Superior Manufacturing Company

CHAPTER 6: COST ANALYSIS FOR DECISION-MAKING

LEARNING OBJECTIVES:

In this chapter, students will: 1. Explain the importance of making decisions based on expected future costs rather than historical costs. 2. Distinguish variable costs, avoidable fixed costs, and unavoidable fixed costs and utilize them for decisionmaking. 3. Compare and contrast job-order costing from process costing in terms of discerning marginal cost. 4. Explain the role that fixed overhead plays in variable and absorption costing and the impact it has on production and pricing decisions. 4. Compare and contrast activity-based costing and justin-time costing and explain how each costing procedure can improve estimates of unit cost. 5. Use profit contribution analysis to make strategic decisions. 6. Explain the implicit assumptions in cost-volume-profit analysis and utilize the information to make production decisions.

Overview of Superior Manufacturing Company

Superior Manufacturing Company lost $688,000 in 2004. Company president Paul Harvey was concerned about the loss and investigated the financial performance of its three industrial product lines (Product 101, 102, and 103). According to the income statement, product lines 102 and 103 lost money that year. Harvey advocated eliminating Product 103 immediately to alleviate some of the financial stress on the company.

To make matters worse, the largest competitor in the industry, the Samra Company, announced it would lower its price from $24.50 to $22.50 per 100 pounds. Herbert Waters, general manager of Superior Manufacturing, believed that if Superior maintained its current price on Product 101 of $24.50, its unit sales would fall by 65%. Harvey noted that the unit cost of Product 101 was $22.84. Therefore, matching the Samra price cut would force the firm to sell below cost.

Relevant Costs

The primary objective of the previous two chapters was to use economic theory to help managers determine the relevant cost associated with a...