TYPES OF DECISION

MAKING
 12-2
13-34

Prepare a make or buy

analysis.

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 12-3

Some Common Relevant Cost Applications

• Relevant costing is of value in solving many different types of

problems. Traditionally, these applications include decisions:
o to make or buy a component
o to keep or drop a segment or product or service line
o to accept a special order at less than the usual price
o to further process joint products or sell them at the split-off
point
• Though by no means an exhaustive list, many of the same
decision-making principles apply to a variety of problems

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 12-4
13-35

The Make or Buy Decision

When a company is involved in more than one activity
in the entire value chain, it is vertically integrated. A
decision to carry out one of the activities in the value
chain internally, rather than to buy externally from a
supplier is called a “make or buy” decision.

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 12-5
13-36

Vertical Integration – Advantages

Smoother flow of
parts and materials

Better quality
control

Realize profits

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 12-6
13-37

Vertical Integration – Disadvantages

Companies may fail to take advantage of
suppliers who can create economies of scale
advantage by pooling demand from numerous
companies.

While the economics of scale factor can be

appealing, a company must be careful to retain
control over activities that are essential to
maintaining its competitive position.

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 12-7
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The Make or Buy Decision – An Example

Essex Company manufactures part 4A that is used in one of its

products. The unit product cost of this part is:

Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of special equip. 3
Supervisor's salary 2
General factory overhead 10
Unit product cost $ 30

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The Make or Buy Decision – Part 1

The special equipment used to manufacture part 4A has no
resale value.
The total amount of general factory overhead, which is
allocated on the basis of direct labor hours, would be unaffected
by this decision.
The $30 unit product cost is based on 20,000 parts produced
each year.
An outside supplier has offered to provide the 20,000 parts at a
cost of $25 per part.
Should the company stop making part 4A and buy it from an
outside supplier?

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 12-9
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The Make or Buy Decision – Part 2

Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
Allocated gen. fact. overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

The avoidable
The avoidable costs
costs associated
associated with
with making
making part
part 4A
4A include
include direct
direct materials,
materials,
direct
direct labor,
labor, variable
variable overhead,
overhead, and
and the
the supervisor’s
supervisor’s salary.
salary.

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 12-10
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The Make or Buy Decision – Part 3

Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
Allocated gen. fact. overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

The
The cost
cost incurred
incurred to
to buy
buy the
the equipment
equipment is is aa sunk
sunk cost;
cost; the
the
depreciation
depreciation simply
simply spreads
spreads this
this sunk
sunk cost
cost over
over the
the
equipment’s
equipment’s useful
useful life.
life.
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 12-11
13-42

The Make or Buy Decision – Part 4

Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
Allocated gen. fact. overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000

The
The allocated
allocated general
general factory
factory overhead
overhead represents
represents allocated
allocated costs
costs
common
common toto all
all items
items produced
produced in in the
the factory
factory and
and would
would continue
continue
unchanged.
unchanged. Thus,
Thus, itit is
is irrelevant
irrelevant to
to the
the decision.
decision.
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13-43

The Make or Buy Decision – Part 5

Cost
Per
Unit Cost of 20,000 Units
Make Buy
Outside purchase price $ 25 $ 500,000

Direct materials (20,000 units) $ 9 180,000

Direct labor 5 100,000
Variable overhead 1 20,000
Depreciation of equip. 3 -
Supervisor's salary 2 40,000
Allocated gen. fact. overhead 10 -
Total cost $ 30 $ 340,000 $ 500,000
Financial advantage of making part 4A $160,000
Should we make or buy part 4A? Given that the total avoidable
costs are less than the cost of buying the part, Essex should
continue to make the part.
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 12-13

Example :How to Structure a Make-or-Buy Problem

(1 of 5)

Swasey Manufacturing needed to determine if it would be cheaper to

make 10,000 units of a component in-house or to purchase them from
an outside supplier for $4.75 each. Cost information on internal
production includes the following:

Total Cost Unit Cost

Direct materials $10,000 $1.00
Direct labor 20,000 2.00
Variable overhead 8,000 0.80
Fixed overhead 44,000 4.40
Total $82,000 $8.20

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 12-14

Example :How to Structure a Make-or-Buy Problem

(2 of 5)

Fixed overhead will continue whether the component is

produced internally or externally. No additional costs of
purchasing will be purchasing will be incurred beyond the
purchase price.

Required:
1. Which alternative is more cost effective and by how much?
2. Now assume that fixed overload includes $10,000 of cost
that can be avoided if the component is purchased
externally. Which alternative is more cost effective and by
how much?

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 12-15
13-44

Opportunity Cost

Opportunity costs are not actual cash outlays and are not
recorded in the formal accounts of an organization.
An opportunity cost is the benefit that is foregone as a
result of pursuing some course of action.
If the space to make Part 4A had an alternative use, the
opportunity cost would have been equal to the segment
margin that could have been derived from the best
alternative use of the space.

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 12-16
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Prepare an analysis
showing whether a special
order should be accepted.

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 12-17
13-46

Special Orders
A special order is a one-time order that is not
considered part of the company’s normal
ongoing business.

When analyzing a special order, only the

incremental costs and benefits are relevant.
Since the existing fixed manufacturing
overhead costs would not be affected by the
order, they are not relevant.

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Special Orders – Example

 Jet Inc. makes a single product whose normal selling price is
$20 per unit.
 A foreign distributor offers to purchase 3,000 units for $10
per unit.
 This is a one-time order that would not affect the company’s
regular business.
 Annual capacity is 10,000 units, but Jet Inc. is currently
producing and selling only 5,000 units.

Should Jet accept the offer?

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 12-19
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Special Orders – Part 1

Jet Inc.
Contribution Inc. Stmt, before considering special order
Revenue (5,000 × $20) $ 100,000
Variable costs:
Direct materials $ 20,000
Direct labor 5,000
Manufacturing overhead 10,000 $8 variable cost
Marketing costs 5,000
Total variable costs 40,000
Contribution margin 60,000
Fixed costs:
Manufacturing overhead $ 28,000
Marketing costs 20,000
Total fixed costs 48,000
Net operating income $ 12,000
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Special Orders – Part 2

If Jet accepts the special order, the incremental revenue will exceed
the incremental costs. In other words, net operating income will
increase by $6,000. This suggests that Jet should accept the order.

Incremental revenue (3,000 × $10) $ 30,000

Incremental cost (3,000 × $8 variable cost) 24,000
Financial advantage of accepting the order $ 6,000

Note: This answer assumes that the fixed costs are

unavoidable and that variable marketing costs must be
incurred on the special order.
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 12-21

Example : How to Structure a Special-Order Problem

(1 of 3)

Leibnitz Company has been approached by a new

customer with an offer to purchase 20,000 units of model T
R 8 at a price of $9 each. The new customer is
geographically separated from the company's other
customers, and existing sales would not be affected.
Leibnitz normally produces 100,000 units of T R 8 per year
but only plans to produce and sell 75,000 in the coming
year. The normal sales price is $14 pet unit. Unit cost
information for the normal level of activities is as follows:

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 12-22

Example : How to Structure a Special-Order Problem

(2 of 3)

Direct materials $3.00

Direct labor 2.80
Variable overhead 1.50
Fixed overhead 2.00
Total $9.30

Fixed overhead will not be affected by whether or not the special order
is accepted.
Required:
1. By how much will operating income increase or decrease if the order
is accepted?

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 12-23
13-50

Quick Check 1
Northern Optical ordinarily sells the X-lens for $50. The
variable production cost is $10, the fixed production cost is
$18 per unit, and the variable selling cost is $1. A
customer has requested a special order for 10,000 units of
the X-lens to be imprinted with the customer’s logo. This
special order would not involve any selling costs, but
Northern Optical would have to purchase an imprinting
machine for $50,000.
(see the next page)

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 12-24
13-51

Quick Check 1a
What is the rock bottom minimum price below which Northern
Optical should not go in its negotiations with the customer? In
other words, below what price would Northern Optical actually
be losing money on the sale? There is ample idle capacity to
fulfill the order and the imprinting machine has no further use
after this order.
a. $50
b. $10
c. $15
d. $29

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Determine the most

profitable use of a
constrained resource.

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 12-26
13-54

Volume Trade-Off Decisions

Companies are forced to make volume trade-off decisions

when they do not have enough capacity to produce all of
the products and sales volumes demanded by their
customers.
• In these situations, companies must trade off, or
sacrifice production of some products in favor of others
in an effort to maximize profits.

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Key Terms and Concepts

When a limited resource of

some type restricts the
company’s ability to satisfy
demand, the company is
said to have a constraint.
The machine or
process that is
limiting overall output
is called the
bottleneck – it is the
constraint.
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Utilization of a Constrained Resource

Fixed costs are usually unaffected in these situations, so the
product mix that maximizes the company’s total contribution
margin should ordinarily be selected.
A company should not necessarily promote those products
that have the highest unit contribution margins.
Rather, total contribution margin will be maximized by
promoting those products or accepting those orders that
provide the highest contribution margin in relation to the
constraining resource.

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Utilization of a Constrained Resource – An Example –

13-57

Part 1
Ensign Company produces two products and selected data are
shown below:
Product
1 2
Selling price per unit $ 60 $ 50
Less variable expenses per unit 36 35
Contribution margin per unit $ 24 $ 15
Current demand per week (units) 2,000 2,200
Contribution margin ratio 40% 30%
Processing time required
on machine A1 per unit 1.00 min. 0.50 min.

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Utilization of a Constrained Resource – An Example –

13-58

Part 2

Machine A1 is the constrained resource and is being used at

100% of its capacity.
There is excess capacity on all other machines.
Machine A1 has a capacity of 2,400 minutes per week.

Should Ensign focus its efforts on Product 1 or

Product 2?

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 12-31
13-59

Quick Check 2
How many units of each product can be processed
through Machine A1 in one minute?
Product 1 Product 2
a. 1 unit 0.5 unit
b. 1 unit 2.0 units
c. 2 units 1.0 unit
d. 2 units 0.5 unit

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 12-32
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Quick Check 2b
What generates more profit for the company, using one
minute of machine A1 to process Product 1 or using
one minute of machine A1 to process Product 2?
a. Product 1
b. Product 2
c. They both would generate the same profit.
d. Cannot be determined.

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 12-33
13-65

Utilization of a Constrained Resource – Part 3

Let’s see how this plan would work.
Alloting Our Constrained Resource (Machine A1)

Weekly demand for Product 2 2,200 units

Time required per unit × 0.50 min.
Total time required to make
Product 2 1,100 min.

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Utilization of a Constrained Resource – Part 4

Let’s see how this plan would work.
Alloting Our Constrained Resource (Machine A1)

Weekly demand for Product 2 2,200 units

Time required per unit × 0.50 min.
Total time required to make
Product 2 1,100 min.

Total time available 2,400 min.

Time used to make Product 2 1,100 min.
Time available for Product 1 1,300 min.

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 12-35
13-67

Utilization of a Constrained Resource – Part 5

Let’s see how this plan would work.
Alloting Our Constrained Resource (Machine A1)

Weekly demand for Product 2 2,200 units

Time required per unit × 0.50 min.
Total time required to make
Product 2 1,100 min.

Total time available 2,400 min.

Time used to make Product 2 1,100 min.
Time available for Product 1 1,300 min.
Time required per unit ÷ 1.00 min.
Production of Product 1 1,300 units

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 12-36
13-68

Utilization of a Constrained Resource – Part 6

According to the plan, we will produce 2,200 units of Product 2
and 1,300 of Product 1. Our contribution margin looks like this.

Product 1 Product 2
Production and sales (units) 1,300 2,200
Contribution margin per unit $ 24 $ 15
Total contribution margin $ 31,200 $ 33,000

The total contribution margin for Ensign is $64,200.

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 12-37
13-69

Determine the value of

obtaining more of the
constrained resource.

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 12-38
13-70

Value of a Constrained Resource – Example

Increasing the capacity

of a constrained
resource should lead to
increased production
and sales.

How much should

Ensign be willing to pay
for an additional minute
of Machine A1 time?
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 12-39
13-71

Value of a Constrained Resource – Solution

The additional machine time would be used to make more units of
Product 1, which had a contribution margin per minute of $24.

Ensign should be willing to pay up to $24

per minute. This amount equals the
contribution margin per minute of machine
time that would be earned producing more
units of Product 1.

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 12-40
13-72

Quick Check 3
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs Tables
Selling price per unit $80 $400
Variable cost per unit $30 $200
Board feet per unit 2 10
Monthly demand 600 100

The company’s supplier of hardwood will only be

able to supply 2,000 board feet this month. Is this
enough hardwood to satisfy demand?
a. Yes
b. No
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 12-41
13-74

Quick Check 3b
Chairs Tables
Selling price per unit $80 $400
Variable cost per unit $30 $200
Board feet per unit 2 10
Monthly demand 600 100

The company’s supplier of hardwood will only be able

to supply 2,000 board feet this month. What plan would
maximize profits?
a. 500 chairs and 100 tables
b. 600 chairs and 80 tables
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
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 12-42
13-76

Quick Check 4
As before, Colonial Heritage’s supplier of hardwood will
only be able to supply 2,000 board feet this month.
Assume the company follows the plan we have
proposed. Up to how much should Colonial Heritage be
willing to pay above the usual price to obtain more
hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero

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 12-43
13-78

Managing Constraints
It is often possible for a manager to increase the capacity of a
bottleneck, which is called relaxing (or elevating) the
constraint, in numerous ways such as:
1. Working overtime on the bottleneck.
2. Subcontracting some of the processing that would be done
at the bottleneck.
3. Investing in additional machines at the bottleneck.
4. Shifting workers from non-bottleneck processes to the
bottleneck.
5. Focusing business process improvement efforts on the
bottleneck.
6. Reducing defective units processed through the bottleneck.

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 12-44
13-79

Prepare an analysis
showing whether joint
products should be sold at
the split-off point or
processed further.

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 12-45
13-80

Joint Product Costs

In some industries, two or more products,
known as joint products are produced from a
single raw material input.
The point in the manufacturing process where
joint products can be recognized as a separate
product is called the split-off point.
A decision as to whether a joint product
should be sold at the split-off point or
processed further is known as a sell or process
further decision.
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 12-46
13-81

Joint Products
For example, in the
Oil petroleum refining
industry, a large
number of products
Common
Joint are extracted from
Production Gasoline
Input crude oil, including
Process
gasoline, jet fuel,
home heating oil,
Chemicals lubricants, asphalt,
and various organic
chemicals.
Split-Off
Point
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 12-47
13-82

Joint Products – Additional Processing

Joint costs
are incurred
up to the
Oil
Separate Final
split-off point Processing Sale

Common
Joint Production Final
Gasoline
Input Process
Sale

Separate Final
Chemicals
Processing
Sale

Split-Off Separate
Point Product
Costs
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 12-48
13-83

The Pitfalls of Allocation

Joint costs are traditionally allocated among
different products at the split-off point. A
typical approach is to allocate joint costs
according to the relative sales value of the end
products.

Although allocation is needed for some

purposes such as balance sheet inventory
valuation, allocations of this kind are very
dangerous for decision making.

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 12-49
13-84

Sell or Process Further

Joint costs are irrelevant in decisions regarding
what to do with a product from the split-off point
forward. Therefore, these costs should not be
allocated to end products for decision-making
purposes.

With respect to sell or process further decisions, it is

profitable to continue processing a joint product
after the split-off point so long as the incremental
revenue from such processing exceeds the
incremental processing costs incurred after the
split-off point.
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 12-50
13-85

Sell or Process Further – An Example

Sawmill, Inc. cuts logs from which unfinished lumber and
sawdust are the immediate joint products.
Unfinished lumber is sold “as is” or processed further into
finished lumber.
Sawdust can also be sold “as is” to gardening wholesalers
or processed further into “presto-logs.”

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 12-51
13-86

Sell or Process Further – Additional Data

Data about Sawmill’s joint products includes:
Per Log
Lumber Sawdust
Sales value at the split-off point $ 140 $ 40

Sales value after further processing 270 50

Allocated joint product costs 176 24
Cost of further processing 50 20

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 12-52
13-87

Sell or Process Further – Part 1

Analysis of Sell or Process Further
Per Log
Lumber Sawdust
Final sales value after further
processing $ 270 $ 50
Sales value at the split-off point 140 40
Incremental revenue from further
processing 130 10
Cost of further processing
Financial advantage (disadvantage)
of further processing

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 12-53
13-88

Sell or Process Further – Part 2

Analysis of Sell or Process Further
Per Log
Lumber Sawdust
Final sales value after further
processing $ 270 $ 50
Sales value at the split-off point 140 40
Incremental revenue from further
processing 130 10
Cost of further processing 50 20
Financial advantage (disadvantage)
of further processing $ 80 $ (10)

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 12-54
13-89

Sell or Process Further – Part 3

Analysis of Sell or Process Further
Per Log
Lumber Sawdust
Final sales value after further
processing $ 270 $ 50
Sales value at the split-off point 140 40
Incremental revenue from further
processing 130 10
Cost of further processing 50 20
Financial advantage (disadvantage)
of further processing $ 80 $ (10)

The lumber should be processed

further and the sawdust should be
sold at the split-off point.
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 12-55

Example : How to Structure the Sell-or-Process-Further Decision

(1 of 3)

• Appletime grows apples and then sorts them into one of three
grades, A, B, or C, based on their condition. Appletime must
decide whether to sell the Grade B apples at split-off or to
process them into apple pie filling. The company normally sells
the Grade B apples in 120 five-pound bags at a per-unit price of
$1.25. If the apples are processed into pie filling, the result will
be 500 cans of filling with additional costs of $0.24 per can. The
buyer will pay $0.90 per can.

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 12-56

Example: How to Structure the Sell-or-Process-Further Decision

(2 of 3)

Required:
1. What is the contribution to income from selling the Grade B
apples in five-pound bags?
2. What is the contribution to income from processing the Grade
B apples into pie filling?
3. Should Appletime continue to sell the Grade B apples in bags
or process them further into pie filling?

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 12-57

Keep-or-Drop Decisions (1 of 2)
• A manager needs to determine whether a segment, such as a particular
product or service line or a geographic sales region, should be kept or
dropped
• Making effective keep-or-drop decisions requires that managers identify
and consider only the relevant information of the business segment in
question
• A segment is a subunit of a company of sufficient importance to warrant
the production of performance reports
• Segmented reports prepared on a variable-costing basis are important
because they provide managers with this valuable information
• Both the contribution margin and the segment margin shown on a
segmented income statement are useful in evaluating the performance of
segments and, in particular, identifying the relevant information necessary
for making effective keep-or-drop decisions

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 12-58

Example : How to Structure a Keep-or-Drop Product-Line

Problem (1 of 4)
• Shown below is a segmented income statement for Norton Materials Inc.’s
three product lines:

Blocks Bricks Tile Total

Sales revenue $500,000 $800,000 $150,000 $1,450,00
0
Less: Variable expenses 250,000 480,000 140,000 870,000
Contribution margin $250,000 $320,000 $ 10,000 $ 580,000
Less direct fixed expenses:
Advertising (10,000) (10,000) (10,000) (30,000)
Supervision salaries (37,000) (40,000) (35,000) (112,000)
Depreciation (53,000) (40,000) (10,000) (103,000)
Segment margin $150,000 $230,000 $(45,000) $ 335,000

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 12-59

Example : How to Structure a Keep-or-Drop Product-Line

Problem (2 of 4)
The roofing tile line has a contribution margin of $10,000 (sales of
$150,000 minus total variable costs of $140,000). All variable costs are
relevant. Relevant fixed costs associated with this line include $10,000
in advertising and $35,000 in supervision salaries.
Required:
1. List the alternatives being considered with respect to the roofing tile
line.
2. List the relevant benefits and costs for each alternative.
3. Which alternative is more cost effective and by how much?

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 12-60

Example : How to Structure a Keep-or-Drop Product-Line

Problem (3 of 4)
Solution:
1. The two alternatives are to keep the roofing tile line or to drop
it.
2. The relevant benefits and costs of keeping the roofing tile line
include sales of $150,000, variable costs of $140,000,
advertising cost of $10,000, and supervision cost of $35,000.
None of the relevant benefits and costs of keeping the roofing
tile line would occur under the drop alternative.

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 12-61

Example : How to Structure a Keep-or-Drop Product-Line

Problem (4 of 4)
3.
Differential
Keep Drop Amount to Keep
Sales $150,000 $— $150,000
Less: Variable expenses 140,000 — 140,000
Contribution margin $ 10,000 $— $ 10,000
Less: Advertising (10,000) — (10,000)
Cost of supervision (35,000) — (35,000)
Total relevant benefit $(35,000) $0 $ (35,000)
(loss)

The difference is $35,000 in favor of dropping the roofing tile line.

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 12-62

Keep or Drop with Complementary Effects

• A potential complication of a keep-or-drop analysis is the

implication such a decision might have on other aspects of the
business
• Such implications must be included in the analysis before
making a final decision
• Sometimes dropping one line would lower sales of another
line, as many customers buy both lines at the same time
• This information can affect the keep-or-drop decision

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 12-63

Example : How to Structure a Keep-or-Drop-Product Line Problem with

Complementary Effects (1 of 4)

Refer to Norton Materials’ segmented income statement. Assume

that dropping the product line reduces sales of blocks by 10% and
sales of bricks by 8%. All other information remains the same.
Required:
1. If the roofing tile line is dropped, what is the contribution
margin for the block line? For the brick line?
2. Which alternative (keep or drop the roofing tile line) is now
more cost effective and by how much?

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 12-64

Example 8.5: How to Structure a Keep-or-Drop-Product Line Problem

with Complementary Effects (2 of 4)

Solution:
1. Previous contribution margin of blocks was $250,000. A 10% decrease
in sales implies a 10% decrease in total variable costs, so the
contribution margin decreases by 10%.
New Contribution Margin for Blocks = $250,000 − 0.10($250,000) =
$225,000
The reasoning is the same for the brick line, but the decrease is 8%.
New Contribution Margin for Bricks = $320,000 − 0.08($320,000) =
$294,400
Therefore, if the roofing tile product line were dropped, the resulting total
contribution margin for Norton Materials would equal $519,400 ($225,000 +
$294,400).

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 12-65

Example : How to Structure a Keep-or-Drop-Product Line Problem with

Complementary Effects (3 of 4)
2.
Differential
Keep Drop Amount to Keep
Contribution margin $ 580,000 $519,400 $ 60,600
Less: Advertising (30,000) (20,000) (10,000)
Cost of supervision (112,000) (77,000) (35,000)
Total $ 438,000 $422,400 $ 15,600

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 12-66

Segmented Income Statements Using Variable Costing

• Variable costing is useful in preparing segmented income
statements because it gives useful information on variable and
fixed expenses
• In segmented income statements, fixed expenses are broken
down into two categories:
o direct fixed expenses and
o common fixed expenses

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 12-67

Direct Fixed Expenses

• Direct fixed expenses are fixed expenses that are directly

traceable to a segment
• These are sometimes referred to as avoidable fixed expenses
or traceable fixed expenses because they vanish if the segment
is eliminated
o For example, if the segments were sales regions, a direct
fixed expense for each region would be the rent for the sales
office

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 12-68

Common Fixed Expenses

• Common fixed expenses are jointly caused by two or more

segments
• These expenses persist even if one of the segments to which
they are common is eliminated
o For example, depreciation on the corporate headquarters
building or the salary of the C E O would be a common fixed
expense for most large companies

Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All Rights Reserved. May not be scanned,
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 12-69

Example: How to Prepare a Segmented Income Statement (1

of 4)

• Audiomatronics Inc. produces MP3 players and smartphones

in a single factory. The following information was provided for
the coming year:

MP3 Smartphones
Players
Sales $400,000 $290,000
Variable cost of goods sold 200,000 150,000
Direct fixed overhead 30,000 20,000

Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All Rights Reserved. May not be scanned,
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 12-70

Example : How to Prepare a Segmented Income Statement (2

of 4)

A 5% sales commission is paid for each of the product lines.

Direct fixed selling and administrative expense was estimated to
be $10,000 for the MP3 line and $15,000 for the smartphone
line. Common fixed overhead for the factory was estimated to be
$100,000; common selling and administrative expense was
estimated to be $20,000.
Required:
Prepare a segmented income statement for Audiomatronics Inc.
for the coming year, using variable costing.

Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All Rights Reserved. May not be scanned,
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 12-71

Example : How to Prepare a Segmented Income Statement (3

of 4)

Solution:

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 12-72

Comparison of Segmented Income Statement With and Without

Allocated Common Fixed Expense

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 12-73

Product Mix Decisions (1 of 2)

• Organizations have wide flexibility in choosing their product

mix
• Product mix refers to the relative amount of each product
manufactured (or service provided) by a company
• Decisions about product mix can have a significant impact on
an organization’s profitability
• Every firm faces limited resources and limited demand for each
product. These limitations are called constraints
• A manager must choose the optimal mix given the constraints
found within the firm

Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All Rights Reserved. May not be scanned,
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 12-74

Example: How to Determine the Optimal Product Mix with One

Constrained Resource (1 of 3)
Jorgenson Company produces two types of gears, X and Y, with
unit contribution margins of $25 and $10, respectively. Each gear
must be notched by a special machine. The firm ownseight
machines that together provide 40,000 hours of machine time
per year. Gear X requires 2 hours of machine time, and Gear Y
requires 0.5 hour of machine time. There are no other
constraints.
Required:
1. What is the contribution margin per hour of machine time for each gear?
2. What is the optimal mix of gears?
3. What is the total contribution margin earned for the optimal mix?

Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All Rights Reserved. May not be scanned,
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 12-75

Example : How to Determine the Optimal Product Mix with One

Constrained Resource (2 of 3)

Solution:

1. Gear X Gear
Y
Contribution margin per unit $25.00 $10.00
Required machine time per unit ÷2 ÷0.5
Contribution margin per hour of machine $12.50 $20.00
time

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 12-76

Example : How to Determine the

Optimal Product Mix with One
Constrained Resource (3 of 3)
2. Since Gear Y yields $20 of contribution margin per hour of
machine time, all machine time should be devoted to the
production of Gear Y.
40,000 total hours
Units Gear Y   80,000 units
0.5 hour per Gear Y

The optimal mix is Gear Y = 80,000 units and Gear X = 0 units.

3. Total Contribution Margin of Optimal Mix = (80,000 units Gear Y)

$10 = $800,000

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 12-77

Example: How to Determine the Optimal Product Mix with One Constrained
Resource and a Sales Constraint (1 of 4)

Jorgenson Company produces two types of gears, X and Y, with

unit contribution margins EXAMPLE 8 of $25 and $10,
respectively. Each gear must be notched by a special machine.
The firm owns eight machines that together provide 40,000
hours of machine time per year. Gear X requires 2 hours of
machine time, and Gear Y requires 0.5 hour of machine time. A
maximum of 60,000 units of each gear can be sold.

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 12-78

Example How to Determine the Optimal Product Mix with One Constrained
Resource and a Sales Constraint (2 of 4)

Required:
1. What is the contribution margin per hour of machine time
for each gear?
2. What is the optimal mix of gears?
3. What is the total contribution margin earned for the
optimal mix?

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written consent of McGraw-Hill Education.
 12-79

Multiple Constrained Resources (1 of 2)

• The presence of only one constrained resource might not be

realistic
• Organizations often face multiple constraints, including:
o limitations of raw materials
o limitations of skilled labor
o limited demand for each product

The solution of the product mix problem in the presence of

multiple constraints is more complicated and requires the
use of a specialized mathematical technique known as
linear programming, which is reserved for advanced cost
management courses
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 7th Edition. © 2018 Cengage. All Rights Reserved. May not be scanned,
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 12-80

Product Mix Decisions (2 of 2)

• Every firm faces limited resources and limited demand for each
product. These limitations are called constraints
• A manager must choose the optimal mix given the constraints found
within the firm

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 12-81
13-90

Activity-Based Costing and Relevant Costs

ABC can be used to help identify potentially relevant
costs for decision-making purposes.

However, managers should exercise

caution against reading more into this
“traceability” than really exists.

People have a tendency to assume that if a cost is

traceable to a segment, then the cost is automatically
avoidable, which is untrue. Before making a decision,
managers must decide which of the potentially relevant
costs are actually avoidable.

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written consent of McGraw-Hill Education.
 12-82
13-91
13-91

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written consent of McGraw-Hill Education.