ACCTBA3 FINALS REVIEWER

I. CHAPTER 1: MANAGERIAL ACCOUNTING AND

THE BUSINESS ENVIRONMENT
Globalization
The marketplace is becoming increasingly global
o Reductions in barriers to free trade (tariffs,
quotas, etc)
o Improvements in global transportation
o Expansion of the Internet
o Increasing sophistication in international
markets
Effects of globalization
o Greater and wider competition
o Greater access to new markets, customers and
workers
o More variety of goods and services for
consumers
The Internet and globalization
o The internet provides companies with greater
access to geographically dispersed customers,
employees and suppliers
However, 78% of the population was
still not connected to the Internet.
Strategy
A game plan that enables a company to attract
customers by distinguishing itself from competitors
Customer Value Propositions
o Customer Intimacy
Understand and respond to individual
customer needs
o Operational Excellence Strategy
Deliver products and services faster,
more conveniently, and at lower prices
o Product Leadership Strategy
Offer higher quality products
Organizational Structure
Decentralization
o Delegation of decision-making authority
throughout an organization
Can be done by giving managers the
authority to make decisions relating to
their area of responsibility
Corporate Organization Chart
o Shows how responsibility is divided (chain of
command)
Board of Directors
President
Puchasing

Personnel

Vice President
Operations

Chief Financial
Officer

Treasurer

Controller

Depicts the line and staff positions in an

organization

Line positions: directly related to the

achievement of the basic objectives of
an organization
Example:
production
supervisors
in
a
manufacturing plant
Staff positions: support and assist line
positions
Example: cost accountants in
the manufacturing plant
Chief Financial Officer
Provides timely and relevant data to
support planning and controlling
activities
Prepares financial statements for
external users

Process Management
Business Process
o A series of steps that are followed in order to
carry out some task in a business
Value Chain
o Consists of the major business functions that
add value to a companys products and services
Business functions making up the value chain
R
Product
Manufacturi Market Distributi
Custo
and
Design
ng
ing
on
mer
D
Service
Three approaches to improving business processes
o Lean Production
o Theory of Constraints
o Six Sigma
Traditional push manufacturing company

Forecast sales

Make sales from

finished goods
inventoy

Order components

Store inventory

Store inventory

Produce goods in
anticipation of
sales

Lean Production
o Lean thinking model
Five-step management approach
1. Identify value in
specific
products/services

5. Continuously
pursue perfection
in business process

4. Create a pull
system

2. Identify business
process that delivers
value

3. Organize
work
arangements

Results in a pull manufacturing

system that reduces inventories and
wasted effort, decreases defects, and
shortens customer response times

Customer places an
order

Goods delivered
when needed

Create production
order

Production begins
as parts arrive

Generate
component
requirements

Components are
ordered

Lean thinking can be used to improve business

processes that link companies together
o Supply Chain Management
Coordination of business processes
across companies to better serve end
consumers
Theory of Constraints
o Based on the observation that effectively
managing the constraint is the key to success
Constraint (bottleneck): anything that
prevents you from getting more of
what you want.
Determined by the step that has the
smallest capacity

1. Identify the
weakest link
2. Allow the
weakest link to set
the tempo

4. Recognize that
the weakest link is
no longer so
3. Focus on
improving the
weakest link

Six Sigma
o Relies on customer feedback and fact-based data
gathering and analysis techniques to drive
process improvement
o Refers to a process that generates no more than
3.4 defects per million opportunities
o Sometimes associated with the term zero defects.
o DMAIC Framework
Stage
Goals
Define
Establish scope and purpose
Diagram the flow
Establish customers requirements
Measure
Gather baseline performance data
Narrow the scope of the project to the most
important problems
Analyze
Identify root cause(s) of the problems
Improve
Develop, evaluate and implement solutions
Control
Ensure problems remain fixed
Seek to improve the new methods over time
IMAs Code of Conduct for Management Accountants
IMA Guidelines for Ethical Behavior
o Competence
Recognize
and
communicate
professional limitations
Follow applicable laws

Provide accurate, clear, concise, and

timely decision support information
o Confidentiality
Do not disclose (and ensure
subordinates
do
not
disclose)
confidential information unless legally
obligated
Do not use confidential information
for unethical or illegal advantage
o Integrity
Mitigate conflicts of interest and advise
others of potential conflicts
Abstain from activities that might
discredit the profession
Refrain from conduct that would
prejudice carrying out duties ethically
o Credibility
Communicate information fairly
Disclose delays or deficiencies
Disclose all relevant information that
could influence a users understanding
of reports and recommendations
IMA Guidelines for Resolution of an Ethical Conflict
o Follow employers established policies
o For an unresolved ethical conflict:
Discuss conflict with immediate
supervisor or next highest uninvolved
manager
If immediate is CEO,
consider BoD or the audit
committee
Contact with levels above the
immediate supervisor should only be
done with the supervisors knowledge
Except where legally prescribed,
maintain confidentiality
Clarify issues in a confidential
discussion with an objective advisor
Consult an attorney as to legal
obligations
Why have ethical standards?
o These are essential for a smooth functioning
economy
o Without ethical standards will lead to a lower
quality of life with less desirable goods and
services at higher prices

Corporate Governance
The system by which a company is directed and
controlled
Boards of directors provide incentives and monitoring
for top management to pursue objectives of
stockholders.
Enterprise Risk Management
Process used by a company to proactively identify and
manage risk
Once a company identifies its risks, specific controls may
be implemented to reduce these risks
Corporate Social Responsibility

Concept whereby organizations consider the needs of all

stakeholders when making decisions
Extends beyond legal compliance to include voluntary
actions that satisfy stakeholder expectations

II. CHAPTER 2: MANAGERIAL ACCOUNTING AND

COST CONCEPTS
Work of Management
Planning
Identify
alternatives

Select
alternative

Develop
budgets to
guide
progress

Prime Cost = Direct Labor + Direct Material

Conversion Cost = Direct Labor + Manufacturing
Overhead

Nonmanufacturing Costs (PERIOD COSTS)

Selling costs
o Necessary to secure the order and deliver the
product
Administrative costs
o Executive, organizational and clerical costs
Income Statement
Format for Merchandising

Directing and Motivating

o Involves managing day-to-day activities to keep
the organization running smoothly
Controlling
o Ensuring that plans are being followed
o Feedback in the form of performance reports
that compare actual results with the budget are
an essential part of the control function
Planning and Control Cycle
Formulating
long- and shortterm plans

Comparing actual to
planned
performance

Decision
Making

Implementing
plans

Format for Manufacturing

Measuring
performance

Comparison of Financial and Managerial Accounting

Financial
Managerial
Users
External persons who
Managers who plan for
make financial
and control an
decisions
organization
Time focus
Historical perspective
Future emphasis
Verifiability
Verifiability
Relevance for planning
vs. relevance
and control
Precision vs.
Precision
Timeliness
timeliness
Subject
Focus is on the whole
Focuses on segments of
organization
an organization
GAAP
Required
Not required
Requirement Mandatory for external
Optional
reports
Manufacturing Costs (PRODUCT COSTS)
Direct Materials (Direct Cost)
o Raw materials that can be conveniently traced
directly to the finished product
Direct Labor (Direct Cost)
o Labor costs that can be easily traced to
individual units of product
Manufacturing Overhead (Indirect Cost)
o Cannot be traced directly to the specific units
produced (indirect materials and indirect labor;
support)

Schedule of Cost of Goods Manufactured

Cost Behavior
How a cost will react to changes in the level of activity
within the relevant range

Variable Costs vs. Fixed Costs

Behavior of Cost (within the relevant range)
Cost
In Total
Per Unit
Variable
Total variable cost
Variable cost per unit
changes as activity level
remains the same over
changes
wide ranges of activity
Fixed
Total fixed cost
Average fixed cost per
remains the same even
unit goes down as
when activity level
activity level goes up
changes
Differential Cost and Revenue
Costs and revenues that differ among alternatives
Opportunity Cost
Potential benefit that is given up when one alternative is
selected over another

Job Order Costing Overview

Direct Materials

Direct Labor
Manufacturing
Overhead

Job 1
Job 2
Job 3

Direct materials and direct labor costs are charged to each

job as work is performed
Manufacturing overhead, including indirect materials and
indirect labor, are allocated rather than directly traced to
each job
Job Cost Sheet

Sunk Costs
Costs that have already been incurred and cannot be
changed now or in the future
These costs should be ignored when making decisions
Summary of the Types of Cost Classifications
Financial reporting
Predicting cost behavior (variable/fixed)
Assigning costs to cost objects (direct/indirect)
Making business decisions
III. CHAPTER 3: SYSTEMS DESIGN: JOB-ORDER
COSTING
Types of Product Costing Systems
Process Costing
o Production of many units of a single,
homogenous product
o The identical nature of each unit of product
enables assigning the same average cost per unit
o Basic formula for process costing:

Job-Order Costing
o Usually used in service-oriented industries
o Many different products are produced each
period
o Manufactured to order
o The unique nature of each order requires tracing
or allocating costs to each job, and maintaining
cost records for each job.
Comparison
Job-Order
Process
Number of jobs worked
Many
Single Product
Cost accumulated by
Job
Department
Average cost computed by
Job
Department

Applying Manufacturing Overhead

An allocation base (a measure such as direct labor-hours
or machine-hours that is used to assign overhead costs to
products and services) is used because:
o It is impossible/difficult to trace overhead costs
to particular jobs
o Manufacturing overhead consists of many
different items
o Many times of manufacturing overhead costs are
fixed in spite of output fluctuation
Predetermined overhead rate
o Determined before the period begins
o Enables estimation of total job costs sooner, as
actual overhead is not known until the end of
the period
o Formula:

Applied Manufacturing Overhead

Note: we use Applied MOH for the COGM schedule.

 Job-Order Costing Document Flow Summary

Sales Order

Production
Order

Job cost
sheet

Materials
requisition
form*
Employee
time ticket*
Production
Order

*Note: Indirect materials and indirect labor are first included in the
manufacturing overhead account before the job cost sheet
Flow of Costs and Applying Manufacturing Overhead
T-account format ; Journal Entries
Raw Materials
Material
DM
Purchases IM
Work In Process
(Job Cost Sheet)
DM
DL
Overhead
Applied
Salaries and Wages
Payable
DL
IL
Mfg. Overhead
Actual
Applied
IM
OH
IL
applied to
Others
WIP
Accounting for Nonmanufacturing Cost
These costs are not assigned to individual jobs, rather
they are expensed in the period incurred.
Debit expense, credit asset/liability
Transferring Completed Units
T-account format ; Journal Entries
Work In Process
(Job Cost Sheet)
DM
DL
COGM
Overhead
Applied
Finished Goods
COGM
COGS
Cost of Goods Sold
COGS
Overhead Application Problems

Underapplied overhead
o Actual MOH > Applied MOH
Overapplied overhead
o Actual MOH < Applied MOH
Allocation of under/overapplied OH

If MOH is:
Underapplied

Oveapplied

ALTERNATIVE 1
Close to COGS
Increase
COGS
Decrease
COGS

ALTERNATIVE 2
Allocation
Increase
WIP
Finished Goods
COGS
Decrease
WIP
Finished Goods
COGS

New format used for COGM and COGS!

Cost
Per
Unit

Total
Cost

Activity Level

Activity Level

Step-variable cost
o Cost of a resource that is obtained in large
chunks and that increases or decreases only in
response to fairly wide changes in activity

Cost

Small changes in production are unlikely to

have any effect on the number of workers
employed
Only wide changes in activity
level will cause a change in
the number of workers
employed

Activity Level

The Linearity Assumption and the Relevant Range

IV. CHAPTER 5: COST BEHAVIOR: ANALYSIS AND

USE
Variable Costs
Cost driver
o A measure of what causes the incurrence of a
variable cost
Units produced
Machine hours
Labor hours
Miles driven, etc.
Examples of variable costs
Merchandising

Manufacturing

>Cost
of
goods sold

>Direct
materials
>Direct labor
>Variable
overhead

Merchandising
And
Manufacturing

>Commissions
>Shipping
costs
>Clerical costs

Fixed Costs
A cost whose total dollar amount remains constant as the
activity level changes
Average fixed cost per unit decrease as the activity level
increases

True variable cost

o Total variable cost is directly proportional to the
activity level
o Variable cost per unit is constant

Cost
Per
Unit

Total
Cost

Activity Level

Service

>Supply
>Travel
>Clerical

We assume a strictly
linear
relationship
between cost and volume
Relevant Range
o Range of activity
within which the
assumptions
are
reasonably valid

Activity Level

Types of fixed costs

o Committed: long-term, cannot be significantly
reduced in the short term
Depreciation, real estate taxes
o Discretionary: may be altered in the short-term
by current managerial decisions
Advertising, research and development
Fixed Costs and the Relevant Range
o The relevant range of activity for a fixed cost is
the range of activity over which the graph of the
cost is flat
o Concludes that discretionary and committed
fixed costs are really just step-variable costs
In the long run, almost all costs can be
adjusted
o Difference with step-variable costs
Step-variable costs can often be
adjusted quickly as conditions change

Width of the steps in step-variable

costs is much narrower
Releva
nt

Range

Cost

Volume

Summary of Cost Behavior Patterns

Cost
Variable

Fixed

In Total
Total variable cost is
proportional to the
activity level within the
relevant range
Total fixed costs remain
the same even when the
activity level changes
within the relevant range

Per Unit
Variable cost per unit
remains the same over
ranges of activity
Average fixed costs per
unit decrease as the
activity level increases

Use both the highs and

lows to ensure that the
value of a is constant
Substitute the values of b and a in the
general formula

Least-Squares Regression Method

o Method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between X and Y variables
o Uses all of the data points to estimate the fixed
and variable cost components of a mixed cost
o Provides a statistic called R2, which is a measure
of the goodness of fit of the regression line to
the data points.
o Goal: to fit a straight line to the data that
minimizes the sum of the squared errors

Mixed Costs (semivariable costs)

Contains both variable and fixed cost elements
Can be expressed as an equation
o
o
o

Y = total mixed cost

a = Total fixed cost
b = Variable cost per unit of activity (slope)
Can be obtained with the formula:

X = The level of activity

Total
Cost

Mixed Cost
Slope =
variable
cost/unit

Intercept = total
fixed cost

Contribution Format
Variable cost element

Fixed cost element

Activity Level

Analysis of Mixed Costs

o Account analysis
Each account is classified as either
variable or fixed based on the analysts
knowledge of how the account behaves
o Engineering approach
Classifies costs based upon an
industrial engineers evaluation of
product methods, and material, labor
and overhead requirements
High-Low Method
o Steps:
Find b (variable cost per unit) with the
formula:

Find a (fixed cost) with the (derived)

formula:

The contribution margin format emphasizes cost

behavior. Contribution margin covers fixed costs and
provides for income.
Used primarily by management

 CVP Graph

Fixed expense

Contribution Margin Ratio

Application

Variable Expense Ratio

Formula

Application

Break-Even Analysis

Target Profit

V. COST-VOLUME-PROFIT RELATIONSHIPS
CVP Relationships in Equation Form

Profit formula

Unit CM formula

Margin of Safety
The excess of budgeted (or actual) sales over the breakeven volume of sales

 Cost Structure and Profit Stability

Cost structure refers to the relative proportion of fixed
and variable costs in an organization.
High fixed cost (or low variable cost) structures
Advantage
Disadvantage
> Income will be higher in > Income will be lower in bad
good years compared to years compared to companies
companies
with
lower with lower proportion of fixed
proportion of fixed costs
costs

Companies with low fixed cost structures enjoy greater

stability in income across good and bad years.

Operating Leverage
Measure of how sensitive net operating income is to
percentage changes in sales

Concept of Sales Mix

Sales mix the relative proportion in which a companys
products are sold
Different products = different selling prices, cost
structures and contribution margin
Key Assumptions of CVP Analysis
Selling price is constant
Costs are linear and can be accurately divided into
variable (constant per unit) and fixed (constant in total)
elements
In multiproduct companies, the sales mix is constant.
In manufacturing companies, inventories do not change.
VI. CHAPTER 11: STANDARD COSTS AND OPERATING
PERFORMANCE MEASURES
Standard Costs
Standards: benchmarks or norms for measuring
performance
o Quantity standards: specify how much of an
input should be used to make a product or
provide a service
o Price standards: specify how much should be
paid for each unit of input
Management by exception: practice in which deviations
from standards deemed significant are brought to the
attention of management

Variance Analysis Cycle

1. Prepare standard
cost performance
report

6. Conduct next
period's
operations

2. Analyze
variances

5. Take corrective
actions

3. Identify
questions
4. Receive
explanations

Setting Standard Costs

Accountants, engineers, purchasing agents, and
production managers combine efforts to set standards
that encourage efficient future operations
Setting Direct Material Standards
Price Standards: final, delivered cost of materials, net of
discounts
Quantity Standards: summarized in a Bill of Materials
Setting Direct Labor Standards
Rate Standards: often a single rate is used that reflects the
mix of wages earned
Time standards: use time and motion studies for each
labor operation
Setting Manufacturing Overhead Standards
Rate Standards: the rate is the variable portion of the
predetermined overhead rate
Quantity Standards: the quantity is the activity in the
allocation base for predetermined overhead
Standard Cost Card

Inputs
Direct materials
Direct labor
Variable mfg. overhead
Total standard unit cost

AxB

Standard
Quantity
or Hours

Standard
Price
or Rate

Standard
Cost
per Unit

3.0 lbs.
2.5 hours
2.5 hours

$ 4.00 per lb.

14.00 per hour
3.00 per hour

12.00
35.00
7.50
54.50

Price and Quantity Standards

Determined separately for the following reasons:
o The purchasing manager is responsible for raw
material purchase prices; the production
manager is responsible for the quantity of raw
materials used
o Buying and using activities occur at different
times. Raw material purchases may be held in
inventory for a period of time before using.
General Model for Variance Analysis
Variance
Analysis
Quantity
Variance

Price Variance
Difference
between
actual price
and
standard
price

Materials PV
Labor Rate
PV
VOH Rate
variance

Difference
between
actual
quantity and
standard
quantity

Materials QV
Labor efficiency
variance
VOH efficiency
variance

FORMULAS (Shortcut, as taught by Sir Drex )

Emphasis on negative may impact morale

Continuous improvement may be more important than
meeting standards

Examples
Standard example

Responsibility for Material Variance

Materials Quantity Variance: Production Manager
Materials Price Variance: Purchasing Manager
o The standard price is used to compute the
quantity variance so that the production
manager is not held responsible for the
purchasing managers performance
Responsibility for Labor Variances
Production managers are usually held accountable, for
they can influence:
o Mix of skill levels assigned to work tasks
o Level of employee motivation
o Quality of production supervision
o Quality of training provided to employees
Variance Analysis and Management by Exception
Larger variances are investigated first
Plotting variance analysis data on a statistical control chart
is helpful in investigation decisions
Advantages of Standard Costs
Management by exception
Promotes economy and efficiency
Enhances responsibility accounting
Simplified bookkeeping
Potential Problems with Standard Costs
Emphasizing standards may exclude other important
objectives
Standard cost reports may not be timely
Invalid assumptions about the relationship between labor
cost and output
Favorable variances may be misinterpreted

In which materials purchased materials used

VII.
CHAPTER
12:
DECENTRALIZATION
SCORECARD

SEGMENT
REPORTING,
AND
THE
BALANCED

Decentralization
Benefits
o Top management can concentrate on strategy
o Lower-level managers gain experience in
decision-making
o Decision-making authority leads to job
satisfaction
o Lower-level decisions often based on better
information
o Lower level managers can respond quickly to
customers
Disadvantages
o May be a lack of coordination among
autonomous managers
o Lower-level managers may make decisions
without seeing the big picture
o Lower-level managers objective may not be
those of the organization
o May be difficult to spread innovative ideas in the
organization

Backtracking

Responsibility Center
Cost Center
o Segment whose manager has control over costs,
but not over revenues or investment funds
Profit center
o Segment whose manage has control over both
costs and revenues, but not investment funds
Investment center
o Segment whose manager has control over costs,
revenues, and investments in operating assets
Decentralization and Segment Reporting
Segment: any part or activity of an organization about
which manager seeks cost, revenue or profit data
Segmented Income Statements
Two keys to building:
o Contribution format should be used because it
separates fixed from variable costs, and enables
calculation of contribution margin
o Traceable fixed costs should be separated from
common fixed costs to enable the calculation of
a segment margin
o Common costs should not be allocated to the
divisions, as these would remain even if one of
the divisions were eliminated

Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net operating
income

Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000
25,000
$

Computer
$ 200,000
80,000
120,000
80,000
$ 40,000

Examples
Standard

75,000

Identifying Traceable Fixed Costs

Traceable costs arise because of the existence of a
particular segment and would disappear over time if the
segment itself disappeared.
Common costs arise because of the overall operation of
the company, and would not disappear if any particular
segment were eliminated.
Segment Margin
Computed by subtracting the traceable fixed costs from
its contribution margin
Best gauge of the long-run profitability of a segment
Return on Investment
Measures net operating income earned relative to the
investment in average operating assets
Formulas

Increasing ROI
o Increase sales
o Reduce expenses
o Reduce assets
Net book value: used by most companies to calculate
average operating assets

Residual Income
Another measure of performance
Measures net operating income earned less the minimum
required return on average operating assets
Encourages managers to make profitable investments that
would be rejected by managers using ROI
Disadvantage: Cannot be used to compare the
performance of divisions of different sizes
Formula

Backtracking

With Analysis

Evaluation
o If an intracompany would result in higher
profits, there is always a range of transfer prices
within which both the selling and buying
divisions would have higher profits should they
agree to the transfer
o If managers are pitted against each other rather
than against their past performances, a no
cooperative atmosphere is almost guaranteed
o Given disputes that accompany the negotiation
process, most rely on other means of setting
transfer prices.

Transfers at the Cost to the Selling Division

Many companies set transfer prices at either the variable
cost or full (absorption) cost incurred by the selling
division
Drawbacks
o Using full cost can lead to suboptimization
o Selling division will never show a profit on any
internal transfer
o Cost-based transfer prices do not provide
incentives to control costs

VIII. APPENDIX 12-A TRANSFER PRICING

Key Concepts
Transfer price: price charged when one segment of a
company provides goods or services to another segment
Objective: motivate managers to act in the best interests
of the overall company
Three approaches
o Negotiated transfer prices
o Transfers at the cost to the selling division
o Transfers at market price
Negotiated Transfer Prices
Results from discussions between the selling and buying
divisions
Advantages:
o Preserve the autonomy of divisions consistent
with decentralization
o Managers are likely to have better information
about potential costs and benefits
Range of Acceptable Transfer Prices
o Upper limit: buying division
o Lower limit: selling division
Formulas (Sir Drexs formulas )
o Selling Division (Lower limit, LL)

Buying Division (Upper limit, UL)

Transfers at Market Price

Market price (price charged for an item on the open
market) : often regarded as the best approach to the
transfer pricing problem
Works best when the product or service is sold in its
present for to outside customers and the selling division
has no idle capacity
Does not work well when the selling division has idle
capacity
Divisional Autonomy and Suboptimization
Managers should be granted autonomy to set transfer
prices and decide whether to sell internally or externally,
even if it may result in suboptimal decisions

the data at hand and isolate the relevant costs in each

situation.

Example

Relevant Cost Analysis

Step 1: Eliminate costs and benefits that do not differ
between alternatives
Step 2: Use the remaining costs (avoidable costs) and
benefits to make a decision.
Total and Differential Cost Approaches
Only rarely will enough information be available to
prepare detailed income statements for both alternatives
Mingling irrelevant costs with relevant costs may cause
confusion and distract attention from critical information
General Formula for Differential Cost

Adding or Dropping Segments

Formula

Make or Buy Analysis

When a company is involved in more than one activity in
the entire value chain, it is vertically integrated
o Advantages
Smoother flow of parts and materials
Better quality control
Realize profits
o Disadvantage
Companies may fail to take advantage
of supplies who can create economies
of scale advantage by pooling demand
A company must be careful to retain
control over activities that are essential
to maintaining its competitive position
Formula

Whichever is lower should be accepted.

IX. CHAPTER 13: RELEVANT COSTS FOR DECISION

MAKING
Relevant Cost: cost that differs between alternatives
Types of relevant costs
o Avoidable costs
Types of irrelevant costs
o Unavoidable costs
o Sunk costs
o Future costs that do not differ between
alternatives
Costs that are relevant in one situation may not be
relevant in another context. The manager must examine

Opportunity Cost: benefit that is forgone as a result of

pursuing some course of action
o Not actual cash outlays and not recorded in the
formal accounts of an organization
Special Orders
Special Order: one-time order that is not considered part
of the companys normal ongoing business
Only incremental costs and benefits are relevant
Since manufacturing overhead costs would not be
affected by the order, they are not relevant.
Formula

 Examples
Dropping Segments

Make or Buy Analysis

Special Orders

Sales (5,000 units @ $40 per unit)

Less variable expenses:
Direct materials (5,000 units @ $14 per unit)
Direct labor (5,000 units @ $8 and $5 per unit)
Variable overhead (5,000 units @ $2 per unit)
Total variable expenses
Contribution margin
Less fixed expense:
Other
Rent on new machine
Total fixed expenses
Net operating income

Total Cost
Current
Situation
$
200,000

Situation
With New
Machine
$
200,000

Differential
Costs and
Benefits
-

70,000
40,000
10,000
120,000
80,000

70,000
25,000
10,000
105,000
95,000

15,000
15,000

62,000
62,000
18,000

62,000
3,000
65,000
30,000

(3,000)
(3,000)
12,000

Differential Cost

Net Advantage to Renting the New Machine

Decrease in direct labor costs (5,000 units @ $3 per unit)
Increase in fixed rental expenses
Net annual cost saving from renting the new machine

$
$

15,000
(3,000)
12,000

Constrained Resources
Constraint: limited resource of some type restricts a
companys ability to satisfy demand
Bottleneck: machine or process that limits overall output
Utilization
o Fixed costs are usually unaffected, so the
product mix that maximizes the companys total
contribution margin should be selected
o A company should not necessarily promote
those products with highest unit CM
o Total CM will be maximized by promoting
products or accepting orders that provide the
highest CM in relation to the constraint
General formula

Several Methods on Managing Constraints

Working overtime on the bottleneck
Subcontracting some of the processing
Investing in additional machines
Shifting workers to the bottleneck
Focusing business process improvement efforts on the
bottleneck
Reducing defective units processed
Joint Costs
Two or more products produced from a common input
Traditionally allocated among different products at the
split-off point
o Split-off point: point in the manufacturing
process where each joint product can be
recognized as a separate product
o Typical approach: allocated joint costs according
to relative sales value of the end products
Can be dangerous for decision making
Sell or Process Further
Joint costs are considered irrelevant here

It is profitable to continue processing a joint product

after the split-off point so long as the incremental
revenue from such processing exceeds the incremental
processing costs incurred after the split-off point
General formula

If there is profit, process further. If loss, sell at split-off

point.

Examples
Managing Constraints

Sell or Process Further

Sales value at the split-off point

Per Log
Lumber
Sawdust
$
140
$
40

Sales value after further processing

270
Allocated joint product costs
176
Analysis of Sell or Process Further
Cost of further processing
50

50
24
20

Per Log
Lumber

Sales value after further processing $

Sales value at the split-off point
Incremental revenue
Cost of further processing
Profit (loss) from further processing $

270
140
130
50
80

Sawdust

50
40
10
20
(10)

In this case, the lumber should be processed

further and the sawdust should be sold at splitoff point.

REMINDERS:
Do not forget to bring the ff:
o CALCULATOR
o Ruler
o Assignment notebook
Please dont rely on this reviewer alone! This is just a
summarized version of the PPTs STUDY WELL! And
best of luck!