Slide 1 ___________________________________ 8.3 Re le va nt Costs o - - PDF document

Slide 1

8.3 Re le va nt Costs

2005 K D Ha the wa y-Dia l

• Re le va nt Costs De finition
• c osts that diffe r

fr

• m one alte r

na tive busine ss

• pportunity to a nothe r
• AKA avoida ble c osts
• Costs that will be e liminate d if anothe r a lte rna tive

is c hose n

• Othe r

te rms use d to de fine re le va nt c osts

• Diffe re ntia l c osts
• Inc re me nta l c osts

Avoida ble Cost

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Othe r re le va nt c ost te rms

• Diffe re ntia l c osts
• T

he diffe re nc e in c osts be twe e n two a lte r na tive s

• Inc re me nta l c osts
• T

he inc r e a se in c osts fr

• m one

a lte r na tive to anothe r

2005 K D Ha the wa y-Dia l

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Irre le va nt Costs

• Ir

re le va nt c osts

• Sunk c ost
• Unavoida ble c osts
• Alre a dy inc urre d c ost
• Should be ignore d
• F

utur e c osts tha t do not diffe r be twe e n the a lte rnative s

• Unavoida ble
• Should be ignore d

2005 K D Ha the wa y-Dia l

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Slide 4

Ide ntifying Re le va nt Costs

• Why ide ntify re le vant c osts?
• Should only c onside r the c osts of

two or more a lte r na tive s tha t would impa c t the de c ision

• Irr

e le vant c osts will only c lutte r the de c ision proc e ss

• What is a re le va nt c ost?
• Costs that a re avoidable ,

inc re me nta l or diffe re ntia l

2005 K D Ha the wa y-Dia l

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Ide ntifying Re le va nt Costs

E xample : Jill is a Junior in c olle ge and ha s be e n offe r e d two inte r nships for the summe r. T he fir st inte r nship is for a busine ss in he r home town a nd the se c ond inte r nship is in China Ide ntify the r e le vant c osts for both inte r nships

2005 K D Ha the wa y-Dia l

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Inte rnship E xa mple

2005 K D Ha the wa y-Dia l

? ? Va lue of expe r ie nc e in la nding fir st job ? ? L

• ng te r

m value to c a r e e r $(5,400.00) $3615.00 T

• tal pr
• fit (c ost)

$ 0.00 $3,840.00 Inc ome E a r ne d $ 0.00 $3,840.00 Inc ome ? ? T ime with he r family $5,400.00 $ 225.00 T

• tal Cost

$ 200.00 $ 200.00 Inc ide nta ls $2,000.00 $ 25.00 T r ave l $3,200.00 $ 0.00 Room & boa r d Inte r nship in China Inte r nship a t home

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Slide 7

Ma ke or Buy

• Ve rtic al inte g r

ation

• De finition
• All the parts of the va lue c ha in of a produc t

tha t is produc e d by a single c ompany

• Adva nta g e s to ma king
• L

e ss de pe nde nt on its supplie rs

• Be tte r qua lity c ontrol
• Company re a lize s profits from parts and

ma te r ia ls

• Adva ntag e s to buying
• E

c onomie s of sc ale

• Hig he r qua lity at a lowe r c ost

2005 K D Ha the wa y-Dia l

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Ma ke or Buy

2005 K D Ha the wa y-Dia l

$120,000 12 T

• tal c ost

20,000 2 Alloc a te d g e ne ral ove rhe ad 10,000 1 De pre c ia tion of Spe c ia l E quipme nt 10,000 1 Supe rvisor’s Sala ry 10,000 1 Va ria ble Ma nufa c turing ove rhe a d 20,000 2 Dire c t L abor $ 50,000 $ 5 Dire c t Mate rials 10,000 Units Pe r Unit

Ross & Simons ma nufa c ture skate boards. Be low is c ost data for whe e ls on the ir most popular br a nd. T he re is no

• the r use for the spe c ia l e quipme nt use d in ma king

the ska te boa rds whe e ls. R

• ss & Simons have be e n

looking at outsourc ing the pa rt. T he y have found a supplie r who will ma ke it for $10. Should the y c ontinue to make or should the y buy?

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Ma ke or Buy

2005 K D Ha the wa y-Dia l

Not Re le va nt Alloc a te d Ge ne ra l Ove r he a d $10,000 Diffe r e nc e in fa vor of ma king $100,000 $90,000 T

• ta l c ost

$100,000 Outside Pur c hase pr ic e ($10/ unit) Not Re le va nt De pr e c ia tion of Spe c ia l E quipme nt $10,000 Supe r visor’s Salary $10,000 Va r iable Ma nufa c tur ing ove r he a d $20,000 Dire c t L a bor $50,000 Dire c t Ma te ria ls Buy Ma ke 10,000 units

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Slide 10

Spe c ia l Orde rs

2005 K D Ha the wa y-Dia l

• Spe c ial or

de r s

• One time or

de rs

• Not pa rt of a c ompa ny’s ongoing

busine ss

• Usua lly hig h volume with a disc ounte d

pric e

• Advantage s
• Use e xc e ss c apac ity
• Inc re me ntal inc r

e ase in r e ve nue

• Disa dvanta ge s
• Pote ntia l to upse t c urre nt c ustome rs if

the y be c ome a ware of the pric e diffe r e ntial

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Spe c ia l Orde rs

2005 K D Ha the wa y-Dia l

Christma s-In- July Inc . produc e s a simple orname nta l tre e toppe r that the y se ll in the Pa c ific Northwe st. A F lorida c ompany who is c urre ntly se tting up its Christma s a ds is inte reste d in the toppe r for both the a ds a nd store displays. T his is a one time orde r that will ha ve no e ffe c t on the c ompany’s normal sale s a nd would not c hang e the total a mount of the c ompany’s fixe d c osts.

• T

he va ria ble e xpe nse s would be $0.35 le ss pe r unit on this

• rde r than on normal sa le s.
• Dire c t la bor is a varia ble c ost in this c ompa ny.
• T

he c ompa ny’s normal a c tivity le ve l is 1,800 units for the ye a r.

• T

he y ha ve c a pa c ity for a nothe r 1,000 units.

• T

he norma l se lling whole sale pric e is $4.00 pe r unit.

• T

he c ompa ny has offe re d to pa y $3.60 pe r unit.

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Spe c ia l Orde rs

2005 K D Ha the wa y-Dia l

$2.35 T

• ta l c ost

0.15 F ixe d se lling & a dministra tive e xpe nse 0.10 Va riable se lling & a dministr a tive e xpe nse 0.15 F ixe d Ma nufa c tur ing ove rhe a d 0.25 Va riable Ma nufa c turing ove r he a d 0.50 Dire c t L a bor $1.20 Dire c t Ma te ria ls Be low is Christma s- In- July Inc c ost of produc ing and se lling a n

• rname nta l tre e toppe r.

Should the y a c c e pt the or de r?

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Slide 13

Spe c ia l Orde rs - solution

Dire c t Ma te ria l $2.35 T

• ta l c ost

0.10 Va r iable se lling & a dministr a tive e xpe nse 0.25 Va r iable Ma nufa c turing ove r he a d 0.50 Dire c t L a bor $1.20 Va r iable c ost pe r unit on norma l sa le s:

2005 K D Ha the wa y-Dia l

Should the y a c c e pt the or de r? $2.35 Norma l va r iable c ost per unit 2.00 Va riable c ost pe r unit on spe c ia l or de r 0.35 Re duc tion in va ria ble c ost pe r unit Va riable c ost pe r unit on spe c ia l or de r

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Spe c ia l Orde rs

2005 K D Ha the wa y-Dia l

2.00 Va riable c ost pe r unit on spe c ia l or de r $875.00 Inc re a se (de c r e a se ) in ne t ope ra ting inc ome 500 Numbe r

• f units on spe c ia l or

de r 1.75 Unit c ontribution ma r g in on spe c ia l or de r $ 3.75 Se lling pric e per spec ia l or de r

Should the y a c c e pt the orde r ?

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