Decision making, whether short or long term, can be defined in simple terms, as the process of selection between one or more alternative course of action. In most cases with absent owners (i.e. shareholders), management is delegated the responsibility of making all the important economic decisions, be it production, marketing and financial, which eventually generate profits or losses for the company.. Management decision making is a complex problem solving process, which must be exhausted through a series of successive stages as indicated below:
- Problem detection and identification Search for an existing model applicable to a problem or the development of a new model General definition of alternatives in light of a problem and a chosen model Determination of the quantitative and qualitative data that is relevant to the problem and analysis of those data relating to alternatives Selection and implementation of an optimal solution that is consistent with management's goals Evaluation after the decision through feedback that provides management with a means of determining the effectiveness of the chosen course of action in the solution of the problem.
In the managerial decision-making process, the managerial accountant plays a decisive role, although he does not make or implement the final decision (stage 5), which is the prerogative of management, but he is nevertheless responsible for supplying the necessary information in each of the the stages of the process for solving a problem.
In the previous classification, it was possible to see how costs are classified from different points of view, although management accounting is interested in everything related to costs, the classifications from point 5 to 10 are the most important.
According to the control that is had on the occurrence of the costs:
Controllable costs: are those costs over which management has control, which implies that it can decide whether they are carried out or not. example most of the costs and expenses of a company
Uncontrollable costs: They are those in which management does not have authority over them, that is, it is not capable of deciding whether or not to occur. Example Depreciation, some wages etc.
According to their behavior:
Variable costs: Are those that change or fluctuate in direct relation to a given activity or volume. Example Raw material, commissions etc.
Fixed costs: They are those that remain constant during a certain period regardless of whether the volume changes., wages, depreciation, rent etc.
Semivariable or semi-fixed: These are those that are made up of a fixed part and a variable part. Example: Most public services. Water, communication, energy etc.
Below is an example of the behavior of fixed and variable expenses taking as an example a part of a flexible budget
In the following table, the behavior of fixed and variable costs will be observed with an example.
As an illustration, below is an example of the behavior of fixed and variable expenses, taking as an example a part of a flexible budget.
| FLEXIBLE PRODUCTION ESTIMATE
AS OF DECEMBER 31, 2001 RD $ |
|||||||
| Unit Production | 7,000 | 8,000 | 9,000 | 10,000 | |||
| Raw material cost | 35,000 | 40,000 | 45,000 | 50,000 | |||
| Workforce | 49,000 | 56,000 | 63,000 | 70,000 | |||
| Fixed General Expenses: | |||||||
| Depreciation and maintenance | 22,000 | 22,000 | 22,000 | 22,000 | |||
| Insurance | 2,000 | 2,000 | 2,000 | 2,000 | |||
| Surveillance | 5,000 | 5,000 | 5,000 | 5,000 | |||
| Taxes | 4,000 | 4,000 | 4,000 | 4,000 | |||
| Rent | 5,000 | 5,000 | 5,000 | 5,000 | |||
| Total Fixed Expenses | 38,000 | 38,000 | 38,000 | 38,000 | |||
| Variable Expense: | |||||||
| Depreciation of machinery | 7,000 | 8,000 | 9,000 | 10,000 | |||
| Heating, lighting and energy | 10,500 | 12,000 | 13,500 | 15,000 | |||
| Indirect labor | 3,500 | 4,000 | 4,500 | 5,000 | |||
| Indirect Materials | 1,400 | 1,600 | 1,800 | 2,000 | |||
| Total Variable Costs | 22,400 | 25,600 | 28,800 | 32,000 | |||
| Total Cost of Budget | 144,400 | 159,600 | 174,800 | 190,000 | |||
| Total unit costs | 20.63 | 19.95 | 19.42 | 19.00 | |||
| Variable unit cost | 15.20 | 15.20 | 15.20 | 15.20 | |||
| Fixed unit cost | 5.43 | 4.75 | 4.22 | 3.80 | |||
| 1,000
miles per month |
2,000
miles per month |
|
| Total cost | 1,200.00 | 1,650.00 |
| less variable expenses | 450.00 | 900.00 |
| Fixed expenses Seg. And Imp. | 750.00 | 750.00 |
In the previous table, it will be noted that both variable and fixed costs have an inverse relationship when studied unitarily.
The flexible budget applied to a problem of daily life
To illustrate the concept of Flexible Budgeting applied on a personal level, let's consider an everyday example, suppose you drive your vehicle within a range of 1,000 to 2,000 miles per month. The vehicle operating cost, including typical fixed expenses such as insurance and taxes and typical variable expenses such as fuels and lubricants, is $ 1,200.00 per month when it reaches 1,000 miles and $ 1,650.00 when it reaches 2,000 miles, in this case there will be a variable cost per mile of 0.45. If the variable cost per mile is 0.45 then the fixed expenses will be $ 750.00 determined as follows:
Based on the above data, the flexible personal budget for the operation of the vehicle will be established as follows:
If, for example, the total costs reach $ 1,530.00 per month having used their vehicles 1,600 miles in that month, a prompt review of the budget will notify you that it is exceeding $ 60.00 (1,530.00 - 1,470.00). more miles per month, unit costs decrease, that is, it has an inverse behavior due to the effect of fixed costs.
| Flexible Budget
Cost per Mile Program Monthly Vehicle for Operation |
||||||||
|
Miles managed |
1,000 |
1,200 |
1,400 |
1,600 |
1,800 |
2,000 |
||
| Fixed costs | 750.00 | 750.00 | 750.00 | 750.00 | 750.00 | 750.00 | ||
| 450.00 | 540.00 | 630.00 | 720.00 | 810.00 | 900.00 | |||
| Total cost | 1,200.00 | 1,290.00 | 1,380.00 | 1,470.00 | 1,560.00 | 1,650.00 | ||
| Fixed Costs per Mile | 0.75 | 0.625 | 0.536 | 0.468 | 0.416 | 0.375 | ||
| Variable Cost per Mile | 0.45 | 0.45 | 0.45 | 0.45 | ||||
| Unit Cost per Mile | 1.20 | 1,075 | 0.918 | 0.866 | 0.825 |
| Flexible Budget | |||
| for monthly vehicle operation | |||
| Expenses | Expenses | cost | |
| Miles | Fixed | Variables | Total |
| 750.00 | 450.00 | 1,200.00 | |
| 1,200 | 750.00 | 540.00 | 1,290.00 |
| 1,400 | 750.00 | 630.00 | 1,380.00 |
| 1,600 | 750.00 | 720.00 | 1,470.00 |
| 1,800 | 750.00 | 810.00 | 1,560.00 |
| 750.00 | 900.00 | 1,650.00 |
On the other hand, although it has always been said that fixed costs remain constant or that they have a linear or continuous behavior as studied. It should be noted that these do not always behave in this way, that is, fixed costs can behave linearly and non-linearly, since they only remain unchanged within a certain range of activity, and then change and remain unchanged within of a next rank, changing later and so on, in other words the fixed costs have staggered or discontinuous functions. That is why it is stated that in the long term all costs are variable (including fixed costs).
In discontinuous functions, it is necessary to determine the fixed cost necessary to be able to work within a certain range, which in turn is necessary to determine the cost or rate for each cost generator. For example, if a company needs an installed capacity to manufacture 1,000 pieces per month, each worker can manufacture 100 pieces per month with a salary of RD $ 2,500.00 per month, with the clarification that for every 100 pieces or fraction an additional worker is needed. In this case, the fixed cost for the factory at that production capacity is $ 2,500.00 x 10.00 = $ 25,000.00, which is determined as follows:
$ 25,000.00 / 1,000 = $ 25.00 for each piece
If it is assumed that only 800 pieces were manufactured in the month, in this case the cost of the resources used is determined as follows: 800 x $ 25.00 = $ 20,000.00. The difference of 200 piece x $ 25.00 = $ 5,000.00 is the cost of idle capacity or unused capacity.
In the event that 725 pieces were manufactured, what would be the fixed cost? In this case it would also be the same 8 x 2,500.00.00 = $ 20,000.00 and 801 pieces were manufactured? The fixed cost would be 9 x $ 2,500.00 = $ 22,500.00.
From the previous example it can be affirmed that the fixed costs remain fixed only within certain ranges. That is: Within the manufacturing range of 701 to 800 pieces the cost is the same as if 725 pieces were manufactured, then it changes to the range of 801 to 900 pieces and so on.
2. Semi-variable or semi-fixed costs
Regarding Semivariable costs, there are several methods to segment them, that is, to determine which is the fixed part and which is the variable part of a cost or expense. This is important because generally in the decision-making process it is essential to have clearly established the amount of fixed and variable costs. The most important segmentation methods are:
- Direct estimation method The point-high method - Low point Method through the Scatterplot The statistical method of least squares or regression analysis.
Of these methods only the last three will be analyzed because they are the ones that have the most frequent practical application:
The high point - low point method, which consists of subtracting the low cost from the high cost and the low volume from the high volume and dividing the cost difference by the volume difference, thus determining the variable rate and finally determining the cost fixed, subtracting from the total cost of any level the variable cost part. Example:
|
Total costs |
Exercise
(You Hours etc.) |
| $ 1,200,000.00 | 100,000 |
| 1,300,000.00 | 150,000 |
| 1,400,000.00 | 200,000 |
| 1,500,000.00 | 250,000 |
| 1,600,000.00 | 300,000 |
| Difference | Difference |
| $ 1,600,000.00 | 300,000 |
| 1,200,000.00 | 100,000 |
| 400,000.00 | 200,000 |
The serious variable rate in this case would be equal = $ 400,000.00 / 200,000 = $ 2.00 per machine hour.
When the total cost is = $ 1,600,000.00, then the variable cost at the volume of 300,000 hours of activity is 300,000 x 2.00 = $ 600,000.00 and the equal fixed cost RD $ 1,000.00. determined as follows:
CT = CF + CV where CF = CT - CV where CF = $ 1,600,000.00 - 600,000.00 = $ 1,000,000.00
As you can see the Fixed Costs will not be altered within a certain range, in this case within the range of 10,000 to 300,000 hours the fixed cost is the same. Here the two approaches made above are confirmed a) that costs remain fixed only in a certain range of action. b) the existence of semi-fixed or semi-variable costs.
- Scatter Diagram Method:
This method is very useful because it covers elements not taken into account by the high point - low point method, because sometimes the points chosen by that method are not necessarily representative of the cost function that I am analyzing.
To determine the fixed and variable part of a total cost, the first step is to graphically indicate the cost that is being analyzed at each of the activity levels, as follows:
The possibility of viewing the diagram allows selecting the points that represent the relationship between the cost and the activity that gives rise to or triggers the consumption of said input using the information previously provided, it will be assumed that the administrators selected what happened between January and June, because They are the most representative points according to the experience of previous years, that is why the line must go through points 1 and 6, according to which the fixed and variable cost is calculated as follows:
The cost and hours for January are: $ 40,000.00 10,000
The cost and hours for June are: $ 90,000.00 30,000
Where the variable cost per hour will be:
Cost 2 - Cost 1 and 2 - and 1 $ 90,000 - $ 40,000
Variable cost = --------- = -----, -------–
Volume 2 - volume 1 X 2 - X 1 30,000 - 10,000
50,000
Variable cost = ------ = $ 2.50
20,000.00
Therefore if the hourly variable cost is $ 2.50, the fixed cost portion of the total January cost would be determined as follows:
Total cost = fixed cost + unit variable cost (x)
$ 40,000.00 = Y 1 + $ 2.50 (10,000.00) = $ 40,000 = Y 1 + $ 25,000.00
Y 1 = 40,000.00 - 25,000.00 = $ 15,000.00, and 1 = $ 15,000.00.
From where $ 15,000.00 is the fixed cost for the month of January. The same can be done for the month of June:
90,000.00 = Y 2 + $ 2.50 (30,000.00) = $ 90,000 = Y 1 + $ 75,000.00
Y 1 = 90,000.00 - 75,000.00 = $ 15,000.00, and 1 = $ 15,000.00
Therefore, within a range of 10,000 to 47,500 hours, the unit variable cost is 2.50 and the fixed cost is $ 15,000.00
- Statistical method; (Regression Analysis)
For our example, consider the following historical data (12 observations), where the fixed and variable part of an item that belongs to an indirect manufacturing cost, such as maintenance cost, will be determined.
Y = 8,233, n = 12
X = 2,550
Before it is necessary to define some symbols that the statistical method uses:
n = the number of observations
Y = arithmetic mean of Y
X = arithmetic mean of X
The arithmetic mean is obtained by dividing the sum (Σ) of either x σ and y by the number of observations.
Within the statistical method, the best-known technique is regression analysis, also known as the least squares method or correlation analysis.This is a statistical tool used to measure the relationship between a dependent variable and one or more independent variables. tell the affinity that both variables exist.
When the relationship is between a dependent variable and an independent variable, it is called a simple regression. If the relationship is between one dependent variable and several independent variables, it is called a multiple regression.
The least squares method works with the equation of the straight line. That is, Y = a + b (x), From where:
Y = is the dependent variable
a = is a constant, which intercepts with the ordinate axis, when x is equal to o
b = is a constant, is the slope of the line, is the variable element of the activity.
x = is the independent variable.
The procedure consists of determining the values of a and b by the following method (there are several):
Σ (y) = na + b Σ (x)
Σ (xy) = a Σ (x) + b Σ (x²)
I substitute the box values in the equations
98,800 = 12 a + 30,600 b
260,571,250 = 30,600a + 82,585,000b
To solve the equation system I multiply by 2,550 in the first equation and by - 1 in the second equation and I obtain:
(2,550) 98,800 = 12 a + 30,600 b
(-1) 260,571,250 = 30,600a + 82,585,000b
251.94 0.000 = 30,600 a + 78,030,000b
-260,571,250 = -30,600 a - 82,585,000b
- 8,631,250 = 0 - 4,555,000b
Solving for b yields b = 8,631,250 / 4,555,000 = 1.8948957 where b = 1.894895719
Substituting ab in any of the original equations, we obtain the constant "a"
98,800 = 12a + 30,600 (1,895); 98,800 = 12a + 57,987, solving for a = 98,800 -57,987 = 12 a, from where a = 40,813.00 / 12 = 3,401.08
Substituting the values of a and b, they are substituted in the original equation of the straight line, that is, Y = a + b (x), (Y = 3,401.08 + 1,895 (x), which means that the fixed costs are equal to 3,401.08 and the variables to 1.8948957. and if for example we consider ax = 2,700 hours, we obtain that CT = 3,401.08 + 1,895 (2,700) = 8,517.58
And c = 3,401.08 + 1,895 (2,700) = 8,517.58, of which the fixed costs are 3,401.08 and the variable costs 5,116.50. Once this operation is done, it is known what the total costs to be disbursed would be for any volume of activity that the company proposed.
- Relevant and irrelevant costs
Relevant costs are those that are modified or changed according to the option adopted, they are also known as differential costs. Example when there is a demand for a special order and there is idle capacity, in this case the only costs that change if the order is accepted, are those of raw material, energy, freight, etc. The depreciation of the building remains unchanged so the former are relevant and the latter irrelevant for decision-making purposes. In other words, the relevant costs are expected future costs that change depending on the selected alternative, that is, they can be discarded if any economic activity changes or is eliminated. The concept of relevance is not a particular attribute of cost,the same cost may be relevant in one circumstance and irrelevant in another. The specific facts of a given situation will determine which costs are relevant which are irrelevant.
Example suppose a company that owns an equipment originally purchased for $ 500,000.00 which is totally depreciated. The company has two options to exit that asset.
- a) Sell them with a scrap value of $ 60,000.00 b) Make investments of $ 10,000.00 to upgrade and put it to work and sell them for $ 75,000.00
In this case, what would be the relevant cost and what would be the relevant income? 10,000.00 will be the relevant cost and it relevant income? $ 75,000.00, in this case the Company would be in better condition with $ 65,000.00 ($ 75,000.00 of relevant income less $ 10,000.00 of relevant costs)
Irrelevant costs are those that remain immutable regardless of the chosen course of action, that is, those that are not affected by the actions of management, are also known as sunk costs, submerged costs or past costs that are irrevocable as the case of the depreciation of a team. In the previous example, the sunk costs are $ 500,000.00, therefore they should not be taken into account for decision-making purposes.
In general, both the relevant income and costs are taken into account when making a decision in the selection of two or more alternatives if they have the following attributes:
- a) The cost or Income must be that which will be incurred or earned respectively in the future b) The cost or Income must be that which will differ when the alternatives are compared.
According to the change caused by an increase in an activity:
Differential costs:
Differential Costs: The relevant costs are also known as differential costs and represent the increases or decreases of the total cost or the change experienced in any element of the cost generated by an increase in the activities or operations of the company. These costs are important in the decision-making process, because they are the ones that show the changes or movements suffered in the company's profits, for example when faced with a commitment to a special order, a change in the composition of a product line, a change in inventory levels. Etc.
When analyzing a decision, the key is the differential effects of each option on the Company's earnings. The differential costs can be: Incremental or Decremental.
- A) Incremental Costs: These are those incurred when the variations in costs are caused by an increase in the activities or operations of the company. I also know how the costs increase when going from one alternative to another. A typical example of incremental costs is the costs incurred by introducing a new product line or a new service to existing ones. The differential and variable costs are often the same.
It is necessary to take into account that in the case of an additional activity that implies that the company works beyond the relevant range (more production or services), the variable costs will increase but also the total fixed costs will suffer a certain increase for the already known cause. In this case, the differential of fixed costs must be included in the analysis of decision-making together with the differential of variable costs.
- b) Decremental Costs: When differential costs are generated by decreases or reductions in the volume of operations or activities experienced by a company, they are called Decremental Costs. For example, by removing a product line. Decrease costs are also the costs experienced when passing from one alternative to another
In the example above the differential cost is $ 10,000.00 and the Incremental cost is also $ 10,000.00, while the differential income is $ 15,000.00 and the Incremental income is also $ 15,000.00.
Submerged Costs: are those that regardless of the chosen course of action are not altered, that is, they remain unchanged before any change. This concept is closely related to past or historical costs which are not taken into account in decision making. An example of this is the depreciation of machinery or any fixed cost committed. If it is a matter of evaluating the alternative of selling a certain volume of items with idle capacity at a lower price than normal, it is irrelevant to take such depreciation. As you can see, the submerged, historical and committed costs have a certain relationship.
According to the type of sacrifice that has been incurred:
Disbursable costs: Are those that involve an outflow of cash, therefore they are recorded in the accounting. These costs later become historical and may or may not be relevant in decision making and are the costs that the accounting records.
- Opportunity cost
It is the cost that arises when making a determination that causes the resignation of another type of alternative that could be considered when carrying out the decision, this is so because when a decision is made to engage in a certain alternative, the benefits of Other options. In this case, the opportunity cost is the lost benefits of ruling out the next best alternative.
A more compressible definition is: An opportunity cost is the benefits sacrificed by having to reject the next best alternative. And the final objective is to establish what is the advantage of one alternative over another.
Because opportunity costs are not costs incurred by the company, they are not included in the accounting records. However, they are relevant costs for decision-making purposes and must be taken into account when evaluating a proposed alternative. Example A company is considering an investment of $ 200,000.00 to acquire new equipment that will increase its productive capacity. Opportunity cost is the profit sacrificed for not investing the $ 200,000.00 in the next best alternative, which is that the company could have invested the $ 200,000 in a real estate company and receive an annual return of $ 30,000.00, so that the cost of opportunity in this case of $ 30,000.00
When considering the costs of the investment alternative in the equipment (best option), the opportunity cost must be taken into account in the analysis, in this way:
| Entry | 250,000.00 | |
| Less: | ||
| Investment Cost | 200,000.00 | |
| Opportunity cost | 30,000.00 | 230,000.00 |
| Incremental or additional results | 20,000.00 |
As you can see when the opportunity cost is included in the information, you can see what is the advantage in terms of RD $ of one alternative over the other.
Example No. 2. A company currently has 50% of the capacity of its idle warehouse and a manufacturer requests to rent said capacity for $ 120,000.00 per year. At the same time, you are presented with the opportunity to participate in a new market, for which you would need to occupy the idle area of the warehouse. For this reason, when carrying out the analysis to determine whether or not to expand, the $ 120,000.00 that he would stop earning for not renting the warehouse should be considered as part of the expansion costs.
| Sale of the expansion | $ 1,300,000.00 | |
| Additional costs of expansion | ||
| Direct raw material | 350,000.00 | |
| Direct labor | 150,000.00 | |
| Variable Manufacturing Ind. Expenses | 300,000.00 | |
| Selling and administrative expenses | 180,000.00 | |
| Opportunity costs | 120,000.00 | 1,100,000.00 |
| Incremental or additional profit | 200,000.00 |
As shown in the previous table, the opportunity cost represents profits derived from options that were rejected in the face of a decision, so they will never appear in the accounting books, however this fact does not exempt the management accountant from considering it in consideration of the carry out an analysis for the purposes of informing management.
Example no. 3: The factory Santo Domingo Oriental SA, Produces several lines of articles that include certain parts, which can be manufactured in the plant or externally. The cost of producing a piece called a Royal Bra is as follows:
| Variable costs | $ 70.00 |
| Committed fixed costs | 20.00 |
| Unit cost | 90.00 |
The number of parts manufactured annually reaches 50,000.00 units. A city workshop offers to manufacture said piece at a cost of $ 80.00 each, without intuiting the freight that would amount to $ 50,000.00 annually. The decision to manufacture externally would produce idle capacity that could be used to produce a certain type of part that could generate savings for the factory in the order of $ 400,000.00 net per year. The normal capacity to produce this line is 50,000 units.
Determine whether or not it is appropriate to continue manufacturing internally or on behalf of a third party.
| Manufacture
Internally |
Manufacture by
Third way |
Cost advantage of one alternative over the other | |
| Variable costs (50,000 x $ 70.00 | $ 3,500,000.00 | ||
| Opportunity cost | 400,000.00 | ||
| Purchase cost | $ 4,000,000.00 | ||
| Freight | 50,000.00 | ||
| Total | $ 3,900,000.00 | 4,050,000.00 | (150,0000.00) |
According to the information from the analysis, it is observed that the best decision is to continue manufacturing, since the cost of manufacturing is $ 3,900,000.00 against $ 4,050,000.0, which is the cost if they produced the parts externally. The cost that was irrelevant in this example is the one referring to the fixed costs of $ 1,000,000.00 (50,000 piece multiplied by $ 20.00), which would not change if the pieces were manufactured internally or externally. The $ 400,000.00 that represents the savings if free capacity is dedicated to other activities, constitute opportunity costs, given the alternative of continuing to manufacture internally.
One of the responsibilities of the management accountant is to produce information necessary for management, in the process of selecting alternatives for the optimal solution of a problem. The function of the report is of utmost importance and aims to collect and summarize all the information accumulated at the different levels of the decision-making process.
There are three generally used reporting templates.
- Using the total cost format, which the relevant and irrelevant costs and income are presented for each alternative, Using the differential cost format, which the relevant costs and income are presented for each option, Using the opportunity cost format, where the relevant costs and income plus opportunity costs are presented for a single course of action.
Each of the three models will provide management (the decision maker) with elements for the same solutions to the problem. However, the management accountant will choose the most appropriate one depending on the type of problem to which a solution is being sought and that transmits information in the most understandable way.
The following example will illustrate the three models cited above:
Companía Muebles Dominicanos SA operates at maximum capacity. During the year 2001 it manufactured a total of 100,000 living room furniture sets. The unit cost per unit is as follows:
| Direct materials | 2,000.00 |
| Direct labour | 1,500.00 |
| Variable Manufacturing Indirect Costs | 2,5.00.00 |
| Fixed Manufacturing Indirect Costs | 3,000.00 |
| Total unit manufacturing cost | 9,000.00 |
During that year there was a significant drop in customer orders to the point that they only sold 50,000 Furniture sets at their regular price of 12,500.00 each and 20,000 at a significantly reduced price of $ 8,000.00 per unit, with little or no probability of sales of the remaining 30,000 over the course of the next year, as it does not want to take it to the inventory of finished furniture items, the Company is studying the following alternative.
- Sell the furniture at a scrap price of $ 2,000.00 per unit and a placement cost of $ 500.00 per unit. Modify the furniture to sell it at $ 4,000.00 a unit and remodeling costs of $ 2,200.00, composed as follows:
| Direct materials | 600.00 |
| Direct labor | 700.00 |
| Indirect manufacturing costs | 900.00 |
| Unit Cost of Remodeling | 2,200.00 |
The first type of report shows the relevant and irrelevant costs and income for each proposal with the following presentation format:
Note that the cost of $ 9,000.00, which is a submerged and irrelevant cost, is not omitted in any of the options or alternatives considered in this model, because in a full cost model, irrelevant costs must appear in the analysis. If a full cost model is used and an irrelevant cost is omitted due to ignorance or neglect of one or more alternatives, it is very likely that management will make an incorrect decision, therefore the managerial accountant must be very careful when using this model.
| DIFFERENTIAL COST FORMAT | |||||||||
| DISPOSAL ALTERNATIVE | REMODELING ALTERNATIVE | ||||||||
|
Sales price |
2,000.00 | Sales Price | 4,000.00 | ||||||
| Lower placement costs | 500.00 | Less: | |||||||
| Utility | 1,500.00 | Direct materials | 600.00 | ||||||
| Direct Labor | 700.00 | ||||||||
| Ind. Costs of Fab. Variables | 900.00 | 2,200.00 | |||||||
| Utility | 1,800.00 | ||||||||
Note that in the differential cost format, the submerged cost of $ 9,000.00 does not appear in the analysis of either of the two alternatives, to some extent this model is superior to the total cost format. On the full cost format, there was a loss of $ 7,500.00 associated with the discard alternative and a loss of $ 7,200.00 associated with the remodel alternative. If management does not fully understand that the $ 9,000.00 of submerged costs shown in both analyzes represents an irrelevant cost, it may reject both options. Such a decision would not be in the best interests of the Companía Muebles Dominicanos SA, if both alternatives to dispose and remodel are rejected, the Company would lose 270,000,000.00 ($ 9,000.00 x 30,000.00) units. By accepting the discard alternative,As indicated in the differential cost model, the company can amortize its losses by $ 4,500,000.00 (1,500.00 x 30,000 units). Or if the alternative of remodeling as shown in the differential cost model is accepted, the company can also amortize its losses in $ 5,400,000.00 ($ 1,800.00 x 30,000 units), therefore a differential cost format is recommended.
| OPPORTUNITY COST FORMAT | ||
| DISPOSAL ALTERNATIVE | ||
| Sales Price | 2,000.00 | |
| Placement Cost | 500.00 | |
| Opportunity cost * | 1,800.00 | 2,300.00 |
| Disadvantages of scrapping | -300 | |
| * Calculation of the opportunity cost of the remodeling alternative: | ||
| Relevant income | 4,000.00 | |
| Less relevant costs | 2,200.00 | |
| Relevant income | 1,800.0 0 |
Of the three models, the opportunity cost format is the most efficient (especially when several alternatives are available) because the opportunity cost of a project is a function of the Increased income sacrificed on other projects. This model assumes that management has some degree of knowledge in managerial accounting, so that it fully understands the analogous concepts of relevance versus irrelevance and sacrificed income (i.e. opportunity costs).
Analysis of the discard alternative produced a disadvantage of $ 300.00. If the alternative of remodeling had been chosen, the result would have been the following:
| OPPORTUNITY COST FORMAT | ||
| REMODELING ALTERNATIVE | ||
| Sales Price | 4,000.00 | |
| Less: Direct materials | 600.00 | |
| Direct labour | 700.00 | |
| Indirect Costs of Variable Manufacturing | 900.00 | |
| Opportunity cost* | 1,500.00 | 3,700.00 |
| Advantages of remodeling | 300 | |
| * Calculation of the opportunity cost of the remodeling alternative: | ||
| Relevant income | 2,000.00 | |
| Less relevant costs | 500.00 | |
| Relevant income | 1,500.00 |
- The flexible budget applied to a problem of daily life
To illustrate the concept of Flexible Budgeting applied on a personal level, let's consider an everyday example, suppose you drive your vehicle within a range of 1,000 to 2,000 miles per month. The vehicle operating cost, including typical fixed expenses such as insurance and taxes and typical variable expenses such as fuels and lubricants, is $ 1,200.00 per month when it reaches 1,000 miles and 1,650 when it reaches 2,000 miles, in this case there will be a variable cost per mile of 0.45. If the variable cost per mile is 0.45 then the fixed expenses will be $ 750.00 determined as follows:
Based on the above data, the flexible personal budget for the operation of the vehicle will be established as follows:
| Flexible Budget | |||
| for monthly vehicle operation | |||
| Expenses | Expenses | cost | |
| Miles | Fixed | Variables | Total |
| 750.00 | 450.00 | 1,200.00 | |
| 1,200 | 750.00 | 540.00 | 1,290.00 |
| 1,400 | 750.00 | 630.00 | 1,380.00 |
| 1,600 | 750.00 | 720.00 | 1,470.00 |
| 1,800 | 750.00 | 810.00 | 1,560.00 |
| 750.00 | 900.00 | 1,650.00 |
If, for example, the total costs reach $ 1,530.00 a month, having used 1,600 miles of vehicles in that month, a prompt review of the budget will warn you that it is exceeding $ 60.00 (1,530.00 - 1,470.00). more miles per month, unit costs decrease, that is, it has an inverse behavior due to the effect of fixed costs.
| Flexible Budget | ||||||||
| Cost per Mile Program | ||||||||
| for Monthly Vehicle Operation | ||||||||
| Miles managed | 1,000 | 1,200 | 1,400 | 1,600 | 1,800 | 2,000 | ||
| Fixed costs | 750.00 | 750.00 | 750.00 | 750.00 | 750.00 | 750.00 | ||
| 450.00 | 540.00 | 630.00 | 720.00 | 810.00 | 900.00 | |||
| Total cost | 1,200.00 | 1,290.00 | 1,380.00 | 1,490.00 | 1,560.00 | 1,650.00 | ||
| Fixed Costs per Mile | 0.75 | 0.625 | 0.536 | 0.468 | 0.416 | 0.375 | ||
| Variable Cost per Mile | 0.45 | 0.45 | 0.45 | 0.45 | ||||
| Unit Cost per Mile | 1.20 | 1,075 | 0.918 | 0.866 | 0.825 |
C ONCEPTS. COST BEHAVIOR CLASSIFICATIONS
Contributed by: Esteban Rojas - [email protected]
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