Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4

th
Edition, Pearson Education Limited 2008
Slide 1.4.1
1.
1.
Accounting for decision making
Accounting for decision making
1.4
1.4
Relevant Information
Relevant Information
for
for
Decision Making
Decision Making
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.2
Introduction
Introduction

This chapter explores the decision
This chapter explores the decision
-
-
making
making
process.
process.

It focuses on specific decisions such as
It focuses on specific decisions such as
accepting or rejecting a one
accepting or rejecting a one
-
-
time
time
-
-
only special
only special
order, insourcing or outsourcing products or
order, insourcing or outsourcing products or
services, and replacing or keeping equipment.
services, and replacing or keeping equipment.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.3
Learning Objectives
Learning Objectives
1 1
Describe a five
Describe a five
-
-
step sequence in the decision
step sequence in the decision
process
process
2 2
Differentiate relevant costs and revenues from
Differentiate relevant costs and revenues from
irrelevant costs and revenues
irrelevant costs and revenues
3 3
Distinguish between quantitative factors and
Distinguish between quantitative factors and
qualitative factors in decisions
qualitative factors in decisions
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.4
Learning Objectives (Continued)
Learning Objectives (Continued)
4 4
Describe a make
Describe a make
-
-
or
or
-
-
buy
buy
-
-
decision process
decision process
5 5
Describe the opportunity cost concept; explain
Describe the opportunity cost concept; explain
why it is used in decision making
why it is used in decision making
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.5
Learning Objective 1
Learning Objective 1
Describe a five
Describe a five
-
-
step sequence in the
step sequence in the
decision process
decision process
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.6
Information and the
Information and the
Decision Process
Decision Process
A decision model is a formal method for
A decision model is a formal method for
making a choice, often involving quantitative
making a choice, often involving quantitative
and qualitative analysis.
and qualitative analysis.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.7
Five
Five
-
-
Step Decision Process
Step Decision Process
1 1
Gathering information
Gathering information
2 2
Making predictions
Making predictions
3 3
Choosing an alternative
Choosing an alternative
4 4
Implementing the decision
Implementing the decision
5 5
Evaluating performance
Evaluating performance
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.8
Learning Objective 2
Learning Objective 2
Differentiate relevant costs and
Differentiate relevant costs and
revenues from irrelevant costs
revenues from irrelevant costs
and revenues
and revenues
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.9
The Meaning of Relevance
The Meaning of Relevance

Relevant costs and relevant revenues are
Relevant costs and relevant revenues are
expected future costs and revenues that differ
expected future costs and revenues that differ
among alternative courses of action.
among alternative courses of action.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.10
The Meaning of Relevance
The Meaning of Relevance
(Continued)
(Continued)

Historical costs are irrelevant to a decision but
Historical costs are irrelevant to a decision but
are used as a basis for predicting future costs.
are used as a basis for predicting future costs.

Sunk costs are past costs which are
Sunk costs are past costs which are
unavoidable.
unavoidable.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.11

Differential profit (net relevant profit) is the
Differential profit (net relevant profit) is the
difference in total operating profit when
difference in total operating profit when
choosing between two alternatives.
choosing between two alternatives.

Differential costs (net relevant costs) are the
Differential costs (net relevant costs) are the
difference in total costs between two
difference in total costs between two
alternatives.
alternatives.
The Meaning of Relevance
The Meaning of Relevance
(Continued)
(Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.12
Learning Objective 3
Learning Objective 3
Distinguish between quantitative
Distinguish between quantitative
factors and qualitative factors in
factors and qualitative factors in
decisions
decisions
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.13
Quantitative and Qualitative
Quantitative and Qualitative
Relevant Information
Relevant Information

Quantitative factors are outcomes that are
Quantitative factors are outcomes that are
measured in numerical terms:
measured in numerical terms:

Financial
Financial

Non
Non
-
-
financial.
financial.

Qualitative factors are outcomes that cannot
Qualitative factors are outcomes that cannot
be measured in numerical terms.
be measured in numerical terms.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.14
One
One
-
-
Time
Time
-
-
Only Special Order
Only Special Order

Gabriela & Co manufactures bath towels in
Gabriela & Co manufactures bath towels in
Jersey.
Jersey.

The plant has a production capacity of 44,000
The plant has a production capacity of 44,000
towels each month.
towels each month.

Current monthly production is 30,000 towels.
Current monthly production is 30,000 towels.

The assumption is made that costs can be
The assumption is made that costs can be
classified as either variable with respect to
classified as either variable with respect to
units of output or fixed.
units of output or fixed.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.15
One
One
-
-
Time
Time
-
-
Only Special Order
Only Special Order
(Continued)
(Continued)
Variable Fixed
Variable Fixed
Costs Costs
Costs Costs
Per Unit
Per Unit
Per Unit
Per Unit

Direct materials
Direct materials

6.50
6.50

-
-
0
0
-
-

Direct labour
Direct labour
.50
.50
1.50
1.50

Manufacturing costs
Manufacturing costs
1.50
1.50
3.50
3.50

Total
Total

8.50
8.50

5.00
5.00
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.16

Total fixed direct manufacturing labour
Total fixed direct manufacturing labour
amounts to
amounts to

45,000.
45,000.

Total fixed overhead is
Total fixed overhead is

105,000.
105,000.

Marketing costs per unit are
Marketing costs per unit are

7 (
7 (

5 of which
5 of which
is variable).
is variable).

What is the full cost per towel?
What is the full cost per towel?
One
One
-
-
Time
Time
-
-
Only Special Order
Only Special Order
(Continued)
(Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.17

Variable (
Variable (

8.50 +
8.50 +

5.00):
5.00):

13.50
13.50

Fixed:
Fixed:
7.00
7.00

Total
Total

20.50
20.50

A hotel in Southampton has offered to buy
A hotel in Southampton has offered to buy
5,000 towels from Gabriela & Co at
5,000 towels from Gabriela & Co at

11.50 per
11.50 per
towel for a total of
towel for a total of

57,500.
57,500.
One
One
-
-
Time
Time
-
-
Only Special Order
Only Special Order
(Continued)
(Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.18

No marketing costs will be incurred for this
No marketing costs will be incurred for this
one
one
-
-
time
time
-
-
only special order.
only special order.

Should Gabriela & Co accept this order?
Should Gabriela & Co accept this order?

Yes!
Yes!

Why?
Why?
One
One
-
-
Time
Time
-
-
Only Special Order
Only Special Order
(Continued)
(Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.19

The relevant costs of making the towels are
The relevant costs of making the towels are

42,500.
42,500.

8.50
8.50

5,000
5,000
=
=

42,500 incremental costs

42,500 incremental costs

57,500
57,500

42,500
42,500
=
=

15,000 incremental
15,000 incremental
revenues
revenues

11.50
11.50

8.50
8.50
=
=

3.00 contribution margin

3.00 contribution margin
per towel
per towel
One
One
-
-
Time
Time
-
-
Only Special Order
Only Special Order
(Continued)
(Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.20

Decision criteria:
Decision criteria:

Accept the order if the revenue differential
Accept the order if the revenue differential
is greater than the cost differential.
is greater than the cost differential.
One
One
-
-
Time
Time
-
-
Only Special Order
Only Special Order
(Continued)
(Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.21
Learning Objective 4
Learning Objective 4
Describe a make
Describe a make
-
-
or
or
-
-
buy decision
buy decision
process
process
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.22
Insourcing versus Outsourcing
Insourcing versus Outsourcing
Outsourcing
Outsourcing
is the process of purchasing
is the process of purchasing
goods and services from outside sellers rather
goods and services from outside sellers rather
than producing goods or providing services
than producing goods or providing services
within the organisation, which is called
within the organisation, which is called
insourcing
insourcing
.
.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.23
Make
Make
-
-
or
or
-
-
Buy Decisions
Buy Decisions

Decisions about whether to outsource or
Decisions about whether to outsource or
produce within the organisation are often
produce within the organisation are often
called make
called make
-
-
or
or
-
-
buy decisions.
buy decisions.

The most important factors in the make
The most important factors in the make
-
-
or
or
-
-
buy
buy
decision are quality, dependability of supplies
decision are quality, dependability of supplies
and costs.
and costs.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.24
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)

Gabriela & Co also manufactures bath
Gabriela & Co also manufactures bath
accessories.
accessories.

Management is considering producing a
Management is considering producing a
part it needs (#2) or using a part produced
part it needs (#2) or using a part produced
by Alec Enterprises.
by Alec Enterprises.
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.25

Gabriela & Co has the following costs for
Gabriela & Co has the following costs for
150,000 units of Part #2:
150,000 units of Part #2:

Direct materials
Direct materials

28,000
28,000
Direct labour
Direct labour
18,500
18,500
Mixed overhead
Mixed overhead
29,000
29,000
Variable overhead
Variable overhead
15,000
15,000
Fixed overhead
Fixed overhead
30,000
30,000
Total
Total

120,500
120,500
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.26

Mixed overhead consists of material handling
Mixed overhead consists of material handling
and set
and set
-
-
up costs.
up costs.

Gabriela & Co produces the 150,000 units in
Gabriela & Co produces the 150,000 units in
100 batches of 1,500 units each.
100 batches of 1,500 units each.

Total material handling and set
Total material handling and set
-
-
up costs equal
up costs equal
fixed costs of
fixed costs of

9,000 plus variable costs of

9,000 plus variable costs of

200 per batch.

200 per batch.
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.27

What is the cost per unit for Part #2?
What is the cost per unit for Part #2?

120,500
120,500

150,000 units
150,000 units
=
=

0.8033/unit
0.8033/unit

Alec Enterprises offers to sell the same part
Alec Enterprises offers to sell the same part
for
for

0.55.
0.55.

Should Gabriela & Co. manufacture the part
Should Gabriela & Co. manufacture the part
or buy it from Alec Enterprises?
or buy it from Alec Enterprises?
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.28

The answer depends on the difference in
The answer depends on the difference in
expected future costs between the alternatives.
expected future costs between the alternatives.

Gabriela & Co. anticipates that next year the
Gabriela & Co. anticipates that next year the
150,000 units of Part #2 expected to be sold
150,000 units of Part #2 expected to be sold
will be manufactured in 150 batches of 1,000
will be manufactured in 150 batches of 1,000
units each.
units each.
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.29

Variable costs per batch are expected to
Variable costs per batch are expected to
decrease to
decrease to

100.
100.

Gabriela & Co. plans to continue to produce
Gabriela & Co. plans to continue to produce
150,000 next year at the same variable
150,000 next year at the same variable
manufacturing costs per unit as this year.
manufacturing costs per unit as this year.

Fixed costs are expected to remain the same
Fixed costs are expected to remain the same
as this year.
as this year.
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.30

What is the variable manufacturing cost
What is the variable manufacturing cost
per unit?
per unit?

Direct material
Direct material

28,000
28,000
Direct labour
Direct labour
18,500
18,500
Variable overhead
Variable overhead
15,000
15,000
Total
Total

61,500
61,500

61,500
61,500

150,000
150,000
=
=

0.41 per unit

0.41 per unit
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.31

Expected relevant cost to make Part #2:
Expected relevant cost to make Part #2:

Manufacturing
Manufacturing

61,500
61,500
Material handling and set
Material handling and set
-
-
ups
ups
15,000
15,000
*
*
Total relevant cost to make
Total relevant cost to make

76,500
76,500

Cost to buy: (150,000
Cost to buy: (150,000

0.55)
0.55)

82,500
82,500

Gabriela & Co will save
Gabriela & Co will save

6,000 by making
6,000 by making
the part.
the part.
*150
*150

100
100
= =

15,000
15,000
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.32

Now assume that the
Now assume that the

9,000 in fixed clerical

9,000 in fixed clerical
salaries to support material handling and set
salaries to support material handling and set
-
-
up
up
will not be incurred if Part #2 is purchased
will not be incurred if Part #2 is purchased
from Alec Enterprises.
from Alec Enterprises.

Should Gabriela & Co buy the part or make
Should Gabriela & Co buy the part or make
the part?
the part?
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.33

Relevant cost to make:
Relevant cost to make:

Variable
Variable

76,500
76,500
Fixed
Fixed
9,000
9,000
Total
Total

85,500
85,500

Cost to buy:
Cost to buy:

82,500
82,500

Gabriela would save
Gabriela would save

3,000 by buying
3,000 by buying
the part.
the part.
Make
Make
-
-
or
or
-
-
Buy Decisions (Continued)
Buy Decisions (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.34
Learning Objective 5
Learning Objective 5
Describe the opportunity cost
Describe the opportunity cost
concept; explain why it is used in
concept; explain why it is used in
decision making
decision making
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.35
Opportunity Costs, Outsourcing
Opportunity Costs, Outsourcing
and Constraints
and Constraints

Assume that if Gabriela buys the part from
Assume that if Gabriela buys the part from
Alec Enterprises, it can use the facilities
Alec Enterprises, it can use the facilities
previously used to manufacture Part #2 to
previously used to manufacture Part #2 to
produce Part #3 for Krysta Ltd.
produce Part #3 for Krysta Ltd.

The expected additional future operating
The expected additional future operating
profit is
profit is

18,000.
18,000.

What should Gabriela & Co do?
What should Gabriela & Co do?
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.36

Gabriela & Co. has three options:
Gabriela & Co. has three options:
1 1
Make Part #2 and do not make Part #3 for
Make Part #2 and do not make Part #3 for
Krysta.
Krysta.
2 2
Buy Part #2 and do not make Part #3 for
Buy Part #2 and do not make Part #3 for
Krysta.
Krysta.
3 3
Buy the part and use the facilities to produce
Buy the part and use the facilities to produce
Part #3 for Krysta.
Part #3 for Krysta.
Opportunity Costs, Outsourcing
Opportunity Costs, Outsourcing
and Constraints (Continued)
and Constraints (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.37

Expected cost of obtaining 150,000 parts:
Expected cost of obtaining 150,000 parts:

Buy Part #2
Buy Part #2
Buy Part #2
Buy Part #2
and do not
and do not
and make
and make
Make
Make
make Part #3
make Part #3
Part #3
Part #3
Part #2
Part #2

82,500
82,500

64,500*
64,500*

76,500
76,500
*
*

82,500
82,500

18,000
18,000
= =

64,500
64,500
Opportunity Costs, Outsourcing
Opportunity Costs, Outsourcing
and Constraints (Continued)
and Constraints (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.38

Opportunity cost is the contribution to profit
Opportunity cost is the contribution to profit
that is foregone (rejected) by not using a
that is foregone (rejected) by not using a
limited resource in its next
limited resource in its next
-
-
best alternative use.
best alternative use.
Opportunity Costs, Outsourcing
Opportunity Costs, Outsourcing
and Constraints (Continued)
and Constraints (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.39

Opportunity costs are not recorded in formal
Opportunity costs are not recorded in formal
accounting records since they do not generate
accounting records since they do not generate
cash outlays.
cash outlays.

These costs also are not ordinarily
These costs also are not ordinarily
incorporated into formal reports.
incorporated into formal reports.
Opportunity Costs, Outsourcing
Opportunity Costs, Outsourcing
and Constraints (Continued)
and Constraints (Continued)
Based upon Bhimani, Horngren, Datar, Foster, Management and Cost Accounting, 4
th
Edition, Pearson Education Limited 2008
Slide 1.4.40
End of Chapter 1.4
End of Chapter 1.4