Four steps in decision making
• Specify problem / goals
Align individual with organizational goals
• Identify options
• Measure benefit & cost
Value = benefit - cost
Opportunity cost
Sunk cost
• Make decision on highest value
Planning & Control Cycle
MA vs. FA
Ethical Considerations
• Foreign Corrupt Practices Act of 1977 - requires that firms maintain internal control
systems to properly execute and record all transactions
• The Sarbanes-Oxley Act of 2002 (SOX) - senior executives of publicly traded
companies take individual responsibility for the accuracy and completeness of
financial report
• The Code of Ethics established by the Institute of Management Accountants - spells
out expected behaviors such as competence, confidentiality, integrity, and credibility
Measure Cost & Benefits
• Only focus on things that are relevant - differ between the options
• Controllable - can avoid by not picking the option
A variable cost is usually controllable, but not always
• Every relevant cost is controllable, not every controllable cost is relevant
• Time horizon
Short term - capacity resources related to plant, equipment, staff is fixed
Long term - can change available capacity by acquiring or disposing resources
Variability
• Fixed cost - goes down when production unit goes up - more spread out
• Variable cost - proportional to the volume of activity
• Semi-variable / mixed cost - contains elements of both
Traceability
• Degree we can directly relate a cost or revenue to a decision option
• Direct cost
Direct fixed cost - cost of a machine, fixed salary of a worker
Direct variable cost - raw material
• Indirect cost
Need to find a way to allocate
• virtually every cost is variable with respect to some activity
Cost Hierarchy
• Unit level - materials for each unit of production
Machine related
Labor related
• Batch level
Equipment setups
Purchase ordering
Inspection
Material handling
• Product level - every time produce a new type of product
Product design
Advertising
R&D
Engineering changes
• Facility level - sustains entire production system
Plant management / depreciation
Factory rent
Property tax
Utilities
Product VS. Period Costs
• Product Cost
Direct - can trace to a particular product
Indirect - manufacturing overhead
• Period Cost
Not relate directly to producing products or services
Management salary / SG&A
Manufacturing Organization
Raw material WIP Finished goods
Cost Allocation
• Overhead costs are indirect, cannot trace to a particular product
Cost pool - total to allocate
Cost objects - a product / line to which allocate cost
Cost driver / allocation basis - attributes or basis which you allocate
Allocation / denominator volume - sum of cost driver across all cost objects
Determine allocation / overhead rate -
Allocate cost -
Contribution Margin
Account Classification Method
High-low Method
Regression Analysis
Segmented Contribution Margin Statements
Profit before taxes
• Appropriate measure for short term decisions because fixed costs do not change
• Used to estimate profit at different sales volumes
Break-even
Profit After Tax
Margin of Safety
Profit Sensitivity
Operating Leverage
• Greater the fixed cost, the more sensitive is profit to changes in volume
Assumptions inherent in CVP Analysis
• revenues increase proportionally with sales volume
• variable costs increase proportionally with sales volume
• selling prices, unit variable costs, and fixed costs are known with certainty
• all revenues and costs occur in a single period
• a known and constant product mix
• CVP analysis is not well suited for a setting in which available capacity is not sufficient
to meet all demand, meaning that companies have to decide which products to cut
back on
Multi-product CVP Analysis
• Unit CM
• CMR
Incremental Cost & Incremental Profit
• Incremental- what we care about, what changes, what’s relevant
• Incremental profit = incremental revenue - incremental profit
Gap between Demand & Supply
• Unavoidable temporary imbalances between the demand and supply
• Excess supply - include extra time, extra material
• Excess demand
rank products by CMU of the constraint resource
Qualitative Considerations
• quantifying the longer-term implications of short-term actions is difficult
• first estimate the short-term effects and then expand the range of considered factors
• It is important for managers to do so because of potential trade-offs between short-
term and long-term interests
• an option may cost the company in the short term but may be the most beneficial
one from a long-term perspective
Joint Cost
