Professional Documents
Culture Documents
Relevant Costs 2007
Relevant Costs 2007
Decisions
A decision model is a formal method of making a choice, often involving both quantitative and qualitative analyses
Relevance
Relevant Information has two characteristics:
It occurs in the future It differs among the alternative courses of action
Relevant Costs expected future costs Relevant Revenues expected future revenues
4
Irrelevance
Historical costs are past costs that are irrelevant to decision making
Also called Sunk Costs- cost that has already been incurred and that cannot be avoided regardless of what a manager decides to do
Types of Information
Quantitative factors are outcomes that can be measured in numerical terms Qualitative factors are outcomes that are difficult to measure accurately in numerical terms, such as satisfaction
Are just as important as quantitative factors even though they are difficult to measure
8
Terminology
Incremental Cost the additional total cost incurred for an activity Differential Cost the difference in total cost between two alternatives Incremental Revenue the additional total revenue from an activity Differential Revenue the difference in total revenue between two alternatives
9
Types of Decisions
One-Time-Only Special Orders Insourcing vs. Outsourcing Make or Buy Product-Mix Customer Profitability Branch / Segment: Adding or Discontinuing Equipment Replacement
10
12
Special Orders
Acki Company receives a one-time order that is not considered part of its normal ongoing business. Acki Company only produces one type of silver key chain with a unit variable cost of TL 16. Normal selling price is TL 40 per unit. A company in KKTC offers to purchase 3,000 units for TL 20 per unit. Annual capacity is 10,000 units, and annual fixed costs total TL78,000, but Acki company is currently producing and selling only 5,000 units.
13
Special Orders
Acki Company Contribution Income Statement Revenue ( , TL4 ) TL . Variable costs: Direct materials TL4 . Direct labor 1 . Manufacturing overhead . Marketing costs 1 . Total variable costs . Contribution margin 1 . Fixed costs: Manufacturing overhead TL . Marketing costs . Total fixed costs 1 . Net income TL1 .
14
Special Orders
If Acki accepts the offer, net income will increase by TL 12.000.
1 1
U h Sp Ch ng
15
16
17
18
19
Qualitative Factors
Nonquantitative factors may be extremely important in an evaluation process, yet do not show up directly in calculations:
Quality Requirements Reputation of Outsourcer Employee Morale Logistical Considerations distance from plant, etc.
20
Opportunity Costs
Opportunity Cost is the contribution to operating income that is forgone by not using a limited resource in its next-best alternative use How much profit did the firm lose out on by not selecting this alternative? The economic benefits that are foregone as a result of pursuing some course of action. Opportunity costs are not actual dollar outlays and are not recorded in the accounts of an organization. Special type of Opportunity Cost: Holding Cost for Inventory. Funds tied up in inventory are not available for investment elsewhere
21
22
23
24
ake 70 27 15 3 9 6 30 90 540 000 300 000 60 000 0 120 000 0 1 020 000
ec ae a ec a a a e ve ea e ec a eq e v ' aa y Ge e a ac y ve a c
ea
1 400 000
Not avoidable and is irrelevant. If the product is dropped, it will be reallocated to other products.
25
26
Product-Mix Decisions
The decisions made by a company about which products to sell and in what quantities Decision Rule (with a constraint): choose the product that produces the highest contribution margin per unit of the constraining resource
27
Less variable expenses per unit Contribution margin per unit Current demand per week (units) Contribution margin ratio Processing time required on machine A1 per unit
29
roduct 2 hould e e pha ized. Provides more valuable use of the constrained resource machine A1, yielding a contribution margin of TL 30 per minute as opposed to TL 24 for Product 1.
31
f there are o other co ideratio the e t pla would e to produce to eet curre t de a d for Product 2 a d the u e re ai i g capacity to ake Product 1
32
W q q
3 q 3
33
P odu on nd (un ) n bu on m g n p un o on bu on m g n
du 3 L 4 L3
P odu L L33
n bu on m g n f
L 64
34
Managing Constraints
i di g way to proce ore u it through a re ource ottle eck
Decision is based on profitability of the customer, not how much revenue a customer generates
36
Decision is based on profitability of the branch or segment, not how much revenue the branch or segment generates
37
Adding/Dropping Segments
Income Statement for 2007
8 -
General Factory Overhead and General Administrative Expenses are unavoidable costs.
A u e that the e uip e t u ed i alter ati e u e a ufacturi g digital i tru e t ha o re ale alue or
38
Incremental Approach
DECISION RULE UM should drop the digital instruments division only if the avoided fixed costs of the division exceed lost contribution margin of this division.
39
Incremental Approach
0 000 0 000
40
41
24
24
2 4 2 2 2 4
42
Joint Products
Joi t Co t
Joint Input Common Production Process Oil
Gasoline
Chemicals
SplitSplit- ff Poi t
44
Joint Products
Joi t Co t
Common Production Process Oil Separate Processing Final Sale
Joint Input
Gasoline
Final Sale
Chemicals
Separate Processing
Final Sale
SplitSplit- ff Poi t
Separate Product Co t
45
46
47
48
w 4 4
49
0 0 0 50 0
50 0 0 0 0
K ?
50
Behavioral Implications
Despite the quantitative nature of some aspects of decision making, not all managers will choose the best alternative for the firm Managers could engage in selfserving behavior such as delaying needed equipment maintenance in order to meet their personal profitability quotas for bonus consideration
51