Chapter 11: Decision Making and Relevant Information Flashcards
What are the 5 steps in decision-making?
1. Obtain information
- Make predictions about future costs
- Choose an alternative
- Implement the decision
- Evaluate performance
Bonus: Receive feedback from every step
What are the 2 characteristics of relevant costs and revenues?
What are relevant costs?
What are relevant revenues?
- Occurs in the future
- Differ among alternatives
Relevant costs: expected future costs
Relevant revenues: expected future revenues
What are the key features of relevant information?
- Sunk costs are irrelevant for future decisions
- Compare differences in expected revenues and costs
- Ignore future revenue and costs that is the same
- Managers should consider qualitative & quantitative nonfinancial factors in decision-making
What is opportunity cost?
Contribution to operating income that is given up by choosing another alternative.
What are inventory holding costs?
Funds tied up in inventory that can’t be invested elsewhere.
What are quantitative factors?
Outcomes that can be measured in numerical terms.
What are qualitative factors?
Outcomes that are difficult to quantitatively measure.
What is incremental cost?
Additional total cost incurred for an activity.
What is differential cost?
Difference in total cost between two alternatives.
What is incremental revenue?
The additional total revenue from an activity.
What is differential revenue?
The difference in total revenue between two alternatives.
Name some types of business decisions.
- One-time special orders
- Make (insourcing) vs. Buy (outsourcing)
- Product mix: which products to sell and in what quantities
- Customer profitability: adding or discontinuing product lines or business segments
- Replacing equipment
What is absorption costing?
Determining the cost of inventory using all variable manufacturing costs and all fixed manufacturing costs.
What is the decision that needs to be made when considering one-time-only special orders?
What is the decision rule?
How is the decision made?
Accept when there is idle production capacity and no long-run implications.
Does the special order generate additional operating income?
Yes = Accept
No = Reject
Compare relevant revenues and costs to determine profitability.
What is the decision that needs to be made when considering insourcing vs. outsourcing?
What is the decision rule?
Producing goods or services within or from outside vendors.
The decision rule is to select the option that will provide the firm with the lowest cost and highest profit.
What are some qualitative outsourcing factors?
- Quality requirements
- Reputation of outsourcer
- Employee morale
- Logistical considerations
What is the decision that needs to be made when considering product mix?
What is the decision rule?
What product should be sold and in what quantities.
The decision rule is to choose the product that produces the highest contribution margin per unit, but considering constraints in capacity and demand.
What is the decision that needs to be made when considering adding or dropping customers?
What is the decision rule?
Should we add or discontinue a product line or business segment.
The decision rule is if adding or dropping a customer adds to operating income.
Yes = Add or don’t drop
No = Drop or don’t add
Decision is based on profitability not revenue.
What is the decision that needs to be made when considering replacing equipment?
What is the decision rule?
What are some of the irrelevant cost related to this decision?
Whether to replace equipment.
The decision rule is to select the alternative that will generate the highest operating income.
Irrelevant Information
- Cost, accumulated depreciation, and book value of equipment
- Potential gains or losses on the transaction
What are the potential problems with using unit-cost data with relevant-cost analysis ?
- Including irrelevant costs in error
- Using the same unit-cost with different output levels
