ACCT6173-Managerial

Accounting
Week 10
Differential Analysis: The Key to Decision
Making
 LEARNING OUTCOMES
• Peserta diharapkan mampu menganalisa
biaya yang berbeda untuk membuat
keputusan (C4).
 Sub Topik
• Cost Concept for Decision Making
• Adding and Dropping Product Lines and Other
Segments
• The Make or Buy Decision
• Opportunity Cost
• Value To Business(Deprival Value)
• Special Orders
• Utilization of a Constrained Resources
• Joint Product Cost and the Contribution Approach
 Cost Concept for Decision
Making

• Managers must decide what products to sell,

whether to make or buy component parts,
what prices to charge, what channels of
distribution to use, whether to accept special
orders at special prices, and so forth. Making
such decision is often a difficult task that is
complicated by numerous alternatives and
massive amounts of data, only some of
which may be relevant
 Cost Concept for Decision
Making
• Only those cost and benefits that differ in
total between alternatives are relevant in a
decision.
• If the cost is the same for two or more
alternatives then the cost can be ignored
 Identifying Relevant
Costs
An avoidable cost is a cost that can be eliminated,
in whole or in part, by choosing one alternative
over another. Avoidable costs are relevant
costs. Unavoidable costs are irrelevant costs.

Two broad categories of costs are never

relevant in any decision. They include:
Sunk costs.
Future costs that do not differ between the
alternatives.
 Identifying Relevant Costs

From a financial standpoint, Cynthia would be better off

taking the train to visit her friend. Some of the non-financial
factor may influence her final decision.

Relevant Financial Cost of Driving

Gasoline (460 @ $0.100 per mile) $ 46.00
Maintenance (460 @ $0.065 per mile) 29.90
Reduction in resale (460 @ $0.026 per mile) 11.96
Parking in New York (2 days @ $25 per day) 50.00
Total $ 137.86

Relevant Financial Cost of Taking the Train

Round-trip ticket $ 104.00

Slide 7
 Adding and Dropping Product
Lines and Other Segments

• Decisions relating whether product lines or

other segments of a company should be
dropped and a new ones added are among the
most difficult that a manager has to make.
• In such decision, many qualitative and
quantitative factors must be considered.
• Any final decision to drop or to add is going to
hinge primarily on the impact the decision will
have on net operating income
 Adding and Dropping Product
Lines and Other Segments
• The next slide will show you the calculation
on how to keep or how to drop the segment
product
• The company should keep the product
because it yields smaller net loss
 Comparative Income Approach
Solution
Keep Drop
Digital Digital
Watches Watches Difference
Sales $ 500,000 $ - $ (500,000)
Less variable expenses: -
Manufacturing expenses 120,000 - 120,000
Shipping The complete 5,000 comparative- 5,000
Commissions income statements
75,000 reveal- that 75,000
Total variable expenses 200,000 - 200,000
Contribution margin
Lovell would
300,000
earn $40,000
-
of (300,000)
Less fixed expenses: additional profit by retaining the

Thank You
General factory overhead 60,000
digital 60,000
watch line. -
Salary of line manager 90,000 - 90,000
Depreciation 50,000 50,000 -
Advertising - direct 100,000 - 100,000
Rent - factory space 70,000 - 70,000
General admin. expenses 30,000 30,000 -
Total fixed expenses 400,000 140,000 260,000
Net operating loss $ (100,000) $ (140,000) $ (40,000)
 The Make or Buy Decision

• Separate companies may carry out each of the

activities in the value chain or a single company
may carry out several.
• When a company is involved in more than one
activity in the entire value chain, it is vertically
integrated
• A decision to carry out one of the activities in
the value chain internally, rather than to buy
externally from a supplier, is called make or buy
decision
 The Make or Buy
Decision
• Strategic aspects of the make or buy
decision.
• Vertical integration provides certain
advantages
• An integrated company is less dependent on
its suppliers and may be able to ensure a
smoother flow of parts and materials for
production than nonintegrated company
 The Make or Buy
Decision
• If company make its own parts then it can
control the quality and can get the exact
amount of parts without worrying not to be
deliver on-time by its suppliers
 The Make or Buy Decision:
An Example
• Essex Company manufactures part 4A that is used in one of its
products.
• The unit product cost of this part is:

Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of special equip. 3
Supervisor's salary 2
General factory overhead 10
Unit product cost $ 30
 The Make or Buy
Decision
• The special equipment used to manufacture
part 4A has no resale value.
• The total amount of general factory overhead,
which is allocated on the basis of direct labor
hours, would be unaffected by this decision.
• The $30 unit product cost is based on 20,000
parts produced each year.
• An outside supplier has offered to provide the
20,000 parts at a cost of $25 per part.

Should we accept the supplier’s offer?

 The Make or Buy Decision
Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
General factory overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

The avoidable costs associated with making part 4A include direct

materials, direct labor, variable overhead, and the supervisor’s salary.

Slide 16
 The Make or Buy Decision
Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
General factory overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

The depreciation of the special equipment represents a sunk

cost. The equipment has no resale value, thus its cost and
associated depreciation are irrelevant to the decision.

Slide 17
 The Make or Buy Decision
Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
General factory overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

Not avoidable; irrelevant. If the product is dropped, it

will be reallocated to other products.

Slide 18
 The Make or Buy Decision
Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
General factory overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

Should we make or buy part 4A? Given that the total avoidable costs
are less than the cost of buying the part, Essex should continue to
make the part.
Slide 19
 Opportunity Cost

• Opportunity cost are not recorded in the

organization’s general ledger because they
do not represent actual dollars outlay.
Rather, they represent economic benefits
that are forgone as a result of pursuing some
course of action.
 Value To
Business(Deprival Value)
• An asset already owned by a company can
have different values to the business
• When a decision needs to be made, an
appropriate value should be attached to the
asset to help make the correct decision
• Historical Cost is not relevant for decision
making because it is a sunk cost
 Value to Business
Deprival value
= Lower of
(Deprival Value)

Replacement Cost Recoverable Value (RV)

(RC) = Higher of

Net Realizable Value Economic Value

(NRV) (EV)
 Special Orders

• A special order is a one-time order that is not

considered part of the company’s normal
ongoing business
• Managers must often evaluate whether a
special order should be accepted, and if the
order is accepted, what price should be
charged
• The company should have an idle capacity to
take special order
 Special Orders
 Jet, Inc. makes a single product whose normal selling price is
$20 per unit.
 A foreign distributor offers to purchase 3,000 units for $10 per
unit.
 This is a one-time order that would not affect the company’s
regular business.
 Annual capacity is 10,000 units, but Jet, Inc. is currently
producing and selling only 5,000 units.
Should Jet accept the offer?
 Special Orders
Jet, Inc.
Contribution Income Statement
Revenue (5,000 × $20) $ 100,000
Variable costs:
Direct materials $ 20,000
Direct labor 5,000
Manufacturing overhead 10,000
$8 variable cost
Marketing costs 5,000
Total variable costs 40,000
Contribution margin 60,000
Fixed costs:
Manufacturing overhead $ 28,000
Marketing costs 20,000
Total fixed costs 48,000
Net operating income $ 12,000
 Special Orders

If Jet accepts the special order, the incremental

revenue will exceed the incremental costs. In other
words, net operating income will increase by
$6,000. This suggests that Jet should accept the
order.

Increase in revenue (3,000 × $10) $ 30,000

Increase in costs (3,000 × $8 variable cost) 24,000
Increase in net income $ 6,000

Note: This answer assumes that the fixed costs are unavoidable
and that variable marketing costs must be incurred on the special
order.
 Joint Product Cost and the
Contribution Approach

• In some industries, a number of end

products are produced from a single raw
material input
• For example are milk products. From milk as
raw material can be processed into cheese,
ice cream or yogurt
• This kind of production is called joint
products
 Joint Product Cost and the
Contribution Approach

• Joint Products is two or more products that

are produced from the same raw materials
and at split of point it will separate into
different products.
• Examples: milk, pineapple, beef, chicken,
crude oil
 Reference
• Garrison, Nooren, Brewer, Cheng, Yuen.
(2015). Managerial Accounting An Asian
Perspective.2e. Mcgraw-hill/Irwin. ISBN:
978-1-259-01182-5
Chapter 14
Thank You