Cornerstones of Cost Management Study Set 4

Business

Quiz 17 :

Activity Resource Usage Model and Tactical Decision Making

Quiz 17 :

Activity Resource Usage Model and Tactical Decision Making

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Can direct materials ever be irrelevant in a make-or-buy decision? Explain. Give an example of a fixed cost that is relevant.
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Relevant Costs:
Relevant costs are future costs that differ across the alternatives.
Irrelevant costs:
If the future cost is same for all alternatives, then there will not be any effect on decision. Such costs are called as irrelevant costs. By considering these costs decisions making will not impact.
Yes, direct materials never irrelevant because, they are future costs and that differ across the alternatives.
For Example, A company that makes engines for commercial ships. A supplier has approached the company and offered to sell one component for manufacturing nacelles, for what appears to be an attractive price. Company faces make or buy decision in this case. Here make or buy are two alternatives.
In this case direct Materials to make nacelles are $ 300,000 is relevant cost , because it is future cost differs across the alternatives.
From the above example it is clear that relevant costs are affects the decision making among the alternatives.
Fixed costs that are relevant costs in sometimes, for example, in the above case if company has to incur additional expense to purchase spare parts that will help to manufacture the nacelles, even though it is capitalized and in the nature of fixed , it is relevant cost and it should be considered in decision making.

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Determining Relevant Costs Six months ago, Lee Anna Carver purchased a fire-engine red, used LeBaron convertible for $10,000. Lee Anna was looking forward to the feel of the sun on her shoulders and the wind whipping through her hair as she zipped along the highways of life. Unfortunately, the wind turned her hair into straw, and she didn't do much zipping along since the car spent so much of its time in the shop. So far, she has spent $1,200 on repairs, and she's afraid there is no end in sight. In fact, Lee Anna anticipates the following costs of restoration: img On a visit to a used car dealer, Lee Anna found a five-year-old Honda CR-V in excellent condition for $9,100-Lee Anna thinks she might really be more the sport-utility type anyway. Lee Anna checked the Blue Book values and found that she can sell the LeBaron for only $3,600. If she buys the CR-V, she will pay cash but would need to sell the LeBaron. Required: 1. In trying to decide whether to restore the LeBaron or buy the CR-V, Lee Anna is distressed because she has already spent $11,200 on the LeBaron. The investment seems too much to give up. How would you react to her concern? 2. List all costs that are relevant to Lee Anna's decision. What advice would you give her?
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Relevant Costs:
Relevant costs are future costs that differ across alternatives. If the future cost is same for all alternatives, then there will not be any effect on decision. Such cost is called as irrelevant cost.
1. She spent 11,200 on Le -Baron, these costs are Sunk costs which can't be considered for decision making a nd those are irrelevant does not affect across the alternatives.
2. In order to restore the Le Baron , following Future costs are associated
img If she go for Honda CR-V, then
img In order to restore the le- Baron could incur costs $ 3,110 which is lower than go for Honda CR-V $ 5,500.
Advise:
Hence, it is advised her to restore the Le- baron instead of go for Honda CR-V.

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What is tactical decision making?
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Tactical decision making consists of choosing among the alternatives with an immediate or limited end in view.
Tactical decision may belongs to short run that an "accepting of special order which is less than the normal selling price" or may belongs to long run that "the company considering making component rather the buying it from outside".
However the tactical decision should support overall objective even if immediate objective is short run or long run. A sound tactical decision achieves not only the limited objective but also serve a larger purpose.
The tactical decision process would be generally as:
1. Recognize and define the problem
2. Identify alternatives as possible solutions to the problem, and eliminate any un feasible alternatives
3. Identify the cost and benefits which associated with each feasible alternative. Eliminate the costs and benefits that are not relevant to the decision.
4. Compare the relevant costs and benefits for each alternative.
5. Asses qualitative factors
6. Select the alternative with the greatest overall benefit.

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What is tactical cost analysis? What steps in the tactical decision-making model correspond to tactical cost analysis?
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Give an example of a future cost that is not relevant.
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Relevant costs always determine which alternative should be chosen. Do you agree or disagree? Explain.
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Describe a tactical decision you personally have had to make. Apply the tactical decisionmaking model to your decision. How did it turn out? (Hint: You could discuss buying a car, choosing a college, buying a puppy, etc.)
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Special-Order Decision, Traditional Analysis, Qualitative Aspects Feinan Sports, Inc., manufactures sporting equipment, including weight-lifting gloves. A national sporting goods chain recently submitted a special order for 4,600 pairs of weight-lifting gloves. Feinan Sports was not operating at capacity and could use the extra business. Unfortunately, the order's offering price of $12.80 per pair was below the cost to produce them. The controller was opposed to taking a loss on the deal. However, the personnel manager argued in favor of accepting the order even though a loss would be incurred; it would avoid the problem of layoffs and would help maintain the community image of the company. The full cost to produce a pair of weight-lifting gloves is presented below. img No variable selling or administrative expenses would be associated with the order. Non-unitlevel activity costs are a small percentage of total costs and are therefore not considered. Required: 1. Assume that the company would accept the order only if it increased total profits. Should the company accept or reject the order? Provide supporting computations. 2. Suppose that Feinan Sports has negotiated with the potential customer, and has determined that it can substitute cheaper materials, reducing direct materials cost by $0.95 per unit. In addition, the company's engineers have found a way to reduce direct labor cost by $0.50 per unit. Should the company accept or reject the order? Provide supporting computations. 3. Consider the personnel manager's concerns. Discuss the merits of accepting the order even if it decreases total profits.
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Make-or-Buy, Traditional and ABC Analysis Brees, Inc., a manufacturer of golf carts, has just received an offer from a supplier to provide 2,600 units of a component used in its main product. The component is a track assembly that is currently produced internally. The supplier has offered to sell the track assembly for $66 per unit. Brees is currently using a traditional, unit-based costing system that assigns overhead to jobs on the basis of direct labor hours. The estimated traditional full cost of producing the track assembly is as follows: img Prior to making a decision, the company's CEO commissioned a special study to see whether there would be any decrease in the fixed overhead costs. The results of the study revealed the following: 3 setups-$1,160 each (The setups would be avoided, and total spending could be reduced by $1,160 per setup.) One half-time inspector is needed. The company already uses part-time inspectors hired through a temporary employment agency. The yearly cost of the part-time inspectors for the track assembly operation is $12,300 and could be totally avoided if the part were purchased. Engineering work: 470 hours, $45/hour. (Although the work decreases by 470 hours, the engineer assigned to the track assembly line also spends time on other products, and there would be no reduction in his salary.) 75 fewer material moves at $30 per move. Required: 1. Ignore the special study, and determine whether the track assembly should be produced internally or purchased from the supplier. 2. Now, using the special study data, repeat the analysis. 3. Discuss the qualitative factors that would affect the decision, including strategic implications. 4. After reviewing the special study, the controller made the following remark: "This study ignores the additional activity demands that purchasing would cause. For example, although the demand for inspecting the part on the production floor decreases, we may need to inspect the incoming parts in the receiving area. Will we actually save any inspection costs?" Is the controller right?
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Make-or-Buy, Traditional Analysis Wehner Company is currently manufacturing Part ABS-43, producing 55,000 units annually. The part is used in the production of several products made by Wehner. The cost per unit for ABS-43 is as follows: img Of the total fixed overhead assigned to ABS-43, $15,400 is direct fixed overhead (the annual lease cost of machinery used to manufacture Part ABS-43), and the remainder is common fixed overhead. An outside supplier has offered to sell the part to Wehner for $58. There is no alternative use for the facilities currently used to produce the part. No significant non-unit-based overhead costs are incurred. Required: 1. Should Wehner Company make or buy Part ABS-43? 2. What is the maximum amount per unit that Wehner would be willing to pay to an outside supplier?
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Resource Supply and Usage, Special Order, Relevancy Elliott, Inc., has four salaried clerks to process purchase orders. Each clerk is paid a salary of $25,750 and is capable of processing as many as 6,500 purchase orders per year. Each clerk uses a PC and laser printer in processing orders. Time available on each PC system is sufficient to process 6,500 orders per year. The cost of each PC system is $1,100 per year. In addition to the salaries, Elliott spends $27,560 for forms, postage, and other supplies (assuming 26,000 purchase orders are processed). During the year, 25,350 orders were processed. Required: 1. Classify the resources associated with purchasing as (1) flexible or (2) committed. 2. Compute the total activity availability, and break this into activity usage and unused activity. 3. Calculate the total cost of resources supplied (activity cost), and break this into the cost of activity used and the cost of unused activity. 4. (a) Suppose that a large special order will cause an additional 500 purchase orders. What purchasing costs are relevant? By how much will purchasing costs increase if the order is accepted? (b) Suppose that the special order causes 700 additional purchase orders. How will your answer to (a) change?
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Sell at Split-Off or Process Further Decision, Alternatives, Relevant Costs Betram Chemicals Company processes a number of chemical compounds used in producing industrial cleaning products. One compound is decomposed into two chemicals: anderine and dofinol. The cost of processing one batch of compound is $74,000, and the result is 6,000 gallons of anderine and 8,000 gallons of dofinol. Betram Chemicals can sell the anderine at split-off for $11 per gallon and the dofinol for $6.75 per gallon. Alternatively, the anderine can be processed further at a cost of $8 per gallon (of anderine) into cermine. It takes 3 gallons of anderine for every gallon of cermine. A gallon of cermine sells for $60. Required: 1. List the alternatives being considered. 2. List the relevant benefits and costs for each alternative. 3. Which alternative is more cost effective and by how much? 4. What if the production of anderine into cermine required additional purchasing and quality inspection activity? Every 500 gallons of anderine that undergo further processing require 20 more purchase orders at $10 each and 15 more quality inspection hours at $25 each. Which alternative would be better and by how much?
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When will flexible resources be relevant to a decision?
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Special-Order Decision, Alternatives, Relevant Costs Sequoia Paper Products, Inc., manufactures boxed stationery for sale to specialty shops. Currently, the company is operating at 90 percent of capacity. A chain of drugstores has offered to buy 30,000 boxes of Sequoia's blue-bordered thank-you notes as long as the box can be customized with the drugstore chain's logo. While the normal selling price is $6.00 per box, the chain has offered just $3.10 per box. Sequoia can accommodate the special order without affecting current sales. Unit cost information for a box of thank-you notes follows: img Fixed overhead is $420,000 per year and will not be affected by the special order. Normally, there is a commission of 5 percent of price; this will not be paid on the special order since the drugstore chain is dealing directly with the company. The special order will require additional fixed costs of $14,300 for the design and setup of the machinery to stamp the drugstore chain's logo on each box. Required: 1. List the alternatives being considered. List the relevant benefits and costs for each alternative. 2. Which alternative is more cost effective and by how much? 3. What if Sequoia Paper Products was operating at capacity and accepting the special order would require rejecting an equivalent number of boxes sold to existing customers? Which alternative would be better?
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Keep-Or-Drop Decision, Alternatives, Relevant Costs Reshier Company makes three types of rug shampooers. Model 1 is the basic model rented through hardware stores and supermarkets. Model 2 is a more advanced model with both dryand wet-vacuuming capabilities. Model 3 is the heavy-duty riding shampooer sold to hotels and convention centers. A segmented income statement is shown below. img While all models have positive contribution margins, Reshier Company is concerned because operating income is less than 10 percent of sales and is low for this type of company. The company's controller gathered additional information on fixed costs to see why they were so high. The following information on activities and drivers was gathered: img In addition, Model 1 requires the rental of specialized equipment costing $20,000 per year. Required: 1. Reformulate the segmented income statement using the additional information on activities. 2. Using your answer to Requirement 1, assume that Reshier Company is considering dropping any model with a negative product margin. What are the alternatives? Which alternative is more cost effective and by how much? (Assume that any traceable fixed costs can be avoided.) 3. What if Reshier Company can only avoid 175 hours of engineering time and 5,000 hours of setup time that are attributable to Model 1? How does that affect the alternatives presented in Requirement 2? Which alternative is more cost effective and by how much?
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What is a relevant cost? Explain why depreciation on an existing asset is always irrelevant.
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"Tactical decisions are often small-scale decisions that serve a larger purpose." Explain what this means.
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What role do past costs play in tactical cost analysis?
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Make-or-Buy Decision, Alternatives, Relevant Costs Each year, Basu Company produces 18,000 units of a component used in microwave ovens. An outside supplier has offered to supply the part for $1.38. The unit cost is: img Required: 1. What are the alternatives for Basu Company? 2. Assume that none of the fixed cost is avoidable. List the relevant cost(s) of internal production and of external purchase. 3. Which alternative is more cost effective and by how much? 4. What if $18,540 of fixed overhead is rental of equipment used only in production of the component that can be avoided if the component is purchased? Which alternative is more cost effective and by how much?
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Resource Supply and Usage, Adding a Service Line, Relevancy Roxanne Morton owns a beauty shop with eight hair and nail professionals. Her shop is relatively large and has four rooms at the back, three of which are currently empty (the fourth is used to store supplies). Roxanne's is popular and typically busy Monday through Friday all day and Saturday until noon. She has been thinking about adding a tanning salon in the back of the shop. She figures that she can buy two tanning beds for $10,000 each. The necessary supplies (cleaning materials, complimentary skin lotion in each room) will run about $450 per month. The extra electricity will cost about $100 per month. Currently, Roxanne pays part-time help to staff the front desk, make appointments, check clients in, and so on. For the hours that the beauty salon is open, the current staff can easily handle the additional tanning salon duties. However, Roxanne knows that she'll have to stay open an additional four hours each weeknight (from 5 p.m. until 9 p.m) as well as six hours on both Saturday and Sunday afternoons. Hiring additional staff for the tanning salon during those hours will cost about $8 per hour. Required: 1. Classify the resources associated with the tanning salon as (1) flexible or (2) committed. 2. (a) Suppose that the tanning salon does very well and Roxanne decides to add one more tanning bed, using the third room at the back of the shop. What additional costs are relevant? (b) Suppose that Roxanne decides to add two more tanning beds? How will your answer to (a) change?
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