How do your account for financial losses in order to maintain quality customer service, for example, a restaurant that gives a free meal to an upset customer or a company that gives repeat customers a discount? From the viewpoint of a management accountant, how would this cost be classified and how would it figure into a company’s financial statements?
The production constraint is often the number of available machine hours. For a merchandiser such as Wal-Mart, the primary constraint is cubic feet of display space. In order to determine which products to emphasize, displaying or producing.
Consider union Bay, a manufacturer of shirts and jeans. Let’s say the company can sell all of the shirts and jeans it produces, but it has only 2,000 machine hours of capacity. The company uses the same machines to produce both jeans and shirts. In this case a machine hour is the constraint. Note that this is short-term decision. Because in the long run. Union Bay could expand its production facilities to meet sales demand if it made financial sense to do so. However, an important piece of information is missing-the time it takes to make each product. Let’s assume that union bay can produce either 20 pairs of jeans or 10 shirts per machine hour. The company will incur the same fixed costs either way, so fixed costs are irrelevant. Which product should it emphasize? Jeans have a higher contribution margin per machine hour than shirts. Therefore, union bay will earn more profit by producing jeans. Why? Because even through jeans have a lower contribution margin per unit, union bay can make twice as many jeans as shirts in the available machine hours. Multiplying the contribution margin per machine hour by the available number of machine hours shows that union bay can earn 480,000 of contribution margin by producing jeans but only #360,000 by producing shirts.
To maximize profit, union bay should make 40,000 jeans. Why zero shirts? Because for every machine hour spent making shirts, union bay would give up $60 of contribution margin.
We make two assumptions about union bay
1. Union bay sales of to her products, if any, won’t be hurt by this decision and.
2. Union bay can sell as many jeans and shirts as it can produce. Let’s challenge these assumptions. First, how could making only jeans hurt sales of the company’s other products? Using other production
