Lecture 7 - Measuring relevant costs and revenues_Reviewed

Lecture 7 - Measuring relevant costs and revenues_Reviewed

1. Lecture 7 Management Accounting 2 Desidre Coopasamy

2. LECTURE TEXT Drury, C., Management and Cost Accounting (12th Edition), Andover: Cengage Learning CHAPTER: 8 This electronic presentation to be used with Drury. Management and Cost Accounting, 12E. From Drury. Management and Cost Accounting, 12E. © 2024 Cengage Learning EMEA, a part of Cengage, Inc. All rights reserved. Reproduced by permission. Text/images may not be modified or reproduced in any way without prior written permission of the publisher. www.cengage.com /permissions

3. CHAPTER 8 – Measuring relevant cost and revenue

4. “The relevant costs and revenues required for decision-making are only those that will be affected by the decision.” (p.205) RELEVANT COSTS Future costs that differ between alternatives IRRELEVANT COSTS Consist of sunk costs, allocated costs and future costs that do not differ between alternatives Identifying relevant costs and revenues Drury, 2024:194-195 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

5. Identifying relevant costs and revenues Drury, 2024:195 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

6. Decisions should not be based only on items that can be expressed in quantitative terms — Qualitative factors must also be considered. EXAMPLE 1 Redundancies might influence employees morale EXAMPLE 2 Outsourcing might increase dependence to external suppliers who could increase the price. Importance of qualitative/non-financial factors Drury, 2024:195-196 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

7. “ Especial price decisions relate to pricing decisions outside the main market. Typically, they involve one-time-only order or orders at a price below the prevailing market price.” p.206 IMPACT 1 Competitors might want a competitive price. IMPACT 2 Decision can prevent the company to accept a better offer. IMPACT 3 Unavoidable costs are treated as constant in the short run but this can be different in the real world. Special pricing decisions Drury, 2024:196-199 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

8. EXAMPLE 1

9. DATA: Monthly capacity for a department within a company = 50 000 units Expected monthly production and sales for next quarter at normal selling price of £40 = 35 000 units Estimated monthly costs and revenues (for 35 000 units): The excess capacity is temporary and a company has offered to buy 3 000 each month for the next three months at a price of £20 per unit. Extra selling costs for the order would be £1 per unit. REQUIRED : Advise whether or not accept the offer. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:196-199

10. Only variable costs considered. The extra selling costs and sales revenues differ between alternatives and are relevant costs/revenues. Extra selling costs £1/per unit 3,000 units x £20 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:196-199

11. CONCLUSIONS: Since relevant revenues exceed relevant costs the order is acceptable subject to the following assumptions: 1. Normal selling price of £40 will not be affected. 2. No better opportunities will be available during the period. 3. The resources have no alternative uses. 4. The fixed costs are unavoidable for the period under consideration. • Note that the identification of relevant costs depends on the circumstances. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:196-199

12. EXAMPLE 2

13. DATA (Continuation from example 1): Assume now spare capacity in the foreseeable future (Capacity = 50 000 units and demand = 35 000 units) and that an opportunity for a contract of 15 000 units per month at £25 (selling price) emerges involving £1 per unit special selling costs. No other opportunities exist so if the contract is not accepted direct labour will be reduced by 30%, manufacturing non-variable costs by £70 000 per month and marketing by £20 000.Unutilised facilities can be rented out at £25 000 per month. REQUIRED : Advise whether or not accept the offer. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:196-199

14. 30% reduction -£70,000 -£20,000 Selling costs £1 Rent For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:196-199

15. CONCLUSIONS: Company will be better off by £31 000 per month if it reduces capacity (assuming there are no qualitative factors). You can present only columns 1 and 2 or just column 3 (note the opportunity cost shown in column 3). In the longer-term all of the above costs and revenues are relevant. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:196-199

16. LIMITING FACTORS Scarce resources that limit the output of a company. Limiting factors should be identified when sales demand is in excess. IMPACT 1 Companies may be required by customers to produce all the products in the mix IMPACT 2 Analysis in this book refers to short term when limiting factors cannot be removed. Product mix decisions when capacity constrains exists Drury, 2024:200-203 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

17. EXAMPLE 3

18. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:200-203

19. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:200-203

20. REPLACEMENT OF EQUIPMENT “It is the capital investment or long-term decision but one aspect of asset replacement decisions that we will consider at this stage is how to deal with the book value (i.e. the written-down value) of old equipment.” (p.213) Written-down value “The original costs of an asset minus depreciation” (p.774) Replacement of equipment – The irrelevance of past costs Drury, 2024:203-204 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

21. EXAMPLE 4

22. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:203-204

23. 90,000-50,000 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:203-204

24. CONCLUSIONS: Note that the depreciation charge is not a relevant cost. Columns 1 and 2 or just column 3 can be presented but it is more meaningful to restate column 3 as follows: Savings on variable operating costs (3 years) 60 000 Sale proceeds of existing machine 40 000 100 000 Less purchase cost of replacement machine 70 000 Savings on purchasing replacement machine 30 000 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:203-204

25. Outsourcing and make-or-buy decisions OUTSOURCING “It is the process of obtaining goods or services from outside suppliers instead of producing the same goods or providing the same services within the organisation” (p.214) Drury, 2024:204-208 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

26. EXAMPLE 5

27. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:204-208

28. 30,000 x £10 Avoidable Redundant Avoidable -£10,000 Unchanged £240,000 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:204-208

29. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:204-208

30. Discontinuation decisions “Most organisations periodically analyse profits by one or more cost objects, such as products or services, customers and locations. Periodic profitability analysis can highlight unprofitable activities that require more detailed appraisal (sometimes referred as special study) to ascertain whether or not they should be discontinued.” (p.218) Drury, 2024:208-211 For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA

31. EXAMPLE 6

32. For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:208-211

33. Total Avoidable -£250 Costs Revenue For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:208-211

34. Direct labour and direct materials – Relevant costs For use with Management and Cost Accounting 12e by Colin Drury ( ISBN 9781473791244) © 2024 Colin Drury Cengage Learning EMEA Drury, 2024:208-211

35. Thanks for your attention.