COST MANAGEMENT

Guan Hansen Mowen

Chapter 18
Activity Resource Usage Model
and Tactical Decision Making

COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.

Cengage Learning and South-Western are trademarks used herein under license.

Study Objectives
1. Describe the tactical decision-making
model.
2. Define the concept of relevant costs and
revenues.
3. Explain how the activity resource usage
model is used in assessing relevancy.
4. Apply the tactical decision-making
concepts in a variety of business
situations.
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Tactical Decision Making

Steps of the tactical decision making process
1. Recognize and define the problem.
2. Identify alternatives as possible solutions to the
problem, and eliminate alternatives that are not
feasible.
3. Identify the predicted costs and benefits
associated with each feasible alternative.
Eliminate the costs and benefits that are not
relevant to the decision.
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Tactical Decision Making

Continued from previous slide
4. Compare the relevant costs and benefits for
each alternative, and then relate each
alternative to the overall strategic goals of the
firm and other important qualitative factors.
5. Select the alternative with the greatest benefit
which also supports the organizations
strategic objectives.

Tactical Decision Making

Step 1: Define the Problem

Each year 25 percent of the harvest by an apple

processor is small and odd-shaped.
These apples cannot be sold in the normal
distribution channels and have simply been
dumped in the orchards for fertilizer.
What should the firm do with these apples?

Tactical Decision Making

Step 2: Identify Feasible Alternatives

Sell the apples to pig farmers.

Eliminate: not enough local farmers

Bag the apples in five-pound bags and sell them to local

supermarkets as seconds.
Feasible

Rent a local canning facility and convert the apples to

applesauce.
Feasible

Rent a local canning facility and convert the apples to pie

filling.
Eliminate: major capital investment required

Continue with the current dumping practice.

Eliminate: status quo

Tactical Decision Making

Step 3: Identify Predicted Costs and Benefits;
Eliminate Irrelevant Costs
Bagging Alternative

Applesauce Alternative

5 lbs of apples per bag

6 lbs of apples to produce five 16ounce cans of applesauce

Cost: $0.05 per pound for labor

and materials (bags and ties)
Revenue: $1.30 per bag

Cost: $0.40 per pound for rent,

labor, apples, cans, and other
materials
Revenue: $0.78 per can

Tactical Decision Making

Step 4: Compare Relevant Costs and Relate to
Strategic Goals
Bagging Alternative
Revenue per lb
Cost per lb
Net benefit per lb

Product
differentiation
strategy

Applesauce Alternative
$0.26
0.05
$0.21

Revenue per lb
Cost per lb
Net benefit per lb

$0.65
0.40
$0.25

Forward
integration
strategy

Tactical Decision Making

Step 5: Select Best Alternative

The apple producer is reluctant to follow a

forward integration strategy
The bagging alternative should be chosen

Tactical Decision Making

continued

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Tactical Decision Making

Continued from previous slide

continued

11

Tactical Decision Making

Continued from previous slide

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Relevant Costs and Revenues

Relevant costs
future costs that differ across alternatives

Irrelevant Costs
Past costs: already incurred sunk costs
are the same across alternatives; ignore

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Relevancy, Cost Behavior, and the

Activity Resource Usage Model
Flexible Resources
Easily purchased in the amount needed
Purchased at the time of use

Committed resources
Purchased before they are used

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Relevancy, Cost Behavior, and the

Activity Resource Usage Model
Flexible resources
The activity resources demanded equal the
resources supplied
Demand changes

relevant

Demand constant

not relevant

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Relevancy, Cost Behavior, and the

Activity Resource Usage Model
Committed resources
Excess of supply over demand is unused
capacity
Demand increase < unused capacity
Demand increase > unused capacity
Demand decrease
Activity capacity reduced
Activity capacity unchanged

not relevant
relevant
relevant
non relevant

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Relevancy, Cost Behavior, and the

Activity Resource Usage Model
A company has five manufacturing engineers
who supply a capacity of 10,000 engineering
hours (2,000 hours each).
The cost of this activity capacity is $250,000,
or $25 per hour. The firm expects to use
9,000 hours.
If the firm decides to reject a special order
requiring 500 hours, the cost of engineering
would be irrelevant.
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Relevancy, Cost Behavior, and the

Activity Resource Usage Model
The firm can purchase a component that will
drop the demand from engineering hours
from 9,000 to 7,000.
Since engineering activity capacity is
acquired in chunks of 2,000, the company
can lay off one engineer or reassign the
engineer to another plant.

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Relevancy, Cost Behavior, and the

Activity Resource Usage Model

19

Illustrative Examples of
Tactical Decision Making
Assumptions of C-V-P Analysis
1. The analysis assumes a linear revenue function and a
linear cost function.
2. The analysis assumes that price, total fixed costs, and
unit variable costs can be accurately identified and
remain constant over the relevant range.
3. The analysis assumes that what is produced is sold.
4. For multiple-product analysis, the sales mix is assumed
to be known.
5. The selling price and costs are assumed to be known
with certainty.
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Illustrative Examples of
Tactical Decision Making
Common Decisions
Make or Buy
Keep or Drop
Special Order
Sell or Process Further

Cost analysis informed by

Activity-based cost management system
Functional-based cost management system
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Illustrative Examples of
Tactical Decision Making
Make-or-Buy Decision
Talmage Company produces a mechanical part used in one of
its engines. (Talmage produces engines for snowblowers.) An
outside supplier has offered to sell a part (Part 34B) for $4.75.
The company normally produces 100,000 units of the part each
year.

Flexible resources:

Committed resources:

Using materials

Providing supervision

Using direct labor

Moving materials

Moving materials

Inspecting products

Providing power

Setting up equipment

Inspecting products
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Illustrative Examples of
Tactical Decision Making
Make-or-Buy Decision

ABC: buy the part

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Illustrative Examples of
Tactical Decision Making
Make-or-Buy Decision

Functional: make the part

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Illustrative Examples of
Tactical Decision Making
Keep-or-Drop Decision

If a segment is
dropped only
the traceable
revenues and
costs should
vanish
ABC
classifications
provide
information on
traceable costs
Drop?

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Illustrative Examples of
Tactical Decision Making
Keep-or-Drop Decision

Dropping the product

saves $45,000!

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Illustrative Examples of
Tactical Decision Making
Accept or reject a special order
Polarcreme, Inc., an ice-cream company, is operating at 80
percent of its 20 million half-gallon capacity.
A distributor from another geographic region offered to buy 2
million units of premium ice cream at $1.75 per unit.
Distributor will provide their own label and pay transportation
costs. This sale is not subject to a sales commission.
Impact of special order on non-unit level activities:
Purchase orders
Receiving orders
Setups

increase
increase
increase

10,000
20,000
13

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Illustrative Examples of
Tactical Decision Making
Accept or reject a special order
Special order unit revenue
Unit-level variable costs:
Dairy ingredients
$0.70
Sugar
0.10
Flavoring
0.15
Direct labor
0.25
Packaging
Commissions
Distribution
0.03
Other
0.05
Unit-level costs
Non-unit-level variable costs for special order
Purchasing ($8 10,000) 2M
0.040
Receiving ($6 20,000) 2M
0.060
Setting up ($8,000 13) 2M
0.052
Non-unit-level costs
Net benefit per unit on special order

$1.75

$1.450

0.152

1.602
$0.148

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Illustrative Examples of
Tactical Decision Making
Sell or Process Further
Joint products have
common processes and costs Joint products with
of production up to a split-off common processes
and common costs
point.
Decision: Sell Grade A tomatoes as produce or process into
hot sauce. 1 lb tomatoes yields 1 bottle of hot sauce.
Revenue at split-off
Revenue from hot sauce
Costs to process into hot sauce

1,000 lb $0.40
1,000 bottles $1.50
$1,000

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Illustrative Examples of
Tactical Decision Making
Sell or Process Further
Sell
Revenues
Processing costs
Total

$400
---$400

Differential Amount
Process Further to Process Further
$1,500
1,000
$ 500

$1,100
1,000
$ 100

Process further

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COST MANAGEMENT
Guan Hansen Mowen

End Chapter 19

COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.

Cengage Learning and South-Western are trademarks used herein under license.

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