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2009 Foster School of Business Cost Accounting L.DuCharme 1
Decision Making andRelevant Information
Chapter 11
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Overview
• Decisions
• Relevant information
• Examples of common decisions
• Opportunity costs
• Capacity constraints
• Replace equipment
• Comprehensive example
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Information and theDecision Process
A decision model is a formal methodfor making a choice, often involvingquantitative and qualitative analysis.
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Five-Step Decision Process
Gather Information
Make Predictions
Choose an Alternative
Implement the Decision
Evaluate Performance
Step 1.
Step 2.
Step 3.
Step 4.
Step 5.
Historical CostsOther Information
Specific Predictions
Fee
db
ack
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Differentiate relevantfrom irrelevant
costs and revenues indecision situations.
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The Meaning of Relevance
Relevant costs and relevant revenues areexpected future costs and revenues that
differ among alternative courses of action.
Historical costs Sunk costs
Differential income Differential costs
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Quantitative and QualitativeRelevant Information
Quantitative factors
Financial Nonfinancial
Qualitative factors
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One-Time-OnlySpecial Order Example
Profit is made if the incremental revenue exceeds incremental costs.
If excess capacity exists, then relevant cost generally equals variable cost to make special order.
Will marketing costs change?
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Two Potential Problems inRelevant-Cost Analysis
Incorrect generalassumptions:
All variable costsare relevant.
All fixed costsare irrelevant.
1 2
Misleadingunit-cost data:
Includeirrelevant costs.
Use same unitcosts at different
output levels.
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Outsourcing versus Insourcing
Outsourcing ispurchasing goodsand services fromoutside vendors.
Insourcing isproducing goods
or providing serviceswithin the organization.
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Make-or-Buy Decisions
This is a very common (frequent) decision made by most organizations.
Purchase managers report three important factors: (1) Quality (2) Supplier dependability (3) Cost
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Make-or-Buy Decisions
In making a “make-or-buy” decision it is often times useful and quick to
compare the cost to outsource versus the costs saved if you outsource.
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Opportunity Costs andOutsourcing
Opportunity cost is the contribution to incomethat is forgone (rejected) by not using a
limited resource in its next-best alternative use.
Generally, opportunity cost is the benefit foregone by not choosing the next best
alternative.
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Opportunity Costs andOutsourcing
Many decisions have an opportunity cost.
What is the opportunity cost for making the decision to come to class today?
Give an example of a decision that had no or zero opportunity cost.
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Capacity Constraints
Deciding whichproducts to produce when there
are capacity constraints.Answer: Produce/sell product(s) with the highest CM/unit of constraint!
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Product-Mix DecisionsUnder Capacity Constraints
Per unit Product #2 Product #3Sales price $2.11 $14.50Variable expenses 0.41 13.90Contribution margin $1.70 $ 0.60Contribution margin ratio 81% 4%
Bismark Co. has 3,000 machine-hours available.
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Product-Mix DecisionsUnder Capacity Constraints
One unit of Prod. #2 requires 7 machine-hours.
One unit of Prod. #3 requires 2 machine-hours.
What is the contribution of each productper machine-hour?
Product #2: $1.70 ÷ 7 = $0.24Product #3: $0.60 ÷ 2 = $0.30
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From a company economic Perspective, the book valueof equipment is irrelevant in
equipment-replacement decisions.
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Conflicts can arisebetween the decision modelused by a manager and the
performance evaluation modelused to evaluate the manager.
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Decisions andPerformance Evaluation
What is the journal entry to sell the existing machine?
Cash $14,000Accumulated Depreciation 50,000Loss on Disposal 16,000 Machine $80,000
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Decisions andPerformance Evaluation
In the real world would the managerreplace the machine?
An important factor in replacement decisionsis the manager’s perceptions of whether thedecision model is consistent with how the
manager’s performance is judged.
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Decisions andPerformance Evaluation
Top management faces a challenge – that is,making sure that the performance-evaluationmodel of subordinate managers is consistent
with the decision model.
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Anatomy of a Decision: Buy a used versus lease a new car
• Example of decision--See spread sheet analysis.
• Quantitative and qualitative analysis—you are only part way done with analysis after the quantitative analysis. Use this as a benchmark against the qualitative factors.
• What qualitative factors have I missed (left out of) in my quantitative analysis?
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End of Chapter 11