Description
Chapter 20 – Master Budgets
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Chapter 20-23
• Static (Fixed) Budget – the purpose of a budget is to coordinate the activities of all departments to meet the company’s overall goal; this chapter is about fixed budgets, which means they’re based on a single prediction of sales or production volume
• Types of Budgets/Parts of a Master Budget:
o Operating Budgets – include…
▪ Sales budgets –
• Based on expected sales volume and expected dollars from these sales (budgeted sales in units x
SALES BUDGET
BUDGETED SALES
We also discuss several other topics like kevin, marketing manager of the north american bowling league, has decided to televise major bowling competitions to viewers in multiple countries rather than only in canada and the u.s. which of the following goals would this most likely help kevin accom
(IN UNITS)
SELLING PRICE PER UNIT Don't forget about the age old question of rhonda brownbill
• This is the first step in preparing the master budget, because plans from most departments are dependent on this budget
▪ Production and manufacturing cost budgets – • Applies only to manufacturing companies
• Shows the number of units to be produced in a period and is based on the unit sales projected in the sales budget, along with inventory consideration
o Safety stock – a quantity of inventory that
provides protection against lost sales caused by unfulfilled demands from customers or delays in shipments from suppliers
• These budgets NEVER show costs, only units of product
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• Production cost budget formula:
Budgeted Ending
Inventory (units of Safety If you want to learn more check out comm 223
stock)
Budgeted
Sales Units for the period (from the
sales budget)
Required units
needed for the period
Number of units in beginning inventory
Don't forget about the age old question of hhs 231
Total units to be produced in the period
▪ Merchandise Purchase Budgets –
• Applies only to merchandising companies
• Expressed in both dollars and units of production o If the formula is expressed in units (and if only one product is involved) we can compute the number of dollars of inventory by multiplying the units to be purchased by the cost per unit
• Merchandise purchase budget formula:
BUDGETED ENDING MERCHANDISE
INVENTORY
(next month’s budgeted sales (units) x Ratio to Inventory to Future Sales
BUDGETED SALES FOR THE PERIOD
BUDGETED BEGINNING MERCHANDISE INVENTORY
Don't forget about the age old question of unr anthropology
MERCHANDISE INVENTORY TO BE
PURCHASED
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• Example of a Purchase Budget for a Merchandiser:
COMPANY
PURCHASES BUDGET
Next Month’s Budgeted Sales (in units)
(given)
x Ratio of Inventory to Future Sales
(given)
= Budgeted Ending Inventory (in units)
(Next Month’s Budgeted Sales x Ratio)
+ Budgeted Sales
(given)
= Required Units of Available Merch
(Budgeted Ending Inventory + Budgeted Sales)
- Beginning Inventory (in units)
(given)
= Units to be Purchased
(Required Units of Available Merch – Beginning Inventory)
▪ Selling expense budgets –
• An estimate of the types and amounts of selling
expenses expected during the budget period
• Based on the sales budget, plus a fixed amount of sales
manager salaries
• Line items on this budget include advertising, delivery
expenses, and marketing expenses
BUDGETED SALES
SALES
COMMISSION PERCENT
SALES
COMMISSIONS
FIXED SALES MANAGER SALARY
TOTAL SELLING EXPENSES
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▪ General and administrative expense budgets –
• Predict the operating expenses not included in the selling expense budget Don't forget about the age old question of in which region did european values and structures penetrate least during colonialism?
• Line items on this budget include insurance, taxes, and depreciation on nonmanufacturing assets
o Capital Expenditures Budgets – shows the dollar amounts estimated to be spent to purchase additional plant assets the company will use to carry out its budgeted business activities, as well as any amounts expected to be received from plant asset disposals, as companies replace old assets with new ones
▪ Important for a company because the content involves large monetary commitments, affects predicted cash flows, and impacts future debt and equity financing
o Financial Budgets – include…
▪ Cash Budgets –
• This is prepared after developing budgets for sales, manufacturing costs, expenses, and capital
expenditures
• Shows the expected cash inflows (receipts – added) and outflows (disbursements – deducted) during the budget period
• Helps the company maintain a cash balance necessary to meet ongoing obligations
o If a cash balance is too high, that is undesirable
because it earns a relatively low (if any) return
• Cash Budget formula:
REPAY LOANS,
BUY SECURITIES
BEGINNING
CASH
BALANCE
BUDGETED CASH
RECEIPTS
BUDGETED CASH
DISBURSE MENTS
PRELIMINARY CASH
BALANCE
(with adequate cash balance)
INCREASE SHORT TERM LOANS
(with low cash
balance)
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• Preparing a Cash Budget:
MONTH
Beginning Cash Balance
(end of last month’s cash balance)
+ Cash receipts from customers
(budgeted sales for current month x % of sales in cash) + (ending A/R from prior month if applicable x % of sales on credit)
= Total Cash Available
(Beg. Cash Bal. + Cash Receipts)
- Purchases of Merchandise
(prior month purchases x % paid from prior month purchases) + (current month purchases x % paid to current month purchases)
- Sales Commissions
(commission % x current month sales)
- Salaries Expense
(given)
- General & Admin (other) Expenses
(given)
- Interest on Bank Loan
(loan interest % (given) x loan payable (given))
= Total Cash Disbursement
(Purchases of Merch + Sales Commissions + Salaries Expense + other expenses + Interest on Bank Loan)
= Preliminary Cash Balance
(Total Cash Avail. – Total Cash Disburs.)
+ Additional Loan from Bank
(Minimum year-end Cash Balance (given) – Preliminary Cash Balance))
= Ending Cash Balance
(Preliminary Cash Bal. + Additional Loan)
= Loan Balance at end of month
(Loan payable (given) + additional loan from bank (OR) – repayment of loan to bank)
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▪ Budgeted Income Statements –
• A managerial accounting report showing predicted
amounts of sales and expenses for the budget period
• Summarizes the income effects of the budgeted
activities
• Comes after the Cash Budgets in the Master Budget
▪ Budgeted Balance Sheets –
• Shows predicted amounts for the company’s assets,
liabilities, and equity at the end of the budgeted period
• Benefits of Budgeting
o Focuses on the future opportunities and threats to the organization, making planning an explicit management
responsibility
o Acts as a monitoring/control system, since management is required to compare the benchmark operations to the company, economy, and industrial norms
o Ensures that every department of a company is contributing to the company’s overall goals
o Effectively communicates specific action plans to all employees o An be used to motivate employees, because it shows attainable goals; incentives are offered by some companies
• Effects of Budgeting on Human Behavior
o A budget must seem realistic or else employees will be discouraged, which will lead to a negative impact on performance o Also, pressure to meet budgets can lead employees to engage in unethical behavior or commit fraud
o However, a well-applied budget can be a positive motivating force on an organization’s employees
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• Timing of Budgets –
o Most companies at least have an annual budget, but many have monthly/quarterly budgets that allow them to periodically
evaluate performance and take corrective action
o Continuous Budgeting –
▪ Used by most companies
▪ Means that, when a budget period has lapsed, these
companies revise their entire set of budgets for the
months remaining, as well as add new monthly/quarterly budgets accordingly, (aka, a rolling budget)
CHAPTER 20 – PRACTICE QUESTION!
Dexter Morgan sells knives. His private business must maintain $50,000 cash at year end, so he has a revolving loan agreement with Miami Metro Bank to borrow cash when the preliminary cash balance a the end of the month falls below $50,000, and to repay the loan when the balance exceeds $50,000 to the extent of either (a) the loan balance, or (b) the amount of excess cash, whichever is smaller. Cash interest is due to the bank at 1% of the beginning of the month loan balance, if any. The following information relates to Dexter’s business in the month of May:
o Sales are 30% cash and 70%credit. Credit sales are collected the month following the sale. April sales were $80,000 and May sales are budgeted at $125,000.
o Knife inventory is purchased on credit, and credit purchases are paid 85% in the month of purchase and 15% the month following the purchase. April purchases were $50,000 and budgeted May purchases are $85,000. o Cash at April 30 was $50,000.
o Loan Payable at April 30 was $135,000.
o Salaries Expense of $18,000 will be paid in May.
o Sales Commissions of 6% of sales will be paid in May.
o Other cash expenses in the amount of $1,800 will be paid in May. Prepare the cash budget for Dexter Morgan as of May 31.
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DEXTER MORGAN
CASH BUDGET
May
Beginning Cash Balance
$50,000
Cash receipts from customers 30% x 125,000 = 37,500
70% x 80,000 = 56,000
= 93,500
93,500
Total Cash Available
143,500
Purchases of Merchandise 85% x 85,000 = 72,250 15% x 50,000 = 7,500 = 79,750
79,750
Sales Commissions
6% x 125,000 = 7,500
7,500
Salaries Expense
18,000
General & Admin (other) Expenses
1,800
Interest on Bank Loan
1% x 135,000 = 1,350
1,350
Total Cash Disbursement
108,400
Preliminary Cash Balance
35,100
Additional Loan from Bank
50,000 – 35,100 = 14,900
14,900
Ending Cash Balance
50,000
Loan Balance at end of month 135,000 + 14,900 = 149,900
149,900
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Chapter 21 – Flexible Budgets/Standard Costs • Standard Costs – preset costs for delivering a product or service under normal conditions; helps managers assess the reasonableness of actual costs incurred for producing the product or providing the service, when
the standard/anticipated costs are compared to the actual costs incurred
• Fixed vs. Flexible Budgets –
o Fixed (static) Budget – based on a single predicted amount of sales or other activity measure
▪ Fixed Budget Performance Report – compares actual results with the results with the results expected under a fixed
budget, to show the variances
o Flexible (variable) Budget – based on several different amounts of sales; more useful than a fixed budget when actual sales activity is different than what was predicted
▪ Flexible Budget Performance Report – compares actual performance and budgeted performance based on actual
sales volume (or other activity level), to show the variances
• Performance Reports – make it easy for managers to see the variances between budgeted amounts and actual amounts
o The effects of these variances are measured with an F or a U ▪ F – Favorable Variance – when compared to a budget, the actual cost or revenue contributes to a higher income; i.e.
actual revenue is higher than standard revenue; i.e. actual cost is lower than standard cost
▪ U – Unfavorable Variance – when compared to a budget, the actual cost or revenue contributes to a lower income; i.e. actual revenue is lower than standard revenue; i.e. actual cost is higher than standard cost
• Direct Materials (price/quantity) Variance –
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o Purchasing managers are in charge of explaining price variances, especially if a price higher than the standard caused the unfavorable variance.
▪ Cheaper prices – though favorable – may indicate a decline in product quality.
o Production managers are responsible for explaining why production processes used more than the standard amount of materials, which would result in an unfavorable variance.
▪ Cheaper than standard materials – though favorable – may not meet the specifications of production, which can lead to excessive waste.
AQ x AP
(actual quantity x actual price)
AQ x SP
(actual quantity x standard price)
SQ x SP
(standard quantity x standard price)
PRICE VARIANCE (AQ x AP) – (AQ x SP)
QUANTITY VARIANCE (AQ x SP) – (SQ x SP)
TOTAL DIRECT MATERIALS VARIANCE
U or F?
• Direct Labor (rate/efficiency) Variance –
o Production managers or personnel administrators are in charge of explaining why wage rate is higher than expected
(unfavorable).
▪ Lower wage rates – though favorable – can mean that workers/employees are less skilled and are producing poorer quality products.
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▪ Higher than standard wage rates – though unfavorable – can indicate that there are more skilled workers working the production line.
o Production managers should also be able to explain an unfavorable number of labor hours that’s higher than the standard.
▪ Using more than the standard labor hours (unfavorable) can indicate that your employees are less-skilled or are not working together efficiently.
▪ Using less than the standard labor hours (favorable) can indicate that highly-skilled employees are working the production line, or workers are becoming careless.
AH x AR
(actual hours x actual rate)
AH x SR
(actual hours x standard rate)
SH x SR
(standard hours x standard rate)
RATE VARIANCE (AH x AR) – (AH x SR)
EFFICIENCY VARIANCE
(AH x SR) – (SH x SR)
TOTAL DIRECT LABOR VARIANCE U or F?
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• Factory Overhead Variances –
o Overhead Controllable Variance –
OVERHEAD
CONTROLLABLE VARIANCE
ACTUAL TOTAL OVERHEAD
INCURRED
BUDGETED TOTAL
OVERHEAD
▪ Types of Overhead Controllable Variances –
• Spending Variance – occurs when management pays an amount different from the standard price to acquire an item; i.e. Supervisor Salaries were higher or lower than expected.
• Efficiency Variance – occurs when standard direct labor hours (the allocation base) expected for
production differ from the actual direct labor hours
used
o Overhead Volume Variance –
OVERHEAD VOLUME VARIANCE
BUDGETED FIXED
OVERHEAD
APPLIED FIXED
OVERHEAD
▪ An unfavorable OH Volume Variance (meaning that the company didn’t reach its predicted operating level), can indicate that customer demand was low, which is not a company employee’s fault.
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• Management By Exception – means that managers focus their attention on the most significant differences between actual costs and standard costs and give less attention to areas where production is reasonably close to the standard; it’s especially useful when directed at controllable items, enabling top management to affect the actions of lower-level managers responsible for the company’s revenues and costs.
CHAPTER 21 – PRACTICE QUESTION!
The following information is available for Merritt’s Winery:
MERRITT’S WINERY
STANDARD COST CARD
PRODUCTION Direct Materials Direct Labor Overhead
COST FACTOR
0.5 gal @ $15 per gal 1 hr @ $18 per hr 1.5 hrs @ $9 per hr
TOTAL $7.50 $18.00 $13.50 $39.00
Direct materials used for production 9,000 gallons
Actual cost per gallon of direct material $14.50 per gallon
Direct labor used for production 18,000 hours
Actual cost per hour of direct labor $18.50 per hour
Units produced 18,400 bottles
A) Compute the direct materials price variance, quantity variance, and total variance, indicating whether each variance is favorable or unfavorable.
AQ x AP
= 9,000 x $14.50 = $130,500
AQ x SP
= 9,000 x $15 = $135,000
SQ x SP
= 9,200 x $15 = $138,000
PRICE VARIANCE = 130,500 – 135,000 = 4,500
FAVORABLE
QUANTITY VARIANCE = 135,000 – 138,000 = 3,000
FAVORABLE
TOTAL VARIANCE $7,500
FAVORABLE
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B) Compute the direct labor rate variance, efficiency variance, and total variance, indicating whether each variance is favorable or unfavorable.
AH x AR
= 18,000 x $18.50 = 333,000
AH x SR
= 18,000 x $18 = 324,000
SH x SR
= 18,400 x $18 = 331,200
RATE VARIANCE = 9,000
UNFAVORABLE
EFFICIENCY VARIANCE
= 7,200
FAVORABLE
TOTAL VARIANCE
1,800
UNFAVORABLE
Chapter 22 – Performance Measurement • Decentralization – when a company’s decisions are made by managers throughout the organization, instead of by a few top executives; these top executives, however, need a system to evaluate the managers’ performances
o Financial information used to evaluate a department depends on whether it is evaluated as a cost center, profit center, or
investment center
▪ Cost center – incurs costs without directly generating revenue; i.e. manufacturing department, accounting
department, advertising department, purchasing
department
▪ Profit center – generates revenues and incurs costs; i.e. production lines (Kraft’s Capri Sun and Kool-Aid) and selling departments
▪ Investment center – generates revenues and incurs costs (like profit centers), except their managers are responsible for the investments made in operating assets; i.e. manager
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of Kraft’s beverage division has the authority to make
decisions such as build a new manufacturing plant
• Responsibility Accounting System – ensures that costs are controlled and managers are being evaluated, by assigning costs to the managers responsible for controlling them; some costs, however, are out of the managers’ hands, so we do not evaluate them on those costs ▪ Uncontrollable Costs – costs that managers have no
influence on; i.e. depreciation expenses, because the
manager has no control of the amount of equipment
assigned to their department
▪ Controllable Costs – costs that managers have the power to determine – or at least significantly affect – the amount
incurred; i.e. the costs of supplies, because some managers are in charge of ordering
o Responsibility accounting budgets - based on the flexible budget approach, which is based on several different amounts/types of sales
o Direct Expenses – can be traced back to a specific department and are incurred for the sole benefit of that department; i.e. the salary of a supervisor in one department is a direct expense of that one department
▪ Doesn’t require and allocation across departments
▪ Direct Expenses are often, but not always, controllable costs o Indirect Expenses – costs that are incurred for the joint benefit of more than one department, and cannot be traced back to only one department; i.e. service departments that provide payroll, human resources for multiple departments, etc.
▪ Allocated across the departments that are benefitting from them
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• Departmental Income Statements – includes direct expenses and the department’s share of indirect expenses
COMPANY
DEPARTMENTAL INCOME STATEMENT
Department 1
Department 2
Sales
(given)
(given)
- Cost of Goods Sold
(given)
(given)
= Gross Profit
(sales - COGS)
(sales - COGS)
Direct Expenses:
- Salaries
(given)
(given)
- Advertising
(given)
(given)
- Utilities
(given)
(given)
- Depreciation
(given)
(given)
- Maintenance
(given)
(given)
= Total Direct Expenses
(salaries + advertising + utilities + depreciation + maintenance)
(salaries + advertising + utilities + depreciation + maintenance)
Departmental Contribution to Overhead
(gross profit – total direct expenses)
(gross profit – total direct expenses)
Indirect Expense Allocations: (determined by allocation bases given in problem)
- Salaries
(Salaries Indirect Cost (given) x % allocated by allocation base)
(Salaries Indirect Cost (given) x % allocated by allocation base)
- Advertising
(Advertising Indirect Cost x % allocated by allocation base)
(Advertising Indirect Cost x % allocated by allocation base)
- Utilities
(Utilities Indirect Cost x % allocated by allocation base)
(Utilities Indirect Cost x % allocated by allocation base)
- Depreciation
(Depreciation Indirect Cost x % allocated by allocation base)
(Depreciation Indirect Cost x % allocated by allocation base)
- Maintenance
(Maintenance Indirect Cost x % allocated by allocation base)
(Maintenance Indirect Cost x % allocated by allocation base)
- Human Resources
(HR Indirect Cost x % allocated by allocation base)
(HR Indirect Cost x % allocated by allocation base)
= Total Indirect Expenses
(salaries + advertising + utilities + depreciation + maintenance + human resources)
(salaries + advertising + utilities + depreciation + maintenance + human resources)
Net Income (loss)
(departmental contribution to overhead – total indirect expenses)
(departmental contribution to overhead – total indirect expenses)
•
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• Return on Investment (ROI) – a ratio of the amount invested to the amount received as a result; a method used to evaluate division performance within investment centers
o ROI Formula: (income ÷ avg invested assets)
RETURN ON INVESTMENT
INVESTMENT CENTER INCOME INVESTMENT CENTER AVERAGE INVESTED ASSETS
• Residual Income – the excess of income from operations over the minimum acceptable income; another method used to evaluate division performance in investment centers
o Residual Income Formula: (actual income – target income)
RESIDUAL INCOME
INVESTMENT CENTER
INCOME
TARGET
INVESTMENT CENTER INCOME
CHAPTER 22 – PRACTICE QUESTION!
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Chapter 20-23
Faye Co. has two operating (production) departments supported by a number of service departments. The following information was collected for a recent period:
Direct Costs
Salaries
Advertising
Utilities
Depreciation
Maintenance
Human Resources Cost of Goods Sold
Paint
Dept
117,150 14,950 18,650 15,450 1,750
322,350
Welding Dept
80,450 5,750
8,650
6,250
550
115,950
Indirect Costs
31,450 25,250 3,250
8,550
24,150 65,850
Indirect costs are allocated as follows: advertising on the basis of sales, human resources on the basis of the number of employees, and all other costs on the basis of square footage. Additional information about the production departments follows:
Square Footage
# of
Employees
Paint Dept Welding Dept
10,200 65 3,000 48
Sales for the Paint Department are $650,000 and sales for the Welding Department are $300,000. Determine the departmental contribution to overhead and the departmental net income for each production department by preparing the departmental income statement. Round to the nearest whole dollar or percent where applicable.
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FAYE CO.
DEPARTMENTAL INCOME STATEMENT
Paint Dept
Welding Dept
Sales
650,000
300,000
- Cost of Goods Sold
322,350
115,950
= Gross Profit
327,650
184,050
Direct Expenses:
- Salaries
117,150
80,450
- Advertising
14,950
5,750
- Utilities
18,650
8,650
- Depreciation
15,450
6,250
- Maintenance
1,750
550
= Total Direct Expenses
167,950
101,650
Departmental Contribution to Overhead
159,700
82,400
Indirect Expense Allocations: (determined by allocation bases given in problem)
- Salaries (sq. ft)
31,450 x 77% =
24,216.50
31,450 x 23% =
7,233.50
- Advertising (sales)
25,250 x 4% =
1,010
25,250 x 8% =
2,020
- Utilities (sq. ft)
3,250 x 77% =
2,502.50
3,250 x 23% =
747.50
- Depreciation
(sq. ft)
8,550 x 77% =
6,583.50
8,550 x 23% =
1,966.50
- Maintenance
(sq. ft)
24,150 x 77% =
18,595.50
24,150 x 23% =
5,554.50
- Human Resources (# of employees)
65,850 x 58% =
38,193
65,850 x 42% =
27,657
= Total Indirect Expenses
91,101
45,179
Net Income (loss)
68,599
39,021
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Chapter 23–Relevant Costing/Decision-Making • A company’s managers use relevant costing to make informed decisions within the company; it includes many types of costs: o Incremental (Relevant) Costs – future costs that will differ among different courses of action; will make a difference in decision-making
o Sunk Costs – come from past decisions and can’t be avoided or changed; are irrelevant to future decisions
• i.e. the cost incurred to purchase new computer
equipment two years ago is not relevant to the decision
of whether to replace the computer equipment
o Other important Types of costs in Relevant Costing:
▪ Out-of-Pocket Costs – require a future outlay of cash;
relevant for current and future decision-making; determined primarily by management
• i.e. future purchases of computer equipment involve
relevant out-of-pocket costs when deciding whether to
replace the computer equipment or not
▪ Opportunity Costs – the potential benefit lost by taking a specific action when alternative actions are available;
(selling price – incremental costs)
• i.e. when a student is determining how much summer
intercession will cost her, she must factor in the amount
of work she will have to take off (and the amount of
money lost) in order to do so
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• i.e. a single-product manufacturing company is approached by a client and is asked to create a special product. The company can’t just think about the potential profit (opportunity cost); they must factor in the time and resources that would be used and compare them to those of other potential projects
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• Managerial Decision-Making Scenarios:
o Additional Business –
▪ Management must not blindly use historical costs,
especially allocated overhead costs; they must focus on the incremental costs to be incurred if the additional business is accepted
SALES VARIABLE
CONTRIBUTION
DIRECT
MATERIALS
DIRECT LABOR
SELLING EXPENSES
OVERHEAD
MARGIN
(PER UNIT AND ANNUAL TOTAL)
CONTRIBUTION MARGIN
FIXED
OVERHEAD
ADMINISTRATIVE EXPENSES
INCREMENTAL OPERATING INCOME
(PER UNIT AND ANNUAL TOTAL) o Make or Buy –
DIRECT
MATERIALS (per unit)
DIRECT LABOR
(per unit)
OVERHEAD COSTS (USING GIVEN RATE per unit)
TOTAL
MANUFACTURING COSTS
(IN COMPARISON TO)
TOTAL PURCHASE PRICE
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o Scrap or Rework –
FULL SELLING PRICE (per unit) x
# OF UNITS
REWORKED
OUT-OF-POCKET COSTS TO
REWORK (per unit) x
# OF UNITS
REWORKED
OPPORTUNITY COSTS OF NOT MAKING NEW UNITS (per unit)
x
# OF UNITS
REWORKED
INCREMENTAL NET INCOME (per unit)
x
# OF UNITS REWORKED
(IN COMPARISON TO)
INCREMENTAL
INCOME TO SCRAP
(per unit)
x
# OF UNITS
REWORKED
o Keep or Replace Equipment –
VARIABLE
TOTAL
CASH RECEIVED TO TRADE IN OLD MACHINE
COST TO BUY NEW MACHINE
MANUFACTURING COST SAVINGS x
LIFE OF
EQUIPMENT
INCREASE
(OR DECREASE) IN NET INCOME