Cost Accounting (14th Edition)

406 CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION
Snowmobile Engine Boat Engine
Contribution margin per unit $240 $375
Machine-hours required to produce one unit 2 machine-hours 5 machine-hours
Contribution margin per machine-hour
$240 per unit ÷ 2 machine-hours/unit $120/machine-hour
$375 per unit ÷ 5 machine-hours/unit $75/machine-hour
Total contribution margin for 600 machine-hours
$120/machine-hour * 600 machine-hours $72,000
$75/machine-hour * 600 machine-hours
$45,000
Decision
Point
When resources are
constrained, how
should managers
choose which of
multiple products to
produce and sell?
Learning
Objective 5
Discuss factors
managers must
consider when adding
or dropping customers
or segments
. . . managers should
focus on how total costs
differ among alternatives
and ignore allocated
overhead costs
The number of machine-hours is the constraining resource in this example and snowmobile
engines earn more contribution margin per machine-hour ($120/machine-hour)
compared to boat engines ($75/machine-hour). Therefore, choosing to produce and sell
snowmobile engines maximizes total contribution margin ($72,000 versus $45,000
from producing and selling boat engines) and operating income. Other constraints in
manufacturing settings can be the availability of direct materials, components, or
skilled labor, as well as financial and sales factors. In a retail department store, the constraining
resource may be linear feet of display space. Regardless of the specific constraining
resource, managers should always focus on maximizing total contribution
margin by choosing products that give the highest contribution margin per unit of the
constraining resource.
In many cases, a manufacturer or retailer has the challenge of trying to maximize
total operating income for a variety of products, each with more than one constraining
resource. Some constraints may require a manufacturer or retailer to stock minimum
quantities of products even if these products are not very profitable. For
example, supermarkets must stock less-profitable products because customers will be
willing to shop at a supermarket only if it carries a wide range of products that customers
desire. To determine the most profitable production schedule and the most
profitable product mix, the manufacturer or retailer needs to determine the maximum
total contribution margin in the face of many constraints. Optimization techniques,
such as linear programming discussed in the appendix to this chapter, help solve these
more-complex problems.
Finally, there is the question of managing the bottleneck constraint to increase output
and, therefore, contribution margin. Can the available machine-hours for assembling
engines be increased beyond 600, for example, by reducing idle time? Can the time
needed to assemble each snowmobile engine (two machine-hours) and each boat engine
(five machine-hours) be reduced, for example, by reducing setup time and processing time
of assembly? Can quality be improved so that constrained capacity is used to produce
only good units rather than some good and some defective units? Can some of the assembly
operations be outsourced to allow more engines to be built? Implementing any of
these options will likely require Power Recreation to incur incremental costs. Power
Recreation will implement only those options where the increase in contribution margins
exceeds the increase in costs. Instructors and students who, at this point, want to explore
these issues in more detail can go to the section in Chapter 19, pages 686–688, titled
“Theory of Constraints and Throughput Contribution Analysis” and then return to this
chapter without any loss of continuity.
Customer Profitability, Activity-Based Costing,
and Relevant Costs
Not only must companies make choices regarding which products and how much of
each product to produce, they must often make decisions about adding or dropping a
product line or a business segment. Similarly, if the cost object is a customer, companies
must make decisions about adding or dropping customers (analogous to a product line)
or a branch office (analogous to a business segment). We illustrate relevant-revenue and