost on pricing decisions.
• Explain why decisions makers sometimes appear to
  use sunk costs in making decisions
• Use linear programming to find the optimal
  solution to a problem of multiple constrained
  resources. (Appendix)

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Model for making Tactical Decisions

• 1. Recognize and define the problem
• 2. Identify the alternatives
• 3. Identify costs and benefits for each
  alternative
• 4. Total the relevant costs and benefits for each
  alternative
• 5. Access qualitative factors
• 6. Selective the alternative with the greatest
  net benefits

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Relevant Costs Defined

• Costs that differ across alternatives
• Costs that deal with future courses of action

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Some Types of Decisions Illustrated

• Make or Buy
• Keep or Drop
• Special Order
• Sell or Process Further
• Product Mix

Important Short-term Perspective
7
Activity Resource Usage Model

• Resources acquired as used and needed.
• Resources acquired in advance of usage (single
  period or short term).
• Resources acquired in advance (multiperiod
  service capacity)

8
Activity Resource Usage Model and Assessing
Relevancy
Resources Acquired as Needed
Demand Changes Demand Constant
Relevant
Not Relevant
9
Activity Resource Usage Model and Assessing
Relevancy - (continued)
Acquired in Advance (Short Term)
Not Relevant
Demand Increase lt Unused Capacity Demand Increase
gt Unused Capacity Demand Decrease (Permanent) 1.
Activity Capacity Reduced 2. Activity Capacity
Unchanged
Relevant
Relevant
Not Relevant
10
Activity Resource Usage Model and Assessing
Relevancy - (continued)
Resources Acquired in Advance
Multiperiod Capacity
Demand Increase lt Unused Capacity Demand Decrease
(Permanent) Demand Increase gt Unused Capacity
Not Relevant
Not Relevant
Capital Decision
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Make-or-Buy Decisions
Assume the following cost data relate to the
decision to produce 12,000 units of a product or
buy from an external source
Total Costs
Unit Cost Rental of equipment 15,000
1.25 Equip. depreciation
3,000 .25 Direct
materials 12,000
1.00 Direct labour
24,000 2.00 Variable
overhead 9,000
.75 Fixed overhead 36,000
3.00 Total
99,000 8.25
Purchase price from an outside vendor is 5.50
per unit
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Make-or-Buy Decisions (Continued)
Alternatives Differential
Make Buy Cost to Make
Rental of equip. 15,000 ----
15,000 Direct materials 12,000
---- 12,000 Direct
labour 24,000 ----
24,000 Variable overhead 9,000
---- 9,000 Purchase
cost 66,000
(66,000) Relevant costs 60,000
66,000 (6,000)
Decision Manufacture parts in-house
13
Keep-or-Drop Decision
Assume the following
Regular Deluxe
Total Sales units
400 200 600
Sales revenue 200,000
150,000 350,000 Less variable
expenses Variable cost of sales
96,000 60,000 156,000
Variable selling admin. 10,000
7,500 17,500 Contribution margin
94,000 82,500 176,500
Less direct fixed expenses Direct fixed
costs 30,000 85,000
115,000 Product margin
64,000 (2,500) 61,500 Less
common fixed costs
30,000 Net income

31,500

Should the Deluxe product line be eliminated?
14
Keep-or-Drop (Continued)

Differential
Keep
Drop Amount to Keep Sales
150,000 ----
150,000 Variable exp. (67,500)
---- (67,500)
Cont. margin 82,500
---- 82,500 Direct
fixed costs (85,000) ----
(85,000) Relevant benefit/loss

(2,500)
Decision Drop the Deluxe product line but
investigate alternative use of facilities. This
analysis provides a benchmark for
future decisions.
15
Special-Order Decisions
Assume the following price quotation sheet for
the XYZ Company which has received an offer buy
at 38 per unit. Direct materials
12 Direct labour
14 Variable
overhead
4 Variable selling and administrative
2 Fixed manufacturing
20 Total
52 Markup--50
26 Target selling price
78

Important XYZ Company has idle capacity and can
produce the special order without affecting its
current production.
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Special-Order Decisions(continued)
Decision Rule The floor for establishing a
price for a special order is an incremental
(variable cost in this case) cost.
Incremental Costs Direct materials
12 Sales price
38 Direct labour 14
Incremental costs 32 Variable overhead
4 Additional income
6/unit Variable S A 2
Total 32
Question What impact is this decision likely to
have on existing customers?
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A Decision to Sell or Process Further (Continued)
Separate Processing
Product A
Joint Costs
Joint Input
Should the company process further?
Separate Processing
Product B
Split-off point
Joint products
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A Decision to Sell or Process Further (continued)
Sell or process further decision
Products
A B
Sales value at split-off
240,000 300,000 Sales value after
additional processing 320,000
480,000 Allocated joint product costs
160,000 200,000 Cost of
further processing
100,000 120,000
Incremental revenue from processing 80,000
180,000 Cost of additional processing
100,000 120,000
Profit (loss) from further processing
(20,000) 60,000 Decision
Sell at
split-off Process further
Joint costs are irrelevant
19
Product Mix Decision

• Organizations are constrained by the availability
  of key resources, e.g., machine capacity for a
  manufacturer, floor space for a retailer

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One Constrained Resource

• Thurman Company produces two types of disks
  players economy and deluxe. The deluxe model
  has a contribution margin of 40 per unit and the
  economy model has a unit contribution margin of
  25. The components of each model must be
  assembled manually. Assembly labour available
  per year is limited to 20,000 hours. The company
  can sell all that it produces of either model.
  The assembly time required for the economy model
  is two hours per unit. Because of the number and
  complexity of the parts for the deluxe model, the
  assembly time required is four hours per model.
  How many of each model should be produced?
• Answer To maximize total contribution margin,
  select the product that yields the highest
  contribution margin per unit of scarce resource
• Deluxe 40/4 10 per hour
• Economy 25/2 12.50 per hour
• The economy model yields the highest CM/unit of
  scare resource. Thus, 20,000/2 10,000 units of
  the economy model should be produced and none of
  the deluxe.

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A Product Mix Decision
Cost and characteristics of two product lines are
given below
Product lines
A B
Sales price per unit 50
60 Variable cost 20
36 Contribution margin 30
24 C/M ratio 60
40 Production time 2 hours
1 hour
Contribution/hour 15
24 Available hours 2,000
2,000 Total Contribution 30,000
48,000
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Two Approaches to Pricing

• 1. Market Driven-Prices are influenced by market
  conditions.
• 2. Cost-Prices are established using cost plus
  markup.

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Some Types of Cost Systems

• Variable Cost
• Absorption Cost
• Full Cost

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A Product Pricing Example
A Product Pricing Example
Assume the Following
Units 60,000
Costs (per unit) Absorption
Costs 40
Variable Mfg. Costs 20
Variable Selling Costs
5 Fixed Mfg. Costs 20
Fixed Selling Admin. 3 Desired profit
12
25
Determining Selling Prices and Markup Percentages
Assume a company uses variable costing
Variable costs
25 Markup required to cover fixed
expenses and obtain desired profit (23 12)
35 Target Selling Price
60 Markup Selling Price/Variable cost
60/25
240 (Starting point for pricing)
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Determining Selling Prices and Markup
Percentages (Continued)
Assume a Company uses absorption costing
Variable Costs
20 Fixed Manufacturing (40-20)
20 Markup required to cover selling and
admin. expenses and obtain desired profit
(812) 20 Target Selling Price
60 Markup Selling
Price/Absorption cost
60/40 150 (Starting point
for pricing)
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Sunk Costs Should Not Affect Decisions, But ...

• Past commitments
• Performance evaluation
• GAAP
• Guidelines
• Barrier to competition

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Graphic Solution
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Impact on Objective Function

• Corner Point X Y Z 25X 10Y
• A 0 0 0
• B 15 0 375
• C 15 20 575
• D 10 40 650
• E 0 40 400
• Optimal solution.

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Definitions of Strategy

• . Planned
• . Ploy
• . Position
• . Perspective
• . Pattern

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ACCPAC

• Financial accounting package
• Report writer
• - specification range
• - report range
• - print range

32
Salary and Benefits Breakdown

• Faculty full time 93.6
• Faculty contract 17.9
• Teaching assistants 12.6
• Research
  24.2
• Support/Administration 111.0
• Other
  11.2
• Total
  270.0 million

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Salary and Benefits Percentage Breakdown

• Administration/service 52.3
• Teaching
  22.9
• Research
  20.5
• Other
  4.1
• Total
  100.0

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Numerical Questions from the Back of Chapter 10

• E10-3
• E10-9
• E10-11
• E10-19

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Question E10-9

• Please go to your text to read the question.

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Question E10-11

• Please go to your text to read the question.

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Question E10-10

• Please go to your text to read the question.

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The End