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Learning Objective 1
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Costs
An opportunity cost is the maximum available contribution to profit forgone (or passed up) by using limited resources for a particular purpose.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Costs
Differential cost and incremental cost are defined as the difference in total cost between two alternatives.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Learning Objective 2
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Make-or-Buy Decisions
The basic make-or-buy question is whether a company should make its own parts to be used in its products or buy them from vendors.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Make-or-Buy Decisions
Qualitative Factors: Control quality Protect long-term relationships with suppliers
Quantitative Factors: Idle facilities or capacity
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Make-or-Buy Example
GE Company Cost of Making Part N900: Total Cost for Cost 20,000 Units per Unit Direct material $ 20,000 $ 1 Direct labor 80,000 4 Variable overhead 40,000 2 Fixed overhead 80,000 4 Total costs $220,000 $11
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Make-or-Buy Example
Another manufacturer offers to sell GE the same part for $10. The essential question is the difference in expected future costs between the alternatives. Should GE make or buy the part?
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Make-or-Buy Example
If the $4 fixed overhead per unit consists of costs that will continue regardless of the decision, the entire $4 becomes irrelevant. If $20,000 of the fixed costs will be eliminated if the parts are bought instead of made, the fixed costs that may be avoided in the future are relevant.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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0 $200,000
0 $10
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
Learning Objective 3
Decide whether a joint product should be processed beyond the split-off point.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Joint Products
Joint products have relatively significant sales values.
They are not separately identifiable as individual products until their split-off point. The split-off point is that juncture of manufacturing where the joint products become individually identifiable.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Joint Products
Separable costs are any costs beyond the split-off point. Joint costs are the costs of manufacturing joint products before the split-off point.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Revenue $30,000 Separable costs beyond split-off @ $.08 Income effects $30,000
$80,000
$50,000
40,000 $40,000
40,000 $10,000
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Learning Objective 4
Identify irrelevant information in disposal of obsolete inventory and equipment replacement decisions.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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1
2
Two examples of past costs that we can consider, to see why they are irrelevant to decisions, are: The cost of obsolete inventory The book value of old equipment
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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What is the book value at the end of 6 years? Original cost $10,000 Accumulated depreciation (6 $1,000) 6,000 Book value $ 4,000
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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1 2
3
4
In deciding whether to replace or keep existing equipment, we must consider the relevance of four commonly encountered items: Book value of old equipment Disposal value of old equipment Gain or loss on disposal Cost of new equipment
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The disposal value of old equipment is relevant (ordinarily) because it is an expected future inflow that usually differs among alternatives.
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Cash operating costs Old equipment (book value) depreciation, or 4,000 lump-sum write-off 4,000 Disposal value (2,500) 2,500 New machine acquisition cost 8,000 (8,000) Total costs $24,000 $21,500 $ 2,500
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Learning Objective 5
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There are two major ways to go wrong when using unit costs in decision making: The inclusion of irrelevant costs Comparisons of unit costs not computed on the same volume basis
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Units Variable cost per unit Variable costs Straight-line depreciation Total relevant costs Unit relevant costs
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Units Variable cost per unit Variable costs Straight-line depreciation Total relevant costs Unit relevant costs
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
Learning Objective 6
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To motivate managers to make the right choices, the method used to evaluate performance should be consistent with the decision model.
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$5,000 1,000
0 $6,000
$3,000 2,000
$1,500 $6,500
$3,000 2,000
0 $5,000
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
If the machine is kept rather than replaced, first-year costs will be $500 lower ($6,500 $6,000), and first-year income will be $500 higher.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Learning Objective 7
Construct absorption and contribution format income statements and identify which is better for decision making.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Absorption Approach
The absorption approach is a costing approach that considers all factory overhead (both variable and fixed) to be product (inventoriable) costs. Factory overhead becomes an expense in the form of manufacturing cost of goods sold only as sales occur.
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Contribution Approach
In contrast, the contribution approach is used by many companies for internal (management accounting) reporting. It emphasizes the distinction between variable and fixed costs. The contribution approach is not allowed for external financial reporting.
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
End of Chapter 6
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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