Jordan Managment Accounting 72

8/8/2019 Jordan Managment Accounting 72

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Learning Objective 4

Prepare an analysisPrepare an analysisshowing whether a specialshowing whether a specialorder should be accepted.order should be accepted.


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Key Terms and Concepts

A special order is a one-timeorder that is not considered

part of the companys normalongoing business.

When analyzing a specialorder, only the incremental

costs and benefits arerelevant.


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S pecial Orders

Jet, Inc. makes a single product whose normalJet, Inc. makes a single product whose normalselling price is $20 per unit.selling price is $20 per unit.

A foreign distributor offers to purchase 3,000 A foreign distributor offers to purchase 3,000units for $10 per unit.units for $10 per unit.This is a oneThis is a one- -time order that would not affect thetime order that would not affect thecompanys regular business.companys regular business.

Annual capacity is 10,000 units, but Jet, Inc. is Annual capacity is 10,000 units, but Jet, Inc. iscurrently producing and selling only 5,000 units.currently producing and selling only 5,000 units.

Should Jet accept the offer?Should Jet accept the offer?


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S pecial OrdersJet, Inc.

Contribution Income tatementRevenue ( 5,000 $20 ) 100,000$Variable costs:

Direct materials 20,000$Direct labor 5,000 Manufacturing overhead 10,000 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$

$8 variable cost$8 variable cost


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S pecial Orders

If Jet accepts the offer, net operatingincome will increase by $6,000.

Increase in revenue (3,000 $10) 30,000$Increase in costs (3,000 $8 variable cost) 24,000Increase in net income 6,000$

Note: This answer assumes that fixed costs areNote: This answer assumes that fixed costs areunaffected by the order and that variable marketingunaffected by the order and that variable marketing

costs must be incurred on the special order.costs must be incurred on the special order.


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Q uick Check

Northern Optical ordinarily sells the X-lens for $50. The variable production cost is $10, the

fixed production cost is $18 per unit, and thevariable selling cost is $1. A customer hasrequested a special order for 10,000 units of the X-lens to be imprinted with the customers

logo. This special order would not involve anyselling costs, but Northern Optical would haveto purchase an imprinting machine for $50,000.

(see the next page)


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Q uick CheckWhat is the rock bottom minimum pricebelow which Northern Optical should not goin its negotiations with the customer? Inother words, below what price wouldNorthern Optical actually be losing money onthe sale? There is ample idle capacity to fulfillthe order and the imprinting machine has nofurther use after this order.a. $50b. $10c. $15

d. $29


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What is the rock bottom minimum price belowwhich Northern Optical should not go in itsnegotiations with the customer? In other words, below what price would NorthernOptical actually be losing money on the sale?There is ample idle capacity to fulfill the order and the imprinting machine has no further useafter this order.a. $50b. $10c. $15

d. $29

Q uick Check

Variable production costVariable production cost $100,000$100,000

Additional fixed cost Additional fixed cost + 50,000+ 50,000Total relevant costTotal relevant cost $150,000$150,000Number of unitsNumber of units 10,00010,000

Average cost per unit Average cost per unit = = $15$15


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Determine the mostDetermine the most

profitable use of aprofitable use of aconstrained resource andconstrained resource andthe value of obtainingthe value of obtaining

more of the constrainedmore of the constrainedresource.resource.


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Key Terms and Concepts

When a limited resourceof some type restricts

the companys ability tosatisfy demand, the

company is said to havea constraint .

The machine or processthat is limiting overalloutput is called thebottleneck it is the

constraint.


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U tilization of a Constrained

Resource: An ExampleEnsign Company produces two products and

selected data are shown below:

Product1 2

Selling price per unit $ 60 $ 50Less variable expenses per unit 36 35 Contribution margin per unit 24$ 15$Current demand per week (units) 2,000 2,200 Contribution margin ratio 40% 30%Processing time required

on machine A1 per unit 1.00 min. 0.50 min.


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Resource

S hould Ensign focus its efforts onS hould Ensign focus its efforts on

Product 1 or Product 2?Product 1 or Product 2?

Machine A1 is the constrained resourceMachine A1 is the constrained resourceand is being used at 100% of itsand is being used at 100% of its

capacity.capacity.There is excess capacity on all other There is excess capacity on all other machines.machines.Machine A1 has a capacity of 2,400Machine A1 has a capacity of 2,400minutes per week.minutes per week.

S hould Ensign focus its efforts onS hould Ensign focus its efforts on

Product 1 or Product 2?Product 1 or Product 2?


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Q uick Check

How many units of each product can beprocessed through Machine A1 in one

minute?

Product 1 Product 2a. 1 unit 0.5 unitb. 1 unit 2.0 unitsc. 2 units 1.0 unitd. 2 units 0.5 unit


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How many units of each product can beprocessed through Machine A1 in oneminute?

Product 1 Product 2a. 1 unit 0.5 unit

b. 1 unit 2.0 unitsc. 2 units 1.0 unitd. 2 units 0.5 unit

Q uick Check

I was just checking to make sureI was just checking to make sureyou are with us.you are with us.


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Q uick Check

What generates more profit for the company,using one minute of machine A1 to process

Product 1 or using one minute of machine A1 to process Product 2?a. Product 1

b. Product 2c. They both would generate the same

profit.

d. Cannot be determined.


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Q uick Check What generates more profit for the

company, using one minute of machine A1 to process Product 1 or using one

minute of machine A1 to process Product2?a. Product 1

b. Product 2c. They both would generate the same

profit.

d. Cannot be determined.

With one minute of machine A1, we couldWith one minute of machine A1, we couldmake 1 unit of Product 1, with a contributionmake 1 unit of Product 1, with a contributionmargin of $24, or 2 units of Product 2, eachmargin of $24, or 2 units of Product 2, each

with a contribution margin of $15.with a contribution margin of $15.

22 $15 = $30 > $24$15 = $30 > $24


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ResourceThe key is the contribution margin per unit of

the constrained resource.

Product 2 should be emphasized.Product 2 should be emphasized. Provides moreProvides morevaluable use of the constrained resource machine A1,valuable use of the constrained resource machine A1,

yielding a contribution margin of $30 per minute asyielding a contribution margin of $30 per minute asopposed to $24 for Product 1.opposed to $24 for Product 1.

Product

1 2Contribution margin per unit $ 24 $ 15Time required to produce one unit 1.00 min. 0.50 min.Contribution margin per minute 24 $ 30$


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Resource

If there are no other considerations, the bestIf there are no other considerations, the bestplan would be to produce to meet currentplan would be to produce to meet current

demand for Product 2 and then use remainingdemand for Product 2 and then use remainingcapacity to make Product 1.capacity to make Product 1.

Product

12

Contribution margin per unit $ 24 $ 15Time required to produce one unit 1.00 min. 0.50 min.Contribution margin per minute 24 $ 30$

The key is the contribution margin per unit of the constrained resource.


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ResourceLets see how this plan would work.Lets see how this plan would work.Alloting Our Constrained Resource (Machine A1)

Weekly demand for Product 2 2,200 unitsTime required per unit 0.50 min.Total time required to makeProduct 2 1,100 min.


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U tilization of a ConstrainedResource

According to the plan, we will produce 2,200 According to the plan, we will produce 2,200units of Product 2 and 1,300 of Product 1.units of Product 2 and 1,300 of Product 1.

Our contribution margin looks like this.Our contribution margin looks like this.

Product 1 Product 2Production and sales (units) 1,300 2,200Contribution margin per unit 24$ 15$Total contribution margin 31,200$ 33,000$

The total contribution margin for Ensign is $64,200.The total contribution margin for Ensign is $64,200.


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Q uick CheckColonial Heritage makes reproductionColonial Heritage makes reproductioncolonial furniture from select hardwoods.colonial furniture from select hardwoods.

The companys supplier of hardwood will onlyThe companys supplier of hardwood will onlybe able to supply 2,000 board feet thisbe able to supply 2,000 board feet thismonth. Is this enough hardwood to satisfymonth. Is this enough hardwood to satisfydemand?demand?a. Yesa. Yes

b. Nob. No

Chairs TablesS elling price per unit $80 $400Variable cost per unit $30 $200

Boa rd feet per unit 2 10Mo nthly dem and 600 100


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Colonial Heritage makes reproduction colonialColonial Heritage makes reproduction colonialfurniture from select hardwoods.furniture from select hardwoods.

The companys supplier of hardwood will onlyThe companys supplier of hardwood will onlybe able to supply 2,000 board feet this month.be able to supply 2,000 board feet this month.Is this enough hardwood to satisfy demand?Is this enough hardwood to satisfy demand?a. Yesa. Yesb. Nob. No

Q uick Check

(2 v 600) + (10 v 100 ) = 2,200 > 2,000

Chairs TablesS elling price per unit $80 $400Variable cost per unit $30 $200

Boa rd feet per unit 2 10Mo nthly dem and 600 100


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Q uick Check

The companys supplier of hardwood willThe companys supplier of hardwood willonly be able to supply 2,000 board feet thisonly be able to supply 2,000 board feet thismonth. What plan would maximize profits?month. What plan would maximize profits?

a. 500 chairs and 100 tablesa. 500 chairs and 100 tablesb. 600 chairs and 80 tablesb. 600 chairs and 80 tablesc. 500 chairs and 80 tablesc. 500 chairs and 80 tables

d. 600 chairs and 100 tablesd. 600 chairs and 100 tables

Chairs TablesS elling price per unit $80 $400Variable cost per unit $30 $200Board feet per unit 2 10M onthly dem and 600 100


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Q uick Check

The companys supplier of hardwood willThe companys supplier of hardwood willonly be able to supply 2,000 board feet thisonly be able to supply 2,000 board feet thismonth. What plan would maximize profits?month. What plan would maximize profits?

a. 500 chairs and 100 tablesa. 500 chairs and 100 tablesb. 600 chairs and 80 tablesb. 600 chairs and 80 tablesc. 500 chairs and 80 tablesc. 500 chairs and 80 tables

d. 600 chairs and 100 tablesd. 600 chairs and 100 tables

Chairs TablesS elling price per unit $80 $400Variable cost per unit $30 $200Board feet per unit 2 10M onthly dem and 600 100

Chairs Tables

Selling price 80$ 400$Variable cost 30 200 Contribution margin 50$ 200$Board feet 2 10 CM per board foot 25$ 20$

Production of chairs 600 Board feet required 1,200 Board feet remaining 800

Board feet per table 10 Production of tables 80


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Q uick Check

As before, Colonial Heritages supplier of hardwood will only be able to supply 2,000 boardfeet this month. Assume the company followsthe plan we have proposed. U p to how muchshould Colonial Heritage be willing to pay abovethe usual price to obtain more hardwood?a. $40 per board footb. $25 per board footc. $20 per board footd. Zero


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As before, Colonial Heritages supplier of hardwood will only be able to supply 2,000 boardfeet this month. Assume the company follows theplan we have proposed. U p to how much shouldColonial Heritage be willing to pay above theusual price to obtain more hardwood?a. $40 per board footb. $25 per board footc. $20 per board footd. Zero

Q uick Check

The additional wood would be used to maketables. In this use, each board foot of

additional wood will allow the company to earnan additional $20 of contribution margin and

profit.


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Managing Constraints

Finding ways toprocess more units

through a resourcebottleneck

At the bottleneck itself: At the bottleneck itself:Improve the processImprove the process

Add overtime or another shift Add overtime or another shiftHire new workers or acquireHire new workers or acquiremore machinesmore machinesS ubcontract productionS ubcontract productionReduce amount of defectiveReduce amount of defectiveunits producedunits produced

Add workers transferred from Add workers transferred fromnonnon--bottleneck departmentsbottleneck departments


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Prepare an analysisPrepare an analysisshowing whether jointshowing whether joint

products should be sold atproducts should be sold atthe splitthe split--off point or off point or

processed further.processed further.


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Joint Products

JointInput

CommonProductionProcess

SplitSplit--Off Off PointPoint

Oil

Gasoline

Chemicals


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Joint Products

S eparateProcessing

S eparate

Processing

FinalSale

FinalSale

FinalS ale

SeparateSeparateProductProduct

CostsCosts

JointInput

CommonProductionProcess

SplitSplit--Off Off PointPoint

JointJointCostsCosts Oil

Gasoline

Chemicals


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The Pitfalls of AllocationJoint costs are oftenJoint costs are often

allocated to end products onallocated to end products onthe basis of thethe basis of the relativerelative

sales valuesales value of each productof each productor on some other basis.or on some other basis.

Although allocation is needed for Although allocation is needed for

some purposes such as balancesome purposes such as balancesheet inventory valuation,sheet inventory valuation,allocations of this kind areallocations of this kind are veryverydangerousdangerous for decision making.for decision making.


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Joint costs are irrelevant in decisionsJoint costs are irrelevant in decisionsregarding what to do with a productregarding what to do with a product

from the splitfrom the split--off point forward.off point forward.

It will always be profitable to continueIt will always be profitable to continueprocessing a joint product after the splitprocessing a joint product after the split- -

off pointoff point so long as the incrementalso long as the incrementalrevenue exceeds the incrementalrevenue exceeds the incrementalprocessing costs incurred after the splitprocessing costs incurred after the split- -

off pointoff point ..

S ell or Process Further


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S ell or Process Further: An

Example S awmill, Inc. cuts logs from whichS awmill, Inc. cuts logs from which

unfinished lumber and sawdust are theunfinished lumber and sawdust are the

immediate joint products.immediate joint products.U nfinished lumber is sold as is or U nfinished lumber is sold as is or processed further into finished lumber.processed further into finished lumber.S

awdust can also be sold as is toS

awdust can also be sold as is togardening wholesalers or processedgardening wholesalers or processedfurther into prestofurther into presto- -logs.logs.


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S ell or Process Further Analysis of Sell or Process Further

Per LogLumber Sawdust

Sales value after further processing 270 $ 50$Sales value at the split-off point 140 40 Incremental revenue 130 10


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S ell or Process Further Analysis of Sell or Process Further

Per LogLumber Sawdust

Sales value after further processing 270 $ 50$Sales value at the split-off point 140 40 Incremental revenue 130 10 Cost of further processing 50 20 Profit (loss) from further processing 80$ (10)$


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Analysis of Sell or Process Further Per Log

Lumber Sawdust

Sales value after further processing 270 $ 50$

Sales value at the split-off point 140 40 Incremental revenue 130 10 Cost of further processing 50 20 Profit (loss) from further processing 80$ (10)$

S ell or Process Further

S hould we process the lumber further S hould we process the lumber further and sell the sawdust as is?and sell the sawdust as is?


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Activity-Based Costing and

Relevant CostsABC can be used to help identify potentiallyrelevant costs for decision-making purposes.

However, before making adecision, managers mustdecide which of the potentially

relevant costs are actuallyavoidable.

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Jordan Managment Accounting 72