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Case Organization
As shown below, we have organized this casebook into four parts. They address a variety of topics, beginning with understanding costs and cost behaviors and ending with performance measurement and incentive systems.
Part I Understanding Costs and Cost Behaviors
Part II Fundamentals of Product and Service Costing
Part III Planning, Budgeting, and Variance Analysis
Part IV Performance Measurement and Incentive Systems
In the remainder of this Preface, we discuss the purpose and content of each of the four parts in detail. At the end, we have included a note to students.
Part I: Understanding Costs and Cost Behaviors
The cases in Part I deal with the nature of costs and cost behaviors, cost-volumeprofit analysis, relevant costs, opportunity costs, sunk costs, and break-even analysis. Relevant costs are expected future costs that change as a result of the decision being considered or that differ among alternative courses of action. Relevant costs must meet two criteria: (1) they must be expected to occur in the future, and (2) they must differ among alternative courses of action. Two important costing concepts that are related to the notion of relevant costs are sunk costs and opportunity costs. Sunk costs are costs that have already been incurred or obligated. They will not change regardless of the course of action selected. Therefore, they are irrelevant in choosing among alternative courses of action. Opportunity costs are the contribution to income that is foregone by not choosing an alternative use for a resource. Because opportunity costs pertain to the future, if they differ among alternative courses of action, they are relevant in choosing among those alternatives.
When making a decision, managers would draw the same conclusion if they use only relevant data as they would draw if they used all of the applicable available data. However, making decisions using only the relevant data streamlines the decision-making process. It allows decisions to be made even when managers don’t have all of the company’s financial information. In addition, it focuses management’s attention on the information that matters rather than on information that is irrelevant to the decision.
Frequently, it is the behavior of various costs that help managers determine whether such costs are relevant to a decision. Why? Because variable costs change in total in proportion to changes in activity level, whereas fixed costs remain unchanged, in the short run, regardless of changes in activity level.
Understanding the concepts of relevant costs, sunk costs, opportunity costs, and cost behavior is crucial to making good management decisions. The cases in this section of the book illustrate the use of these concepts in a variety of decision contexts, including outsourcing, accepting special orders, determining product mix, setting prices, and optimizing the use of constrained resources. The FinePrint Company case provides a basic introduction to the concepts of cost behavior and relevant costs in the context of a decision regarding whether or not to accept a special order, and in the context of an outsourcing decision. Blackheath Manufacturing Company demonstrates the use of cost behaviors and relevant costs in a pricing decision. Giberson’s Glass Studio considers the impact of constrained resources on costs relevant to a decision about product mix, and it raises the issue of the relevance of cost allocation in a business situation where almost all of the costs are fixed. The Horizon Insurance Agency pertains to an outsourcing decision and highlights the importance of treating a multiyear decision using an investment framework. Breeden Security, Inc. (A) has four budget options to be evaluated using break-even analysis, including a scenario where sales volumes and production volumes differ. BW Manufacturing Company addresses product planning, including decisions about whether to keep or drop a product line and about product pricing, using contribution margin analysis. Finally, Greenlawn Commercial Package Business and The Craddock Cup explore more generally the concepts of relevant costs, sunk costs, and cost-volume-profit analysis in a services environment.
Part II: Fundamentals of Product and Service Costing
The cases in Part II address issues associated with determining the cost of products and services, including overhead allocation, allocation of common costs, and activity-based costing. Some costs (such as certain material and labor costs) can be traced directly to products or services. These costs are called direct costs. Other costs (such as manufacturing supplies, maintenance costs, occupancy costs, and plant administration, among others) often cannot be traced directly to products or services. These costs are called indirect costs, and they often represent service or manufacturing overhead costs. To obtain the full cost of a product or service, companies must include all related direct costs and some amount of indirect costs. The distribution of indirect, or overhead, costs to a product, service, or other unit of output, is called cost allocation. Traditionally, manufacturing overhead costs were accumulated by department and distributed among products in proportion to each product’s use of some easily determined resource, typically direct labor hours or dollars.
In recent years, however, companies have paid considerable attention to the process of cost allocation. First, pooling costs by department may not promote accurate costing because different costs in any given department might be driven by different activities. Instead of departments, companies have tried grouping overhead costs by type of activity (such as setup, purchasing, inspection, etc.) which may have clearer causeand- effect relationships to product costs than do manufacturing departments. Second, direct labor may not be a good indicator of the indirect resources consumed by a product. Therefore, in place of direct labor, companies have begun to use a measure of activity associated with each group of overhead costs to allocate those overhead costs to products or services. For example, the number of production runs might be used to allocate set-up costs, costs of inspection, and other production-run related costs. This focus on activities in allocating overhead costs has become known as activity-based costing. Shun Electronics Company begins the process of exploring this topic by looking at how a company pools its overhead and the danger of cross-product subsidies arising. Breeden Security, Inc. (B) deals with the differences in traditional costing and activity-based costing in distributing overhead costs in a manufacturing environment. Johnson Beverage, Inc. uses activity-based costing to allocate customer service costs and assess customer profitability. Finnegan’s Gardens introduces the use of activity-based costing to determine service-level profitability. Gibson Insurance Company explores the allocation of shared infrastructure costs and its implications for determining business unit costs and product costs. Data Services at Armistead illustrates the use of activity-based thinking in distributing costs among different lines of business in ways that support strategic decisions.
Finally, Wendy’s Chili: A Costing Conundrum addresses the issue of joint costs and the challenge of costing by-products. Wendy’s must determine the cost of a bowl of chili in assessing the profitability of each of its products. This task is particularly difficult because chili is made using a by-product of its hamburgers.
Part III: Planning, Budgeting, and Variance Analysis
The cases in Part III provide the opportunity for in-depth discussion of important issues pertaining to planning and budgeting (including flexible budgeting techniques), basic variance analysis, and strategic profitability analysis.
With Blackheath Manufacturing Company—Revisited, students are asked to prepare a production budget and a budgeted income statement, balance sheet, and statement of cash flows using information regarding the company’s product costs and sales forecasts. This case provides students with an excellent overview of the steps involved in the preparation of a budget.
Toddler Treasures, Inc. illustrates basic variance analysis and its use in measuring and assessing performance. Charley’s Family Steak House (A) and (B) and EntertainmentNow.com address flexible budgeting and strategic profitability analysis, and they also require a reconciliation of actual to planned results in a way that highlights the impact of important strategic factors on the difference.
The Oriole Furniture, Inc. (A) case describes a typical annual budgeting process for a division within a company. Students are presented with a situation in which a division is falling well short of its budget during the year, and they are asked to consider actions the company might take midyear to help ensure it reaches its budget by year-end. The case challenges students to consider the purpose of budgets and to discover that ultimately the budget must be linked to realistic plans and strategies or it becomes a meaningless exercise. Finally, the Consumer Service Company (A) case addresses ethical issues associated with negotiating a profit plan via a classroom role play opportunity.
Part IV: Performance Measurement and Incentive Systems
The cases in Part IV address issues associated with performance measurement and incentive systems. Several of these cases focus on the choice of performance measures. First, Performance Measurement at Thomas J. Lipton provides the opportunity to address the challenges surrounding the choice of performance measures in general, and the surrounding use of ROI as a performance measure in particular. This case requires students to compare and contrast the benefits related to the use of ROI and Residual Income as performance measures. It also requires students to develop an understanding of alternative measures of income and investment used in the calculation of each of these metrics. Second, Maverick Lodging provides students the opportunity to examine the design and implementation of a balanced scorecard, and The Gail Palmer Ashton Graduate School of Business offers the opportunity to explore the challenge of designing some performance metrics in a university setting.
Two cases focus on some interesting issues surrounding transfer pricing decisions. Specifically, Lynchburg Foundry: The Ductile Dilemma deals with transfer pricing in a manufacturing environment within the context of the castings industry; Xyberspace Consulting, Inc. deals with pricing shared services within the context of a consulting firm.
The Mountain Lumber Company case addresses issues associated with performance measures and incentive compensation. It asks students to evaluate a performance measurement and incentive plan for a lumber company. This case can be used to introduce issues related to performance measurement and compensation, and it can also serve to address a comprehensive set of issues at the end of a module pertaining to performance measurement and incentive systems.
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