Chapter 9: Relevant Costs

Question 1

Every decision involves choosing between at least ____ alternatives, after comparing the ____ costs and and the benefits of the alternatives

Answer 1

2

Relevant

Question 2

Relevant costs

Answer 2

Costs that differ between alternatives in a particular decision. (That are yet to be incurred)

In managerial accounting, this term is synonymous with avoidable costs, incremental costs, and differential costs.

Question 3

Differential costs (aka Incremental costs)

Answer 3

Any cost that differs between alternatives in a decision-making situation. In managerial accounting, this term is synonymous with avoidable cost, incremental cost, and relevant cost.

Question 4

Example

Answer 4

Family is deciding whether or not to go to the movie theater or renting a movie, the relevant costs, those that differ between the two alternatives, include 1) Cost of renting a movie, 2) Ticket price at the theater, 3) Cost of popcorn and drinks at the theater

If you go to the movie, no rent cost
If you rent the movie, no movie ticket cost

Question 5

Avoidable cost

Answer 5

Any cost that can be eliminated (in whole or in part) by choosing one alternative over another in a decision-making situation.

In managerial accounting, this term is synonymous with incremental cost, relevant cost, and differential cost.

Example: Choosing the movie ticket rather than renting a movie, renting a movie is an avoidable cost

Question 6

Any costs that are unavoidable across the alternatives being considered is ______

Answer 6

Irrelevant

if mortgage is $2000 a month regardless it should not be involved in the decision making

Question 7

Opportunity cost (are relevant costs)

Answer 7

The potential benefit given up when one alternative is selected over another.

Example: Giving up work to go the movie, the opportunity cost is the $35 you would have made working

Question 8

Sunk cost (irrelevant cost)

Answer 8

Any cost that has already been incurred and cannot be changed by any decision made now or in the future.

Example: Already bought the movie ticket, now it cant be refunded

Question 9

TWO important conclusions to relevant costs

Answer 9

1) They differ among alternatives

2) They are costs that will be incurred in the future

Question 10

Costs that are always relevant

Answer 10

Avoidable
Incremental
Differential costs
Opportunity costs

Question 11

To figure out if costs that are avoidable (differential) in a particular decision situation and therefore relevant, follow these steps:

Answer 11

1) Eliminate costs and benefits that do not differ between alternatives (these irrelevant costs consist of (a) sunk costs and (b) future costs that do not differ between alternatives
2) Use the remaining costs and benefits that do differ between alternatives in making the decision. he costs that remain are the differential or avoidable costs

Question 12

Common fixed cost

Answer 12

A fixed cost that supports the operations of more than one segment of an organization and is not avoidable in whole or in part by eliminating any one segment.

Rent may split 4 ways between the segments, but the total rent amount per month is the same (dropping the segment still means there is a rent expense)

Question 13

Segment margin

Answer 13

The difference between the revenue generated by a segment and its own traceable cost.

Unless another product can get generate more than the segment margin, the company is better off keeping the line

Question 14

Make-or-buy decision (aka outsourcing or subcontracting)

Answer 14

A decision on whether an item should be produced internally or purchased from an outside supplier.

Question 15

Special order

Answer 15

A one-time order not considered part of the company’s normal ongoing business.

Remember to drop fixed overhead

Question 16

In general, a special order is profitable as long as the incremental revenue from the special order exceeds the incremental costs of the order

Answer 16

Incremental revenue is the sell price x quantity

Question 17

Target costing

Answer 17

A method of costing in which, before launching a new product, management estimates how much the market will be willing to pay for the product and then takes steps to ensure that the cost will be low enough to provide an adequate profit margin.

The company’s required profit margin is subtracted from the estimated selling price to determine the target cost for the new product – if it becomes clear meeting the target cost is not possible, drop the new product immediately

Question 18

Advantages to target costing (over cost-plus markup approach)

Answer 18

1) Product is not made unless the company is reasonably confident that customers will be willing to buy the product at a price that provides the company with adequate profit
2) The target costing approach inspires a much higher level of cost-consciousness than the cost-plus approach and probably results in less expensive products that are more attractive to customers

Question 19

Constraint

Answer 19

A limitation under which a company must operate—such as limited machine time available or limited raw materials available—that restricts the company’s ability to satisfy demand.

When a limited resource of some type restricts the company’s ability to satisfy demand

Fixed costs do not matter, choose option that maximizes the firms TOTAL contribution margin

Question 20

Bottleneck

Answer 20

A machine or process that limits total output because it is operating at capacity. (a constraint)

When demand for a company’s products and services exceeds its ability to supply them

Question 21

Contribution margin per unit of the constrained resource

equation kinda

Answer 21

Computed by dividing the contribution margin by the amount of the constrained resource that a unit of product requires

Example: $15 CM per unit, 2minutes to make, $7.50/min (Higher number wins)

Question 22

Relaxing the constraint (elevating the constraint)

Answer 22

An action that increases the capacity of a bottleneck

Example: asking the stitching machine operator to work overtime

Question 23

The capacity of a bottle neck can be effectively increase in a number of ways, including:

Answer 23

• Working overtime on the bottleneck
• Subcontracting some of the processing that would be done at the bottleneck
• Investing in additional machines at the bottleneck
• Shifting workers from processes that are not bottlenecks to the process that is a bottleneck
• Focusing business process improvement efforts, such as TQM and business process reengineering, on the bottleneck
• Reducing defective units

Last three are ideal as they are free and may yield additional savings

Question 24

Split-off point

Answer 24

That point in the manufacturing process where some or all of the joint products can be recognized as individual products.

Question 25

Joint products

Answer 25

Two or more products that are produced from a common input.

Example: A chicken contains breasts, wings, legs, thighs, etc

Question 26

Intermediate product

Answer 26

Partially finished product

Question 27

End product

Answer 27

Fully finished product

Question 28

Joint cost (common cost : allocated among products)

Answer 28

A cost item among those incurred up to the split-off point in a process that produces joint products.

The cost incurred up to the split-off point

Question 29

Sell-or-process-further decisions

Answer 29

Decisions as to whether a joint product should be sold at the split-off point or sold after further processing.

Question 30

It is profitable to continue processing a joint product after the split-off point

Answer 30

so long as the incremental revenue from such processing exceeds the incremental processing cost incurred after the split-off point

Question 31

Even if a joint product was disposed of at the split-off point without any further processing

Answer 31

All of the joint costs must be incurred and no part is avoidable by disposing of any one of the products that emerge from the split-off point

Question 32

For each end product, use these three steps to make sell-or-process-further decision (equation)

Answer 32

1) Calculate the sales value if processed further minus the sale value at each split-off point.
The sales value is quantity of product x the unit price of each unit

2) Determine the cost of further processing beyond the split-off-point
3) Take the amount in step 1 and subtract it from the amount in step 2. If the result is a positive number, than choose to process further. If it is a negative number, than choose to sell at the split-off point

Question 33

Depreciation of equipment is a ______ cost and should be _____

Answer 33

Sunk cost

SHOULD BE IGNORED

Question 34

Allocations of common fixed costs like _______________ should be _______________

Answer 34

General overhead (DO NOT INCLUDE GENERAL OVERHEAD)

IGNORED

Question 35

When is data relevant

Answer 35

Only costs and benefits that differ in TOTAL between alternatives are relevant in decision making

Question 36

If fixed costs are ___ more than then the contribution margin, you should ____ keep the line

Answer 36

more

Keep

Question 37

Idle Space that has no alternative use

Answer 37

Has an opportunity cost of zero

Question 38

To maximize total contribution margin,

Answer 38

A firm should promote those products or accept those orders that provide the highest unit contribution margin PER UNIT OF THE CONSTRAINED RESOURCE

Question 39

Managers should focus much of their attention on managing ___________

Answer 39

Bottlenecks

Question 40

Managers should emphasize products that most

Answer 40

profitably utilize the constrained resource

Question 41

Four steps to help determine the most profitable use of a constrained resource

Answer 41

1) Calculate each product’s contribution margin per unit
2) Identify the constringing resource, and calculate the quantity of that resource used to make one unit of each product
3) Calculate each product’s contribution margin per unit of the constraining resource (Step 1 / Step 2)
4) Rank the products from the highest contribution margin per unit of the constraining resource to the lowest

Question 42

Note that the joint costs of buying the wool and separating the wool (joint costs) are ______ when considering the profitability of the _____ operation

Answer 42

Relevant

Entire

The joint costs could be avoided if the entire operation was shut down

Question 43

Joint costs are not relevant when

Answer 43

Considering the profitability of any one product

Question 44

General Rule #1b

Answer 44

Costs relevant in one decision situation are not necessarily relevant in another

Question 45

General Rule #2a

Answer 45

If, by dropping a segment, the company is able to avoid more in fixed costs than it loses in contribution margin, then it would be better off dropping the segment (i.e. overall net income should improve)

If the company would not be able to avoid as much in fixed costs as it would lose in contribution margin, then it would not be better off dropping the segment

Question 46

General Rule #2b

Answer 46

If, by adding a segment, the company is able to increase contribution margin by more than any related increase in fixed costs, then it would be better off adding the segment (i.e. overall net income should improve)

If the company would have to incur more fixed costs than any related increase in contribution margin, then it would not be better off adding the segment

Question 47

General Rule #3

Answer 47

The company should outsource only if the outside purchase price is less than the costs that can be avoided by not producing internally