Chapter 10 - Relevant information for decision making Flashcards
1 Describe a five-step sequence in the decision process
The five steps which managers might undertake in a decision process are: (a) obtain information, (b) make predictions, (c) choose alternative courses of action, (d) implement decisions, and (e) evaluate performance.
Remember all decision models are simplifications of the real world.
2 How do we determine if a cost or revenue is relevant? Differentiate relevant costs and revenues from irrelevant costs and revenues
To be relevant to a particular decision, a revenue or cost must meet two criteria: (a) it must be an expected future revenue or cost, and (b) it must differ among alternative courses of action.
What is a differential cost?
The difference in total cost between two alternatives is a differential cost.
3 Distinguish between quantitative factors and qualitative factors in decisions
The consequences of alternative actions can be quantitative and qualitative. Quantitative factors are outcomes that are measured in numerical terms. Some quantitative factors can be easily expressed in financial terms, others cannot. Qualitative factors, such as employee morale, cannot be measured in numerical terms. Due consideration must be given to both financial and non-financial factors in making decisions.
What is incremental costs?
Incremental costs are additional costs to obtain an additional quantity, over and above existing or planned quantities, of a cost object.
Simply looking at the per-unit cost in the budgeted income statement (especially when absorption costing is used) is misleading!
Not all variable costs are necessarily relevant and not all fixed costs are necessarily irrelevant: additional capacity could be required.
4 Identify two potential problems in relevant-cost analysis and describe problems that could incur with unitised costs
There are two common problems in relevant-cost analysis: (a) assuming all variable costs are relevant, and (b) assuming all fixed costs are irrelevant.
Unit-cost data mislead decision makers in two major ways: (a) when costs that are irrelevant to a particular decision are included in unit costs, and (b) when unit costs that are calculated at different output levels are used to choose among alternatives. Generally, use total costs rather than unit costs in relevant-cost analysis.
5 Describe the opportunity cost concept and explain why it is used in decision making
Opportunity cost is the maximum available contribution to income that is forgone (rejected) by not using a limited resource in its next-best alternative use. The idea of an opportunity cost arises when there are multiple uses for resources and some alternatives are not selected. Opportunity cost is often included in decision making because it represents the best alternative way in which an organisation may have used its resources had it not made the decision it did.
6 Describe the key concept in choosing which among multiple products to produce when there are capacity constraints
In choosing among multiple products when resource capacity is constrained, managers should emphasise the product that yields the highest contribution margin per unit of the constraining or limiting factor. An example of a constraining factor could be machine hours. Then the product that should be produced is the produce that contributes more margin per machine-hour.
Usually not incorporated in financial accounting reports.
Not linked to any cash receipts or disbursements.
7 Explain why the book value of equipment is irrelevant in equipment-replacement decisions
Expected future revenues and costs are the only revenues and costs relevant in any decision model. The book value of existing equipment in equipment-replacement decisions represents past (historical) cost and therefore is irrelevant.
Define sunk costs
Past costs that are unavoidable because they cannot be changed.
What is a performance report?
A report that compares actual results with budgeted amounts.
What is a performance report?
A report that compares actual results with budgeted amounts.
What is the decision-facilitating role of management accounting information?
Provides necessary information for planning and decision-making
Improves employees’ abilities to make desirable decisions
Enables employees to achieve organization’s goals and objectives
What is the decision-influencing role of management accounting information?
Provides information to align interests of employees with organization
Directs employee effort to activities that benefit the organization
Motivates individuals
What is an important purpose of management accounting?
Enhance firm value by ensuring effective and efficient use of scarce resources
What is the role of book value in the decisions about replacement of machines?
Book value is irrelevant in decisions about the replacement of equipment because it is a past (historical) cost. All past costs are down the drain.
