Decision Making

and
Relevant Information

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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

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Types of Decisions
One-time-only special orders
In sourcing vs. outsourcing
Make or buy
Customer profitability
Equipment replacement

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One-Time-Only Special Orders
Accepting or rejecting special orders when there is
idle production capacity and the special orders have
no long-run implications
Decision rule: Does the special order generate
additional operating income?
Yes—accept
No—reject
Compares relevant revenues and relevant costs to
determine profitability

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Example
 Example : Surf Gear manufactures quality beach towels at its highly
auto mated Burlington, North Carolina, plant. The plant has a
production capacity of 45,000 towels each month. Current monthly
production is 30,000 towels. Retail department stores account for all
existing sales. The next slide shows the expected results for the coming
month (August).

 Azelia is a luxury hotel chain that purchases towels from Mugar

Corporation. The workers at Mugar are on strike, so Azelia must find a
new supplier. In August, Azelia contacts Surf Gear and offers to buy
5,000 towels from them at $11 per towel. Based on the following facts,
should Surf Gear’s managers accept Azelia’s offer?

© 2012 Pearson Prentice Hall. All rights reserved.

© 2012 Pearson Prentice Hall. All rights reserved.
© 2012 Pearson Prentice Hall. All rights reserved.
Insourcing vs. Outsourcing
Insourcing—producing goods or services within an
organization
Outsourcing—purchasing goods or services from
outside vendors
Also called the make-or-buy decision
Decision rule: Select the option that will provide the
firm with the lowest cost, and therefore the highest
profit.

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…
 Example : The Soho Company manufactures a two-in-one video system
consisting of a DVD player and a digital media receiver (that downloads
movies and video from Internet sites such as Netflix). Columns 1 and 2 of the
following table show the expected total and per-unit costs for
manufacturing the DVD player. Soho plans to manufacture the 250,000
units in 2,000 batches of 125 units each. Variable batch-level costs of $625
per batch vary with the
number of batches, not the total number of units produced.
Broadfield, Inc., a manufacturer of DVD players, offers to sell Soho 250,000
DVD players next year for $64 per unit on Soho’s preferred delivery
schedule.

Assume that financial factors will be the basis of this make-or-buy decision.
Should Soho’s managers make or buy the DVD player?

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© 2012 Pearson Prentice Hall. All rights reserved.
Make-or-Buy Illustration

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Make Or Buy: Alternative use for
released capacity
 In the simple make-or-buy decision in we assumed that the capacity currently used to
make DVD players will remain idle if Soho purchases DVDs from
Broadfield. Often, however, the released capacity can be used for other, profitable
purposes.
 Example : If Soho decides to buy DVD players for its video systems from
Broadfield, then Soho’s best use of the capacity that becomes available is to
produce 100,000 Digiteks, a portable, stand-alone DVD player. From a manufacturing
standpoint, Digiteks are similar to DVD players made for the video system. With help
from operating managers, Soho’s management accountant estimates the future revenues
and costs presented in the following slide if Soho decides to manufacture and sell Digiteks:
 Because of capacity constraints, Soho can make either DVD players for its
video-system unit or Digiteks, but not both. Which of the two alternatives
should Soho’s managers choose: (1) make video-system DVD players and do
not make Digiteks or (2) buy video-system DVD players and make Digiteks?

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Comparison of the two courses of actions is presented in the following
slide under
a.Total alternatives approach and,
b. Opportunity cost approach
© 2012 Pearson Prentice Hall. All rights reserved.
© 2012 Pearson Prentice Hall. All rights reserved.
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, and so
on

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Equipment-Replacement Decisions
Example: Toledo Company, a manufacturer of aircraft
components, is considering replacing a metal-cutting machine
with a newer model. The new machine is more efficient than
the old machine, but it has a shorter life. Revenues from
aircraft parts ($1.1 million per year) will be unaffected by the
replacement decision. The following slide presents the data
the management accountant prepares for the existing
(old) machine and the replacement (new) machine:
Toledo Corporation uses straight-line depreciation. To focus
on relevance, we ignore the time value of money and income
taxes. Should Toledo’s managers replace its old machine?

© 2012 Pearson Prentice Hall. All rights reserved.

© 2012 Pearson Prentice Hall. All rights reserved.
Equipment-Replacement Decisions,
Illustrated (Relevant Costs Only)

© 2012 Pearson Prentice Hall. All rights reserved.

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 self-serving behavior such
as delaying needed equipment maintenance in order
to meet their personal profitability quotas for bonus
consideration.

© 2012 Pearson Prentice Hall. All rights reserved.