Decision Making using Differential Analysis Decision making involves quantifying

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Decision Making using Differential Analysis

Decision making involves quantifying relevant revenues and costs with the goal of maximizing net cash flows. In many situations it is difficult to quantify all the important elements of a decision. Fixed costs are generally - Select your answer -relevantnot relevantCorrect 1 of Item 1  in the short-term because they are often unavoidable. Costs that have been incurred in the past and cannot be recouped are not relevant. These costs are called - Select your answer -fixed costsopportunity costssunk costsvariable costsCorrect 2 of Item 1 . Revenue given up by not choosing an alternative is relevant. This is an example of - Select your answer -a fixed costan opportunity costa sunk costa variable costCorrect 3 of Item 1 . Factors that cannot be expressed in numerical terms may or may not be relevant to the decision.

Indicate whether the costs that are described are relevant or irrelevant for decision-making purposes.

Managers often have to choose between mutually exclusive alternatives. The first step is to identify the alternatives and the relevant revenues and costs of each option. The next step is to compare the alternatives. This is called - Select your answer -differentialoverheadregressionstatistical Correct 1 of Item 2  analysis, or incremental analysis. The concept is to determine the differential income or loss from choosing one option over the other. If irrelevant costs are included in one option, the cost - Select your answer -shouldshould notCorrect 2 of Item 2  also be included in the other options for comparison purposes.

Make or buy decisions, sell or process further decisions, lease or buy decisions, whether to accept an order at a discounted price, and when to replace equipment, are all examples of common decisions where differential analysis is used.

Many formats may be used. Click here for a template that includes all revenues and costs. Click here for a template with relevant costs only.

Make or Buy Decision:

Zee-Drive Ltd. is a computer manufacturer. One of the items they make is monitors. Zee-Drive has the opportunity to purchase 19,500 monitors from an outside supplier for $213 per unit. One of the company's cost-accounting interns prepared the following schedule of Zee-Drive's cost to produce 19,500 monitors:

You are asked to look over the intern's estimate before the information is shared with members of management who will decide to continue to make the monitors or buy them. The company's controller believes that the estimate may be incorrect because it includes costs that are not relevant. If Zee-Drive buys the monitors, the direct labor force currently employed in producing the monitors will be terminated and there would be no termination costs incurred. There are no materials on hand and no commitments to suppliers to purchase materials, so all materials would need to be purchased to make the monitors. Variable overheads are avoidable if monitors are bought. Fixed manufacturing overhead costs would be reduced by $57,500, but non-manufacturing costs would remain the same if monitors are bought.

Fill in the differential analysis. If an amount box does not require an entry, leave it blank or enter "0".

Keep or Replace Machine:

Skiles Coporation is a manufacturer of classic rocking chairs. The company has been using a particular sanding and finishing machine for over 10 years and believes that it may be time to replace the machine. The company is trying to decide whether replacing the old machine is a wise economic decision. The company's controller pulled together the following information on the old machine and the new possible replacement machine.

Select the relevant or irrelevant information below:

Fill in the differential analysis. If an amount box does not require an entry, leave it blank or enter "0".

The cost to hire and train temporary labor to cover normal business processes so permanent employees can work on the project that is being considered - Select your answer -RelevantIrrelevantCorrect 4 of Item 1 The future depreciation on a new machine with the decision to replace an older fully depreciated machine (assume no tax benefit for depreciation) - Select your answer -RelevantIrrelevantCorrect 5 of Item 1 The revenue given up by not choosing an alternative - Select your answer -RelevantIrrelevantCorrect 6 of Item 1 The risk of substandard quality from an outside supplier with the decision to outsource - Select your answer -RelevantIrrelevantCorrect 7 of Item 1 Variable costs that are the same for all alternatives under consideration - Select your answer -RelevantIrrelevantCorrect 8 of Item 1

Explanation / Answer

(B) MAKE OR BUY DECISION

Cost of producing 19,500 monitors

Cost to purchase 19,500 monitors

Difference costs/(savings) of buying 19,500 monitors

Direct materials

$ 120

$

$

Direct labor

( 67*19500)

Variable factory overhead

- Select your answer -Fixed manufacturing overheadFixed non-manufacturing overheadRedundancy costsCorrect 12 of Item 2

22.05

(57500)

- Select your answer -Outside purchase costsFixed non-manufacturing overheadMonitors in finished goods inventoryCorrect 16 of Item 2

39

-

Total costs

$ 181.06

$ 213

$

Dirct labour cost is a sunk cost since they are permanent.so we prepare statement of comparative cost.

If the company buys then there will be a saving of $67 per unit which is labour cost . Material cost will be incurred if we produce. There is a savings in variable overheads if monitors are purchased. Which is $38 per unit. Fixed manufacturing overhead reduces by $57500 which means a saving of ($57500/19500) or 2.95$ per unit. So total savings comes to

                                $67+$38+$2.95= $107.95

Total cost of production = $289-$107.95

                                                =$181.05

Hence production is a better option than manufacturing.

Annual variable costs of old machine

   Selling price of old machine

Matching lives

Purchase price of new machine

Accumulated depreciation of old machine

Irrelevant

Relevant

            Irrelevant

Relevant

Irrelevant

Cost of producing 19,500 monitors

Cost to purchase 19,500 monitors

Difference costs/(savings) of buying 19,500 monitors

Direct materials

$ 120

$

$

Direct labor

( 67*19500)

Variable factory overhead

- Select your answer -Fixed manufacturing overheadFixed non-manufacturing overheadRedundancy costsCorrect 12 of Item 2

22.05

(57500)

- Select your answer -Outside purchase costsFixed non-manufacturing overheadMonitors in finished goods inventoryCorrect 16 of Item 2

39

-

Total costs

$ 181.06

$ 213

$

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