ch. 7 - incremental analysis

op cost

• The amount of profit foregone because you didn't use a limited resource in the best use

differential/incremental cost

• The difference in cost between two alternatives

outlay cost

• A cost that requires a cash disbursement

useful info requirements

• Accuracy

• Timeliness

• Relevancy

relevant info

• Two requirements

  • Affects future cash flows quantitatively

  • Something unique between competing alternatives

    • If it's not then it does not matter

    • ex. Cash you receive from selling an asset

    • ex. Avoidable issues

    • ex. a change in a fixed cost

• Exception

  • Opportunity costs are always relevant

irrelevant ex.

• Sunk costs

  • Not in the future

• Depreciation

  • Not a physical loss of money

  • Which is why NBV or caring amount is also irrelevant

• Loss or gain on a sale

  • Not a physical loss of money

• Allocated/common fixed costs

  • Not in the future

• Unavoidable issues

  • Will be there no matter what

one time only special orders

• Occurs if you are customizing a product or buying in bulk (order is only placed once)

• Look at:

  • Incremental cash inflows v. incremental cash outflows and their opportunity cost

  • Accept if

    • Inflows> outflows

  • Reject if

    • Inflows< outflows

  • Indifferent if

    • Inflows= outflows

•  selling price for bulk formula

  • Selling price - vc = cm

• Min selling price = vc costs

  • When you don’t know cm, use this

insourcing v. outsourcing

• Cost to make v. Cost to buy

• Incremental cash outlay + op cost of forgoing something else v. External purchase price

• No opportunity cost for;

  • Idle machinery

  • Buying

ex. dealing with fixed overhead( total costs)

what you are saving by outsourcing

to deal with the fixed overhead, we need to first multiply everything by 25,000 (units) to get a total

• vc = 25,000*(1.5+2.5+0.8) = 120,000

• fc overhead = 10,000

• selling 2-0.8 = 1.2 *25,000 = 30,000

total savings = 120,000+10,000+30,000 = 160,000

savings per unit = 160,000/25,000 = 6.4

ex. of finding relevant costs

relevant costs

6+24+12+(0.4*15) = 48

 

48*10,000 = 480,000

adding/dropping product lines or dept.

• deciding on removing or retaining your offerings

  • look at qualitative aspects along with quantitative

• purposely losing money in an aspect to increase money in another

  • printers cheap, ink expensive

  • if dairy is losing money you should not discontinue cuz not having it will discourage people from coming to the store in the first place, affecting you're other dept. as well

• Compare inflows to ouflows

  • When you drop, what are you savings (costs) and losses (sales)

  • Saved costs included salary of line manger for ex.

ex. of comparing inflows to outflows

inflow

• 50,000 in sales lost = -50,000

outflow

• 40,000 in vc saved = +40,000

• 8,000 in traceable fc saved = +8,000

-50,000+40,000+8,000 = -2,000

by dropping you will lose 2,000

ex. comparing diff. net inc. changes resulting in changing and dropping product lines

dropping net inc. difference

-845,000+390,000+65,000+275,000+25,000=-90,000

 

inflow

sales

• 6,500*110 = 715,000

outflow

vc cost of sales =390,000

vc distribution costs =65,000

traceable fc = 275,000

salary = 25,000

 

so, net inc. 715,000-390,000 -65,000-275,000-25,000 -145,000 = -185,000 

 

diff. between og and and 110 price = -185,000+55,000 = -130,000

 

now, find diff. between discont and 110 price = -130,000+90,000 = -40,000  

 

 

If discont. = 120,000 inc in other product lines then what is net inc. diff.?

-90,000+120,000 = 30,000 inc,

to make decisions involving ltd. resources

• AKA dealing with constraints

• Formula

  • CM per unit/ units of the scarce resource

    • Units of the scarce resource can be DLH

joint products

• You have a main larger product, should you sell it as is or process it further?

• Compare cash inflows to cash outflows

ex. of joint products

chicken (cost to kill = $2)

• thighs

  • sell as is for $14 or make peruvian chicken for $5 and sell for $24

• breast

  • sell as is for $15 or make kfc chicken for $3 and sell for $25

process of killing the chicken  = joint production process

• yields joint costs

• irrelevant amongst the competing alternative of what you can sell

split off point

• chicken into things and breasts etc.

• can either choose to sell at this point or decide to further process

thighs and breasts = joint and main products

peruvian chicken and kfc = final products

making peruvian chicken and kfc = separable costs

 

for thighs	split off	further process
relevant cash inflows	14	24
relevant cash outflows	-	(5)
net cash flows	14	19

 

for breasts	split off	further process
relevant cash inflows	15	25
relevant cash outflows	-	(3)
net cash flows	15	22

ex. of joint products, comparing w/out a table

processing further

• a

  • 60,000-20,000 = 40,000

    1. 45,000

• b

  • 98,000-20,000 = 78,000

    1. 75,000

• c

  • 62,000-18,000 = 44,000

    1. 30,000

by comparing to the sales value at split off we should process b and c further