1.6. Relevant Information for Decision Making with a Focus on Operational Decisions

Question 1

What is a….
1. Differential Analysis?
2. Incremental Analysis?

Answer 1

Differential
1. decision process that compares differential revenues and costs of alternatives
2. take alternative creating maximum “benefits minus cost” amount
2. e.g. which of two machines to purchase

Incremental
1. analyzing incremental revenues and costs between the existing situation and proposed alternatives
2. take alternative with the highest increment in “benefit minus costs”
3. e.g. increase production from 1000 to 1200 units per day

Question 2

What are opportunity costs?

Answer 2

• opportunity cost is the maximum available benefit forgone (or passed up) by using such a resource for a particular purpose instead of the best alternative use

Question 3

What are avoidable costs?

Answer 3

• Costs that will not continue if an ongoing operation is changed or deleted.

Question 4

What are unaviodable costs?

Answer 4

• Costs that will continue even if a company discontinues an operation.

Question 5

What are common costs?

Answer 5

• those costs of facilities and services that are shared by users

Question 6

What is meant by optimal use of limited resources?

What are possible limiting factors? (2)

Answer 6

• a limiting factor or scarce resource restricts or constraints the production or sale of a product or service
• labor hours and machine hours (in manufacturing firms)
• square feet of floor space or cubic meters of display space (in sales stores)

Question 7

What is a sunk cost?

1.
2.
3.

Answer 7

• historical or past cost that has already incurred to the company, and therefore is irrelevant to the decision making process
• e.g. book value of asset
• in decision making, only furute costs and revenues that differ among alternative course of action are of interest

Question 8

What can be said about Decision Making versus performance Evaluation?

1.
2.

Answer 8

• methods of evaluating managers performance should be consistent with appropriate decision model for the company
• assume that top management uses accounting income to measure a managers performance

Question 9

In a make or buy decision, which of the following is the fundamental question that is asked in making the decision?

Answer 9

• what is the difference in future costs between the two alternatives?

Question 10

Assume no opportunity costs. When deciding whether to add or delete a department, managers should keep the department as long as ________
from the department exceeds ________.

Answer 10

contribution margin
avoidable fixed costs