MANAGEMENT SCIENCE - Breakeven analysis

- Linear Programming
 It is a scientific approach to solving management
problems (Taylor, 2013)
 Encompasses several mathematically oriented
techniques and a logical to problem solving
 Using scientific and research-based approaches to help
a business make decisions, improve performance, and
meet goals
 Can be used in a variety of organization to solve many
different types of problems
 Management science initially includes any application of
science to management problems or to the process of
management itself
 Also referred to as operations research quantitative
methods, quantitative analysis, and decisions science
 Problem-solving process used by an interdisciplinary
team to develop models that represent simple and complex
functional relationships and provide management guidance
for decision-making.
- Forecasting
- Queuing Theory
IMPORTANCE OF DECISION-MAKING
Decision-making in management is important because you may
encounter situations where you have several options that may
impact the workplace in different ways. They may affect
employees, other members of management or the company's
reputation. Here are some other reasons why decision- making
in management is important.
 Ensuring the company keeps growing
 Choosing business partners
 Choosing effective operations and strategies
STEPS IN DECISION MAKING (SCIENTIFIC METHOD
APPROACH)

"Management Science uses several scientific approaches to 1. OBSERVATION

help the management of organizations to solve problems for
decision-making"
CHARACTERISTICS OF MANAGEMENT SCIENCE
 Examine Functional Relationships from a Systems
 Use the Interdisciplinary Approach
 Uncover New Problems for Study
 Use a Modeling-Process Approach to Problem Solving
Other Characteristics of Management Science:
 A primary focus on managerial decision-making
 The application of science to decision making
 A dependence on electronic computers
 An appraisal resting on criteria of economic effectiveness
IMPORTANCE OF MANAGEMENT SCIENCE
- Understanding the situation
2. PROBLEM DEFINITION
- Pinpointing the problem and setting of objectives
3. MODEL CONSTRUCTION
- Abstract mathematical representation of a problem
4. SOLUTION
- Logical resolve to a problem
5. IMPLEMENTATION
- Execution of the solution
Illustrative example: Problem-solving
David decided to establish a business called "David's Rice" - a
rice retailing business in his hometown. He canvassed local
farmers and suppliers and got a very affordable bargain of
P1,800 per sack of 50-kilogram rice. Besides the purchase cost,
David has to shoulder the freight of P5 per sack to deliver the
purchase to his store. David is, however, frustrated in calculating
how much should be the price per sack and kilo, given that he
wants to earn a net of P1,100 per sack. He also wants to make a
simulation of any possible scenario.

Steps in Decision Making (Scientific method approach)

1.Observe
What is the situation all about?
Management -David is new to business and he is frustrated in calculating the
Science Accounting price per. sack and kilo.

2. Problem Definition
What do we want to have?
-A formula to compute the once per sack and kilo.

3. Model construction
Management Science
What equation can be designed?
- It is a discipline whose application to resolving business
What are the variables?
problems is of great significance
What are the given data?
-A simple linear equation with the following variables:
Accounting
Cost of rice per sack ( P 1,800)
- Accounting provides financial information that are useful in
Freight charge per sack (P5.00)
decision making
Target profit per sack ( P 1,100)
TOOLS AND TECHNIQUES IN DECISION MAKING
Substituting:
Price per sack-Cost per sack = Profit
Some of the tools and Techniques in Decision making:
Thus,
a - (b + c) = d
- Regression and correlation analysis
-Program evaluation review technique
 Profit Center
a - (b + c) = d - A segment whose manager has control over both costs and
a - (P1,800+P5)=P1,100 revenues, but no control over investment funds.
a - ( P 1,805)=P1,100
a =P1,100+P1,805 Revenues
a= P2,905 per sack Sales
Interest
4. Solution Other
Is the equation design credible? Costs
Can it be used in other scenarios? Mfg.costs
How do we know if it is correct? Commissions
-Price per sack-Cost per sack - Profit Salaries
2 ,905-(P1,800+P5)=P1,100 Other
2 ,905-P1,805=P1,100
P 1,100=P1,100 ✔ Investment Center
- A segment whose manager has control over costs, revenues,
5. Implementation and investments in operating assets.
-Apply the equation

RESPONSIBILITY ACCOUNTING. PERFORMANCE

MEASURES AND BALANCED SCORECARD
INVESTMENT CENTERS COST CENTERS
Decentralization

 Practice of delegating decision- making authority to the

lower levels
 Decentralized decision making PROFIT CENTERS
-Allows managers at lower levels to make and
implement key decisions pertaining to their areas of COST CENTERS
responsibility
 Centralized decision making
-Decisions are made at the very top level and lower-
level managers are charged with implementing those
decisions

Decentralization in Organizations

Benefits of Decentralization DECENTRALIZATION AND SEGMENT REPORTING

- A segment is any part or activity of an organization about
 Lower-level managers gain experience in decision-making. which a manager seeks cost, revenue, or profit data.
 Top management freed to concentrate on strategy  An Individual Store
 Decision-making authority leads to job satisfaction.  A Sales Territory
 Lower-level decisions often based on better information  A Service Center
 Lower level managers can respond quickly to customers.
- A corporation could segment its business by geographic region.
Disadvantages of Decentralization - A corporation could segment its business by customer channel.
 Lower-level managers may make decisions without seeing
“the big picture." KEYS TO SEGMENTED INCOME STATEMENTS
 Lower-level manager's objectives may not be those of the
organization. There are two keys to building segmented income statements: A
 May be a lack of coordination among autonomous contribution format should be used because it separates fixed
managers. from variable costs and it enables the calculation of a
 May be difficult to spread innovative ideas in the contribution margin.
organization.
Traceable fixed costs should be separated from common fixed
costs to enable the calculation of a segment margin.
COST, PROFIT, AND INVESTMENTS CENTERS
Cost, profit, and investment centers are all known as
Sales xx
responsibility centers.
Variable Cost (xx)
Contribution Margin xx
Cost Center
Fixed Margin (xx)
-A segment whose manager has control over costs, but not over
Net Operating Margin xx
revenues or investment funds.

TRACEABLE COSTS CAN BECOME COMMON COSTS

 Total lease $4000 $16000 $20000 $40000
It is important to realize that the traceable fixed costs of one cost
segment may be a common fixed cost of another segment
LEVELS OF SEGMENTED STATEMENTS
For example, the landing fee paid to land an airplane at an
airport is traceable to the particular flight, but it is not traceable to Webber, Inc. has two divisions
first-class, business-class, and economy-class passengers

IDENTIFYING COMMON FIXED COSTS

Common cost arise because of the overall operation of the

company and would not disappear if any particular segment
were eliminated

-No computer division but

-We still have a company president. Let’s look more closely at the Television Division’s income
statement.

IDENTIFYING TRACEABLE FIXED COSTS Our approach to segment reporting uses the contribution format.

Traceable costs arise because of the existence of a particular Income Statement

Contribution Margin Format Cost of goods sold
segment and would disappear over time if the segment itself
Television Division consists of variable
disappeared
Sales $300,000 manufacturing costs
-No computer division means Variable COGS 120,000
-No computer division manager Other variable costs 30,000 Fixed and variable
Total variable costs 150,000 costs are listed in
TRACEABLE AND COMMON COSTS Contribution margin 150,000 separate sections
Traceable fixed costs 90,000
Fixed Costs: Division margin $60,000
 Traceable
 Common- Don’t allocate common costs to segments
Income Statement
ABC Company A Division B Division Company Television Computer
Sales xx Sales xx Sales xx Sales $500,000 $300,000 $200,000
Variable Cost (xx) Traceable Fixed Cost (xx) Traceable Fixed Cost (xx)
Contribution Margin xx Contribution Margin xx Contribution Margin xx Variable costs 230,000 150,000 80,000
CM 270,000 150,000 120,000
Common Fixed Cost (xx) Traceable FC 170,000 90,000 80,000
Net Contributing
Margin xx Division margin 100,000 60,000 40,000
Common costs 25,000
Net operating $75,000
SEGMENT MARGIN income

The segment margin, which is computed by subtracting the Common costs should not be allocated to the divisions.
traceable fixed costs of a segment from its contribution margin, is These costs would remain even if one of the divisions were
the best gauge of the long-run profitability of a segment. eliminated.

ACTIVITY-BASED COSTING Income Statement

Contribution margin is
Contribution Margin Format
computed by taking sales
Television Division
Activity-based costing can help identify how costs shared by minus variable costs
more than one segment are traceable to individual segments. Sales $300,000
Variable COGS 120,000
Other variable costs 30,000 Segment margin is
Assume that three products, 9-inch, 12-inch, and 18-inch pipe,
Total variable costs 150,000 Television’s
share 10,000 square feet of warehousing space, which is leased
Contribution margin 150,000 contribution to
at a price of $4 per square foot
Traceable fixed costs 90,000 profits.
Division margin $60,000
If the 9-Inch, 12-Inch, and 18-inch pipes occupy 1,000, 4,000,
and 5,000 square feet, respectively, then ABC can be used to
trace the warehousing costs to the three products as shown.
TRACEABLE COSTS CAN BECOME COMMON COSTS
Pipe Products
9inch 12-inch 18-inch Total As previously mentioned, fixed costs that are traceable to one
Warehouse 1000 4000 5000 10000 segment can become common if the company is divided into
sq. ft. smaller segments.
Lease $4 $4 $4 $4
price per Let's see how this works using the Webber, Inc. example!
sg.ft.
Webber’s Television Division CM 490,000 40,000 450,000
Traceable FC 246,000 26,000 220,000
Segment margin 244,000 14,000 230,000
Common costs 200,000
Profit $44,000

Quick Check:
How much of the common fixed costs of $200,000 can be
avoided by eliminating the bar?
A. none of it
Product Lines B. Some of it
C. All of it
Income Statement
Televison Regular Big Screen Answer: A. - A common fixed cost cannot be eliminated by
Division dropping one of the segments.
Sales $300,000 $200,000 $100,000
Variable costs 150,000 95,000 55,000
CM 150,000 105,000 45,000 COMMON COSTS AND SEGMENTS
Traceable FC 80,000 45,000 35,000
Division margin 70,000 60,000 10,000 Common costs should not be arbitrarily allocated to segments
Common costs 10,000 based on the rationale that "someone has to cover the common
Net operating $60,000 costs" for two reasons
income
1. This practice may make a profitable business segment appear
to be unprofitable,

Fixed costs directly traced to the Television Division 2. Allocating common fixed costs forces managers to be held
$80,000 + $10,000 = $90,000 accountable for costs they cannot control.

Quick Check:
If Hogland’s allocates its common costs to the bar and the
EXTERNAL REPORTS restaurant, what would be the reported profit of each
segment?
The Financial Accounting Standards Board now requires that
companies in the United States include segmented financial
data in their annual reports.
Suppose square feet is used as the basis for
1. Companies must report segmented results to shareholders allocating the common fixed cost of \$ 200000 How
using the same methods that are used for internal segmented much would be allocated to the bar if the bar
reports. occupies 1,000 square feet and the restaurant 9,000
2. Since the contribution approach to segment reporting does
square feet?
not comply with GAAP, it is likely that some managers will a. $ 20,000
choose to construct their segmented financial statements using b. $30,000
the absorption approach to comply with GAAP. c. 540000
d. $50,000
OMISSION OF COSTS

Costs assigned to a segment should include all costs attributable Answer: A. - The bar would be allocated 1/10 of
to that segment from the company's entire value chain. the cost or $20,000.

Business Functions Making Up The Value Chain Should the bar be eliminated?
a. Yes The profit was $44,000 before
R&D Product Manufacturing Marketing Distribution Customer
Design Service b. No eliminating the bar. If we eliminate the
bar, profit drops to $30,000
INAPPROPRIATE METHODS OF ALLOCATING COSTS Income Statement
AMONG SEGMENTS Hoagland’s Bar Restaurant
Lakeshore
 Failure to trace costs directly Sales $700,000 $700,000
 Inappropriate allocation base Variable costs 250,000 250,000
CM 450,000 450,000
Income Statement Traceable FC 220,000 220,000
Hoagland’s Bar Restaurant Segment margin 230,000 230,000
Lakeshore Common costs 200,000
Sales $800,000 $100,000 $700,000 Profit $30,000
Variable costs 310,000 60,000 250,000
 Income Statement
Hoagland’s Bar Restaurant
Lakeshore
Sales $800,000 $100,000 $700,000
Variable costs 310,000 60,000 250,000
CM 490,000 40,000 450,000
Traceable FC 246,000 26,000 220,000
Segment margin 244,000 14,000 230,000
Common costs 200,000 20,000 180,000
Profit $44,000 $(6,000) $50,000

Hurray, now everything adds up!!

Activity:

Data for September concerning Greenberger Corporation's two

major business segments— Fibers and Feedstocks-appear
below:

Sales revenues, Fibers $750,000

Sales revenues, Feedstocks $620,000
Variable expenses, Fibers $368,000
Variable expenses, Feedstocks $254.000
Traceable fixed expenses, Fibers $98,000
Traceable fixed expenses, Fibers $112,000

Common fixed expenses totaled $344,000 and were allocated as

follows: $175,000 to the Fibers business segment and $169,000
to the Feedstocks business segment.

Required:
Prepare a segmented income statement in the contribution
format for the company. Omit percentages, show only dollar
amounts

Answer:

Income Statement
Greenberger Fibers Feedstocks
Corporation
Sales $1,370,000 $750,000 $620,000
Variable costs 622,000 368,000 254,000
CM 745,000 382,000 366,000
Traceable FC 210,000 98,000 112,000
Segment margin 538,000 284,000 254,000
Common costs 344,000 175,000 169,000
Profit $194,000 $ 109,000 85,000