University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

127

Pages:

22
Author:

Koen Pineda

Chapter 13: Short-Run Decision Making: Relevant Costing Part 2 2 Keep-or-Drop Decisions ► Often, a manager needs to determine whether a segment, such as a product line, should be kept or dropped. ► Segmented reports prepared on a variable-costing basis provide valuable information for these keep-or-drop decisions. ► Both the segment’s contribution margin and its segment margin are useful in evaluating the performance of segments. ► However, while segmented reports provide useful information for keep-or-drop decisions, relevant costing describes how the information should be used to arrive at a decision. 2 Cornerstone 13-3 Structuring a Keep-or-Drop Product Line Problem 2 Cornerstone 13-3 Structuring a Keep-or-Drop Product Line Problem (continued) 2 Keep-or-Drop with Complementary Effects ►Sometimes dropping one line would lower sales of another line, as many customers buy both lines at the same time. ►This information can affect the keep-or-drop decision. 2 Cornerstone 13-4 Structuring a Keep-or-Drop Product Line Problem with Complementary Effects The roofing tile line has a contribution margin of $10,000 (sales of $150,000 minus total variable costs of $140,000). All variable costs are relevant. Relevant fixed costs associated with this line include $10,000 in advertising and $35,000 in supervision salaries. Assume that dropping the product line reduces sales of blocks by 10 percent and sales of bricks by 8 percent. Required: 1. If the roofing tile line is dropped, what is the contribution margin for the block line? For the brick line? 2. Which alternative (keep or drop the roofing tile line) is now more cost effective and by how much? 2 Cornerstone 13-4 Structuring a Keep-or-Drop Product Line Problem with Complementary Effects (continued) 2 You Decide Relevant Decision Making You are an elected official in a major city that is considering whether or not to move forward with a proposed plan to demolish the city’s existing professional sports stadium and build an elaborate new stadium. One of the most difficult aspects of this decision is estimating the new stadium’s incremental revenues and costs that would result if it were built. What specific types of relevant revenues and costs would you consider in making this important decision? 2 You Decide Relevant Decision Making (continued) There are many stadium events for which the associated relevant revenues and costs must be estimated accurately if the correct decision is to be made. These stadium events (and their relevant revenues and costs) include: • Main attraction sporting events (e.g., ticket revenues from baseball, basketball, and/or football games for which the stadium would be built; additional staffing, cleanup, and insurance costs) • Concessions and other sales (e.g., contribution margins or fees earned from product and service sales—most new stadiums boast as many high-end shopping opportunities as an upscale mall!) • Television contract terms (e.g., the amount and percentage of revenue brought in by additional games being televised in the new stadium, perhaps in primetime slots) • Offseason events (e.g., the ticket revenue from boxing matches, music concerts, etc.). For this relevant stadium decision, estimating the relevant revenues might be even more difficult than estimating the relevant costs. For instance, projecting how many more people will want to attend games in a new stadium can be unclear, as well as how much money they would be willing to spend for various seats located around the stadium. 2 You Decide Relevant Decision Making (continued) Several New York City area stadiums experienced tremendous difficulty in accurately estimating these same items. For example, the New York Yankees and New York Mets organizations built new stadiums with price tags of over $1.2 billion and $800 million, respectively! However, in the new Yankee stadium, many of the more expensive seats—the ones behind the batter and, thus, most visible on television—remained empty because of their hefty $2,500 per seat price tag. In fact, the Yankee organization decreased some of its highest ticket prices by 50 percent during the stadium’s first season in an attempt to fill these high profile empty seats. In other words, decision makers struggled to estimate the amount of incremental revenue that would result from some of the more important seats in a new Yankee stadium. Undaunted by such challenging relevant analyses, however, the New York area also built a $1.6 billion new Meadowlands Stadium to be shared by the New York Jets and New York Giants. In addition to the previously mentioned relevant items, some citizens raise objections to such large amounts of money being spent on replacing existing fully functional sporting facilities with gargantuan sports palaces. They argue that $1 billion could be better spent on different causes. Such sentiments, whether you agree or disagree with them, represent potentially important qualitative factors that effective managerial accountants should take into account when performing relevant analyses for proposed new stadiums, especially when these citizens represent tax payers or potential fans the stadium builders count on for purchasing expensive tickets in the future. When making such an important decision, relevant costs for things like sporting events, concessions, television contracts, and off-season events must be considered in addition to qualitative factors like citizen sentiment. 2 Further Processing of Joint Products ► Joint products have common processes and costs of production up to a split-off point. At that point, they become distinguishable as separately identifiable products. The point of separation is called the split-off point. ► Sometimes it is more profitable to process a joint product further, beyond the split-off point, prior to selling it (sell orprocess-further decision). 2 Cornerstone 13-5 Structuring the Sell-or-Process Further Decision 3 Product Mix Decisions ► Most of the time, organizations have wide flexibility in choosing their product mix. ► Product mix refers to the relative amount of each product manufactured (or service provided) by a company. ► Decisions about product mix can have a significant impact on an organization’s profitability. ► Every firm faces limited resources and limited demand for each product. These limitations are called constraints. ► A manager must choose the optimal mix given the constraints found within the firm. 3 Cornerstone 13-6 Determining the Optimal Product Mix with One Constrained Resource 3 Cornerstone 13-6 Determining the Optimal Product Mix with One Constrained Resource (continued) 3 Cornerstone 13-7 Determining the Optimal Product Mix with One Constrained Resource and a Sales Constraint 3 Cornerstone 13-7 Determining the Optimal Product Mix with One Constrained Resource and a Sales Constraint (continued) 3 Multiple Constrained Resources ► The presence of only one constrained resource might not be realistic. ► Organizations often face multiple constraints, including: ► limitations of raw materials ► limitations of skilled labor ► limited demand for each product ► The solution of the product mix problem in the presence of multiple constraints is considerably more complicated and requires the use of a specialized mathematical technique known as linear programming, which is reserved for advanced cost management courses. 4 Cost-Based Pricing ► Demand is one side of the pricing equation; supply is the other side. ► Since revenue must cover all costs for the firm to make a profit, many companies start with cost to determine price. ► That is, they calculate product cost and add the desired profit. ► The mechanics of this approach are straightforward. Usually, there is a cost base and a markup. ► The markup is a percentage applied to the base cost. ► It includes desired profit and any costs not included in the base cost. ► Companies that bid for jobs routinely base bid price on cost. 4 Cornerstone 13-8 Calculating Price by Applying a Markup Percentage to Cost 4 Target-Costing and Pricing ► Many American and European firms set the price of a new product as the sum of the costs and the desired profit. The rationale is that the company must earn sufficient revenues to cover all costs and yield a profit. ► Target costing is a method of determining the cost of a product or service based on the price (target price) that customers are willing to pay. ► The marketing department determines what characteristics and price for a product are most acceptable to consumers. 4 Cornerstone 13-9 Calculating a Target Cost