Chapter 10 – Short-term Decision Making

Short-term decisions often address a temporary circumstance or an immediate need while long-term
decisions align more with permanent problem solving and meeting strategic goals. These decisions
require different types of analyses.

Process of decision making:

Relevant costing – focusing on the costs and benefits that differ between alternatives when making
decisions.
- Incremental/Differential cost (relevant costs) – difference in cost between any two alternatives
- Relevant benefits/differential revenue – difference in revenue between any two alternatives

*Costs and Revenues that do not differ between alternative options are irrelevant to decision making.
Irrelevant data can be ignored, so we must be able to tell the difference.

Avoidable cost – a cost that can be eliminated by choosing one alternative over another.
- For example – decision of going to movies or stay home and rent DVD
o If we choose going out to movies, the cost of renting a DVD is avoidable
o If we choose staying home and renting DVD, the cost of going out to movies is avoidable
o Rent on your apartment is unavoidable, not matter what option is chosen

Avoidable costs are relevant costs (cost of going out to movie or staying in and renting DVD).
Unavoidable costs are irrelevant costs (cost of apartment rent).

Sunk Cost – cost that has already been incurred and cannot be avoided, no matter what a manager
decides to do
- Sunk costs are irrelevant costs

Opportunity Cost – potential benefit that is given up when one alternative is selected over another

*EA1
Accept or Reject a Special Order

Normal capacity – the production level a company can achieve without adding additional production
resources

Relevant range – quantitative range of units that can be produced based on the company’s current
productive assets.

Textbook example – section 10.2

Since fixed costs have already been met with normal production and Franco has the capacity to product
800 more units, only the variable costs need to be considered. Cost of 800 units are $1,650 per unit and
special offer is for $1,800 per unit, so Franco would be making $150 per chair. Franco should accept this
offer.

*EA4

Make or Buy a Component

Does a company make a component that it needs in manufacturing a product or buy that component
already made?

Outsourcing – using another company to provide goods or services that your company requires
Textbook example – Section 10.3
*EA7

Keep or Discontinue a Segment or Product

For decision making purposes, companies can divide their organization into segments such as product
lines, geographic location, etc.
- Segment – portion of the business that management believes has sufficient similarities in product
lines, geographic locations, or customers to warrant reporting that portion of the company as a
distinct part of the entire company
Textbook example – section 10.4

Should the Snow Boots product line be discontinued? We must separate relevant costs from non-
relevant cost. Non-relevant costs, like allocated costs, are costs that won’t change whether this product
goes away or not.
- Allocated costs – cost associated with areas of the company that do not generate revenue but are
necessary for running the organization
o Examples are executive salaries, human resources, accounting
o Allocated costs do not go away if a product is discontinued. Instead the costs would be re-
allocated among the remaining product lines.
When the allocated costs are pulled away, it becomes evident that the Snow Boots line is contributing
toward meeting the fixed costs of the organization and overall profitability. The loss was due to the
evenly shared allocated costs. The company needs to consider the way allocated costs are being
assigned to products and determine if another method would be a better match of costs and services.

*EA8

Sell or Process Further

Businesses are often faced with the decision to sell partially completed products as is or to process
them further for sale as other products.
- Split-off point – the point at which some products are removed from production and sold while
others receive additional processing
- Joint costs – costs that have been shared by products up to the split-off point

Textbook example – section 10.5

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