Chapter 11 - Cost

Question 1

Relevant information

Answer 1

• Expected future cost and revenues
  (past cost are sunk)
• amounts differ among alternatives

Question 2

why is it important to use relevant information?

Answer 2

time is limited.

we don’t need to analyze information that doesn’t differ among the alternatives.

Question 3

Make vs. Buy Decisions

Answer 3

Factors that need to be considered
If I buy the part, what else can I do with the production facility?

Alternative use of the facility

• The quality of the supplier’s product
• The reliability of the supplier’s delivery schedule
• The net cost (benefit) of outsourcing versus insourcing

Question 4

Make vs. Buy Decisions

Answer 4

Think in terms of future cash impact on company
$ already spent are sunk costs, not relevant

Which outcome will have the most favorable cash impact on company?

Note that companies also like to consider net income impacts, even if it differs from cash answer

Question 5

Opportunity Costs

Answer 5

Contribution to income foregone by not using a resource in its next best alternative:

Applies when capacity is constrained
If there is excess capacity, opportunity costs = 0 (no alternative for capacity)

Not recorded in books and records; used for analysis only.

Question 6

Product Mix

Answer 6

When capacity (square footage, labor hours available, etc.) is constrained:

Which product should I make when I can’t make them all?

Choose product with highest contribution margin per unit of the constrained resource.

Question 7

Product mix example

Answer 7

Step 1 – Compute the contribution margin per unit
(SP - VC = CM)

Step 2 – Compute the CM per unit of constrained resource
(CM / Labor hours = CM/ Hour)

Question 8

Adding/Discontinuing Segments

Answer 8

Focus on total costs and revenues difference among alternatives
- Will my total cash increase or decrease?

Overhead - If total overhead does not change, it is not relevant to analysis
- Even if segment/customer was allocated overhead

Question 9

Segment Example

Answer 9

Sale
(COGS)
=GM
(VOH)
(Allocated corp. OH)
= Operating Income

Question 10

Equipment Replacement

Answer 10

Focus on cash impact over all years that equipment will be used:

Management is probably also interested in operating income impact

- Although the cash impact is the key driver
  - The cash and income impacts are the sameover the life of the new equipment.

Question 11

Operating Decisions vs. Operating Income

Answer 11

• Although the true economic benefit to the company is the impact on cash, most managers are evaluated based on current year’s income
• The accountant should consider both impacts (economic and income) when computing an analysis.