MA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch1

MaryCrishRanises 7 views 81 slides Sep 29, 2024
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About This Presentation

MA-15e_IE-PPT_Ch11.pptx
MA-15e_IE-PPT_Ch11.pptx
MA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptxMA-15e_IE-PPT_Ch11.pptx


Slide Content

Differential Analysis and Product Pricing Chapter 11

Learning Objectives Obj. 1 : Prepare differential analysis reports for a variety of managerial decisions. Obj. 2 : Determine the selling price of a product, using the product cost method. Obj. 3 : Describe and illustrate the managing of manufacturing bottlenecks. Obj. 4 : Describe and illustrate the use of yield pricing for a service business.

Differential Analysis (slide 1 of 6) Managerial decision making involves choosing between alternative courses of action. Differential analysis , sometimes called incremental analysis, analyzes differential revenues and costs in order to determine the differential impact on profit of two alternative courses of action. Differential revenue is the amount of increase or decrease in revenue that is expected from a course of action compared to an alternative. Differential cost is the amount of increase or decrease in cost that is expected from a course of action as compared to an alternative.

Differential Analysis (slide 2 of 6) Differential profit (loss) is the difference between the differential revenue and differential costs. Differential profit indicates that a decision is expected to increase income. Differential loss indicates that a decision is expected to decrease income. Assume Bryant Restaurants is deciding whether to replace some of its customer seating (tables) with a salad bar. Bryant’s differential analysis for this decision is shown in Slide 5.

Differential Analysis—Bryant Restaurants

Differential Analysis (slide 3 of 6) The differential analysis is prepared in three columns, where positive amounts indicate the differential effect is to increase profit and income and negative amounts indicate the effect is to decrease profit and income. The first column is the revenues, costs, and profit (loss) for maintaining floor space for tables (Alternative 1). The second column is the revenues, costs, and profit (loss) for using that floor space for a salad bar (Alternative 2). The third column is the difference between the revenues, costs, and profit (loss) of two alternatives.

Differential Analysis (slide 4 of 6) The salad bar (Alternative 2) is being considered over keeping the existing tables (Alternative 1). The differential revenue of a salad bar over tables is $20,000 ($120,000 − $100,000). Because the salad bar would increase revenue and profit, it is entered as a positive $20,000 in the Differential Effects column. The differential cost of a salad bar over tables is $5,000 ($65,000 − $60,000). Because the salad bar would increase costs and decrease profit, the $5,000 is entered as a negative $(5,000) in the Differential Effects column. The differential effect of a salad bar over tables is determined by subtracting the differential costs from the differential revenues in the Differential Effects column.

Differential Analysis (slide 5 of 6) The differential profit of a salad bar is $15,000 ($20,000 − $5,000). Based upon the differential analysis, Bryant Restaurants should decide to replace some of its tables with a salad bar. Doing so will increase its profit and income by $15,000. Over time, Bryant Restaurants should review its decision based upon actual revenues and costs. If the actual revenues and costs differ significantly from those shown in Slide 5, another differential analysis should be performed.

Differential Analysis (slide 6 of 6)

Lease or Sell (slide 1 of 3) Management may lease or sell a piece of equipment that is no longer needed. This may occur when a company changes its manufacturing process and can no longer use the equipment in the manufacturing process. In making a decision, differential analysis can be used.

Lease or Sell (slide 2 of 3) Assume that on June 22 of the current year, Marcus Company is considering leasing or selling of the following equipment: Cost of equipment $ 200,000 Accumulated depreciation ( 120,000 ) Book value $ 80,000 Lease (Alternative 1): Total revenue for five-year lease $ 160,000 Total estimated repair, insurance, and property tax expenses during life of lease $ 35,000 Residual value at end of fifth year of lease Sell (Alternative 2): Sales price $ 100,000 Commission on sales 6%

Differential Analysis—Lease or Sell Equipment

Lease or Sell (slide 3 of 3) Only the differential revenues and differential costs associated with the lease-or-sell decision are included in the differential analysis. The $80,000 book value ($200,000 − $120,000) of the equipment is a sunk cost and is not considered in the differential analysis. Sunk costs are costs that have been incurred in the past, cannot be recouped, and are not relevant to future decisions. That is, the $80,000 is not affected regardless of which decision is made.

Discontinuing a Segment or Product A product, department, branch, territory, or other segment of a business may be generating losses. As a result, management may consider discontinuing (eliminating) the product or segment. Discontinuing the product or segment usually eliminates all of the product’s or segment’s variable costs such as direct materials, direct labor, variable factory overhead, and sales commissions. However, fixed costs such as depreciation, insurance, and property taxes may not be eliminated. Thus, it is possible for total company income to decrease rather than increase if the unprofitable product or segment is discontinued.

Income (Loss) by Product

Differential Analysis— Continue or Discontinue Bran Flakes

Make or Buy (slide 1 of 2) Companies that manufacture products made up of components that are assembled into a final product, such as automobile manufacturers, must decide whether to make a part or purchase it from a supplier. Differential analysis can be used to decide whether to make or buy a part.

Make or Buy (slide 2 of 2) Assume that an automobile manufacturer has been purchasing instrument panels for $240 a unit. The factory currently operates at 80% of capacity, and no major increase in production is expected in the near future. The cost per unit of manufacturing an instrument panel internally is estimated on February 15 as follows: Direct materials $ 80 Direct labor 80 Variable factory overhead 52 Fixed factory overhead 68 Total cost per unit $280

Differential Analysis— Make or Buy Instrument Panels

Replace Equipment (slide 1 of 3) The usefulness of a fixed asset may decrease before it is worn out. For example, old equipment may no longer be as efficient as new equipment. Differential analysis can be used for decisions to replace fixed assets such as equipment and machinery. The analysis normally focuses on the costs of continuing to use the old equipment versus replacing the equipment. The book value of the old equipment is a sunk cost and, thus, is irrelevant.

Replace Equipment (slide 2 of 3) Assume that on November 28 of the current year, a business is considering replacing an old machine with a new machine. Old Machine: Book value $100,000 Estimated annual variable manufacturing costs 225,000 Estimated selling price 25,000 Estimated remaining useful life 5 years New Machine: Purchase price of new machine $250,000 Estimated annual variable manufacturing costs 150,000 Estimated residual value Estimated useful life 5 years

Differential Analysis— Continue with or Replace Old Equipment

Replace Equipment (slide 3 of 3)

Process or Sell (slide 1 of 2) During manufacturing, a product normally progresses through various stages or processes. In some cases, a product can be sold at an intermediate stage of production, or it can be processed further and then sold. Differential analysis can be used to decide whether to sell a product at an intermediate stage or to process it further. In doing so, the differential revenues and costs from further processing are compared. The costs of producing the intermediate product do not change, regardless of whether the intermediate product is sold or processed further.

Process or Sell (slide 2 of 2) Assume that a business produces kerosene as an intermediate product as follows: Kerosene: Batch size 4,000 gallons Cost of producing kerosene $2,400 per batch Selling price $2.50 per gallon The kerosene can be processed further to yield gasoline as follows: Gasoline: Input batch size 4,000 gallons Less evaporation (20%) (800) (4,000 × 20%) Output batch size 3,200 gallons Cost of producing gasoline $3,050 per batch Selling price $3.50 per gallon

Differential Analysis— Sell Kerosene or Process Further into Gasoline

Accept Business at a Special Price (slide 1 of 3) A company may be offered the opportunity to sell its products at prices other than normal prices. For example, an exporter may offer to sell a company’s products overseas at special discount prices. Differential analysis can be used to decide whether to accept additional business at a special price. The differential revenue from accepting the additional business is compared to the differential costs of producing and delivering the product to the customer. The differential costs of accepting additional business depend on whether the company is operating at less than capacity. If the company is operating at less than full capacity, then the additional production does not increase fixed manufacturing costs. However, selling and administrative expenses may change because of the additional business.

Accept Business at a Special Price (slide 2 of 3) Assume that B-Ball Inc. manufactures basketballs as follows: On March 10 of the current year, B-Ball Inc. received an offer from an exporter for 5,000 basketballs at $18 each. Production can be spread over three months without interfering with normal production or incurring overtime costs. Pricing policies in the domestic market will not be affected. Monthly productive capacity 12,500 basketballs Current monthly sales 10,000 basketballs Normal (domestic) selling price $30.00 per basketball Manufacturing costs: Variable costs $12.50 per basketball Fixed costs 7.50 Total manufacturing costs $20.00 per basketball

Differential Analysis— Accept Business at a Special Price

Accept Business at a Special Price (slide 3 of 3) The special business is accepted even though the sales price of $18 per unit is less than the manufacturing cost of $20 per unit because the fixed costs are not affected by the decision and are, thus, omitted from the analysis.

Check Up Corner Differential Analysis (slide 1 of 2) For the three cases that follow, prepare a differential analysis. Case A ( Discontinue a Product ): Product K has revenue of $65,000, variable cost of goods sold of $50,000, variable selling expenses of $12,000, and fixed costs of $25,000, creating a loss from operations of $(22,000). Required: Prepare a differential analysis dated February 22 to determine whether to continue Product K (Alternative 1) or discontinue Product K (Alternative 2), assuming fixed costs are unaffected by the decision. Case B ( Make versus Buy ): A company manufactures a component of a product for $80 per unit, including fixed costs of $25 per unit. The component could be purchased from an outside supplier for $60 per unit, plus $5 per unit freight. Required: Prepare a differential analysis dated November 2 to determine whether the company should make (Alternative 1) or buy (Alternative 2), assuming fixed costs are unaffected by the decision.

Check Up Corner Differential Analysis (slide 2 of 2) Case C ( Sell or Process Further ): Product T is produced for $2.50 per gallon. Product T can be sold without additional processing for $3.50 per gallon, or processed further into Product V at an additional total cost of $0.70 per gallon. Product V can be sold for $4.00 per gallon. Required: Prepare a differential analysis dated April 8 to determine whether to sell Product T (Alternative 1) or process it further into Product V (Alternative 2).

Check Up Corner Differential Analysis Solution (slide 1 of 3)

Check Up Corner Differential Analysis Solution (slide 2 of 3)

Check Up Corner Differential Analysis Solution (slide 3 of 3)

Setting Normal Product Selling Prices (slide 1 of 3)

Setting Normal Product Selling Prices (slide 2 of 3) Managers can use one of two market methods to determine selling price. Demand-based method The demand-based method sets the price according to the demand for the product. If there is high demand for the product, then the price is set high. Likewise, if there is low demand for the product, then the price is set low. Competition-based method The competition-based method sets the price according to the price offered by competitors. For example, if a competitor reduces the price, then management adjusts the price to meet the competition.

Setting Normal Product Selling Prices (slide 3 of 3)

Cost-Plus Methods Cost-plus methods determine the normal selling price by estimating a cost amount per unit and adding a markup, computed as follows: Management determines the markup based on the desired profit for the product. The markup should be sufficient to earn the desired profit plus cover any costs and expenses that are not included in the cost amount.

Product Cost Method (slide 1 of 7)

Product Cost Method (slide 2 of 8)

Product Cost Method (slide 3 of 8) The product cost method is applied using the following steps: Step 1: Estimate the total product cost as follows: Step 2: Estimate the total selling and administrative expenses. Product costs: Direct materials $XXX Direct labor XXX Factory overhead XXX Total product cost $XXX

Product Cost Method (slide 4 of 8) Step 3: Divide the total product cost by the number of units expected to be produced and sold to determine the total product cost per unit, computed as follows: Step 4: Compute the markup percentage as follows: The desired profit is normally computed based on a rate of return on assets as follows:

Product Cost Method (slide 5 of 8) Step 5: Determine the markup per unit by multiplying the markup percentage times the product cost per unit as follows: Step 6: Determine the normal selling price by adding the markup per unit to the product cost per unit as follows: Product cost per unit $XXX Markup per unit XXX Normal selling price per unit $XXX

Product Cost Method (slide 6 of 8) Assume the following data for 100,000 calculators that Digital Solutions Inc. expects to produce and sell during the current year: Manufacturing costs: Direct materials ($3.00 × 100,000) $ 300,000 Direct labor ($10.00 × 100,000) 1,000,000 Factory overhead 200,000 Total product (manufacturing) costs $1,500,000 Selling and administrative expenses 170,000 Total cost $1,670,000 Total assets $ 800,000 Desired return 20%

Product Cost Method (slide 7 of 8) The normal selling price is determined under the product cost method as follows: Step 1: Total product cost: $1,500,000 Step 2: Total selling and administrative expenses: $170,000 Step 3: Total product cost per unit: $15.00

Product Cost Method (slide 8 of 8) Step 4: Markup percentage: 22% Step 5: Markup per unit: $3.30 Step 6: Normal selling price: $18.30 Total product cost per unit $15.00 Markup per unit 3.30 Normal selling price per unit $18.30

Target Costing Method (slide 1 of 2) Target costing is a method of setting prices that combines market-based pricing with a cost-reduction emphasis. Under target costing, a future selling price is anticipated, using the demand-based or the competition-based methods. The target cost is then determined by subtracting a desired profit from the expected selling price, computed as follows: Target costing tries to reduce costs.

Target Cost Method

Target Costing Method (slide 2 of 2) The target cost is normally less than the current cost. Managers must try to reduce costs from the design and manufacture of the product. The planned cost reduction is sometimes referred to as the cost drift. Costs can be reduced in a variety of ways such as the following: Simplifying the design Reducing the cost of direct materials Reducing the direct labor costs Eliminating waste

Check Up Corner Setting Product Selling Prices (slide 1 of 2) SMB Company recently began production of a new product, Q, which required an investment of $2,500,000 in assets. The costs of producing and selling 100,000 units of Product Q are estimated as follows: Variable costs: Direct materials $18 per unit Direct labor 16 Factory overhead 6 Selling and administrative expenses 4 Total variable costs $44 per unit Fixed costs: Factory overhead $1,200,000 Selling and administrative expenses $ 600,000

Check Up Corner Setting Product Selling Prices (slide 2 of 2) Using the cost-plus approach to product pricing, a 12% return on invested assets is required. Determine the amount of desired profit from the production and sale of Product Q. Using the product cost method, determine (1) the cost per unit, (2) the markup percentage, and (3) the selling price. If the market price for a similar product is estimated at $61, compute the reduction in manufacturing cost per unit needed to maintain (1) the desired profit [from part (a)] and (2) the existing selling and administrative expenses under target costing.

Check Up Corner Setting Product Selling Prices Solution (slide 1 of 2)

Check Up Corner Setting Product Selling Prices Solution ( slide 12 of 2)

Production Bottlenecks (slide 1 of 5)

Production Bottlenecks (slide 2 of 5) When a company has a production bottleneck in its production process, it should attempt to maximize its profits, subject to the production bottleneck. In doing so, the unit contribution margin of each product per production bottleneck constraint is used.

Production Bottlenecks (slide 3 of 5) Assume that PrideCraft Tool Company makes three products: A, B, and C. All three products are processed through a heat treatment operation, which hardens the steel tools. PrideCraft Tool’s heat treatment process is operating at full capacity and is a production bottleneck. The product unit contribution margin and the number of hours of heat treatment used by each type of tool are as follows: Product A Product B Product C Unit selling price $130 $140 $160 Unit variable cost 40 40 40 Unit contribution margin $ 90 $ 100 $120 Heat treatment hours per unit 1 hr. 4 hrs. 8 hrs.

Production Bottlenecks (slide 4 of 5) In a production bottleneck operation, the best measure of profitability is the unit contribution margin per production bottleneck constraint. For PrideCraft Tool, the production bottleneck constraint is heat treatment process hours. Therefore, the unit contribution margin per bottleneck constraint is expressed as follows:

Production Bottlenecks (slide 5 of 5) The unit contribution per production bottleneck hour for each of the products produced by PrideCraft Tool is computed as follows:

Appendix: Total Cost Method (slide 1 of 8)

Total Cost Method

Appendix: Total Cost Method (slide 2 of 8) The total cost method is applied using the following steps: Step 1: Estimate the total manufacturing cost as follows: Step 2: Estimate the total selling and administrative expenses. Manufacturing costs: $XXX Direct materials XXX Direct labor XXX Factory overhead XXX Total manufacturing cost $XXX

Appendix: Total Cost Method (slide 3 of 8) Step 3: Estimate the total cost as follows: Step 4: Divide the total cost by the number of units expected to be produced and sold to determine the total cost per unit, as follows: Total manufacturing costs $XXX Selling and administrative expenses XXX Total cost $XXX

Appendix: Total Cost Method (slide 4 of 8) Step 5: Compute the markup percentage as follows: The desired profit is normally computed based on a rate of return on assets as follows: Step 6: Determine the markup per unit by multiplying the markup percentage times the total cost per unit as follows: Step 7: Determine the normal selling price by adding the markup per unit to the total cost per unit as follows: Total cost per unit $XXX Markup per unit XXX Normal selling price per unit $XXX

Appendix: Total Cost Method (slide 5 of 8) Assume the following data for 100,000 calculators that Digital Solutions Inc. expects to produce and sell during the year: Manufacturing costs: Direct materials ($3.00 × 100,000) $ 300,000 Direct labor ($10.00 × 100,000) 1,000,000 Factory overhead: Variable costs ($1.50 × 100,000) $150,000 Fixed costs 50,000 Total factory overhead 200,000 Total manufacturing cost $1,500,000 Selling and administrative expenses: Variable expenses ($1.50 × 100,000) $150,000 Fixed costs 20,000 Total selling and administrative expenses 170,000 Total cost $1,670,000 Desired return 20% Total assets $800,000

Appendix: Total Cost Method (slide 6 of 8) Using the total cost method, the normal selling price is determined as follows: Step 1: Total manufacturing cost: $1,500,000 Step 2: Total selling and administrative expenses: $170,000 Step 3: Total cost: $1,670,000

Appendix: Total Cost Method (slide 7 of 8) Step 4: Total cost per unit: $16.70 Step 5: Markup percentage: 9.6% (rounded)

Appendix: Total Cost Method (slide 8 of 8) Step 6: Markup per unit: $1.60 Step 7: Normal selling price: $18.30 Total cost per unit $16.70 Markup per unit 1.60 Normal selling price per unit $18.30

Appendix: Variable Cost Method (slide 1 of 8)

Variable Cost Method

Appendix: Variable Cost Method (slide 2 of 8) The variable cost method is applied using the following steps: Step 1: Estimate the total variable product cost as follows: Variable product costs: $XXX Direct materials XXX Direct labor XXX Variable factory overhead XXX Total variable product cost $XXX

Appendix: Variable Cost Method (slide 3 of 8) Step 2: Estimate the total variable selling and administrative expenses. Step 3: Determine the total variable cost as follows: Step 4: Compute the variable cost per unit as follows: Total variable product cost $XXX Total variable selling and administrative expenses XXX Total variable cost $XXX

Appendix: Variable Cost Method (slide 4 of 8) Step 5: Compute the markup percentage as follows: The desired profit is normally computed based on a rate of return on assets as follows: Step 6: Determine the markup per unit by multiplying the markup percentage times the variable cost per unit as follows: Step 7: Determine the normal selling price by adding the markup per unit to the variable cost per unit as follows: Variable cost per unit $XXX Markup per unit XXX Normal selling price per unit $XXX

Appendix: Variable Cost Method (slide 5 of 8) Assume the following data for 100,000 calculators that Digital Solutions Inc. expects to produce and sell during the current year: Manufacturing costs: Direct materials ($3.00 × 100,000) $ 300,000 Direct labor ($10.00 × 100,000) 1,000,000 Factory overhead: Variable costs ($1.50 × 100,000) $150,000 Fixed costs $ 50,000 Total factory overhead 200,000 Total manufacturing cost $1,500,000 Selling and administrative expenses: Variable expenses ($1.50 × 100,000) $150,000 Fixed costs $20,000 Total selling and administrative expenses 170,000 Total cost $1,670,000 Desired return 20% Total assets $800,000

Appendix: Variable Cost Method (slide 6 of 8) The normal selling price is determined under the variable cost method as follows: Step 1: Total variable product cost: $1,450,000 Variable product costs: Direct materials ($3.00 × 100,000) $ 300,000 Direct labor ($10.00 × 100,000) 1,000,000 Variable factory overhead ($1.50 × 100,000) 150,000 Total variable product cost $1,450,000

Appendix: Variable Cost Method (slide 7 of 8) Step 2: Total variable selling and administrative expenses: $150,000 ($1.50 × 100,000) Step 3: Total variable cost: $1,600,000 ($1,450,000 + $150,000) Step 4: Variable cost per unit: $16.00

Appendix: Variable Cost Method (slide 8 of 8) Step 5: Markup percentage: 14.4% (rounded) Step 6: Markup per unit: $2.30 Step 7: Normal selling price: $18.30 Variable cost per unit $16.00 Markup per unit 2.30 Normal selling price per unit $18.30

Yield Pricing in Service Businesses (slide 1 of 4) Yield pricing is a type of “accepting business at a special price” differential analysis. Alpine Airline provides flight services between Atlanta and Dallas. Assume an analysis reveals the following fixed and variable costs for a flight: Fixed Costs per Flight Variable Costs per Passenger Plane depreciation $10,400 Crew salaries 1,000 Fuel 3,000 $12 Ground salaries 2,000 8 Airport fees 2,000 Passenger services 15 Total $18,400 $35

Yield Pricing in Service Businesses (slide 2 of 4) Alpine’s variable cost per passenger is not large. This is because many of the costs do not vary by changing the number of seats sold on a flight. For example, the number of crewmembers per flight is fixed and does not vary with the seats sold on a flight. Assume the plane has a capacity of 200 seats, of which 170 have been sold at an average ticket price of $150. The contribution margin for each passenger is as follows:

Yield Pricing in Service Businesses (slide 3 of 4) The break-even number of seats per flight is: Thus, each flight is earning a profit, since the actual seats sold (170) exceed the break-even number of seats (160).

Yield Pricing in Service Businesses (slide 4 of 4) To attract customers to its 30 unsold seats, Alpine offers a 50% discounted ticket for standby passengers. Assuming 10 standby passengers purchase the discounted ticket, Alpine will have additional income based on the contribution margin of these seats, determined as follows: Discounted ticket price (50% × $150) $ 75 Variable cost per passenger (35 ) Contribution margin per standby passenger $ 40 Number of standby passengers per flight × 10 Income from standby passengers per flight $400
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