L8/9- Relevant Costs for Decision Making Flashcards
Define Relevant costs
Costs and Benefits that differs between alternatives.
Define Irrelevant Costs
Cost that differs between alternatives.
Any cost or benefit that does not differ between
alternatives is irrelevant and can be ignored in a decision.
Define Alternative Costs
Costs that can be eliminated (in whole or in part) by choosing
one alternative over another
Are Alternative Costs, relevant costs
Yes
Define Unavoidable costs
Are never relevant and include:
–Sunk Costs
–Future Costs
Define Sunk Costs
A cost that has already been incurred and that cannot
be avoided regardless of what a manager decides to do
By rule of thumb are variable relevant or irrelevant
Relevant
By rule of thumb, are fixed costs relevant or irrelevant
Irrelevant, BUT Fixed costs that differ between alternatives (e.g., beyond the
relevant range) are relevant
One of the most important decisions managers make is
whether to add or drop a business segment such as a
product or a store. how should relevant costs be
used in this decision. What 2 approaches
1) Compare contribution margins and fixed costs
2) Compare profits:
Describe Compare contribution margins and fixed costs approach
(i) A segment should be added only if the increase in total contribution
margin is greater than the increase in fixed cost.
(ii) A segment should be dropped only if the decrease in total
contribution margin is less than the decrease in fixed cost.
Describe the Compare Profits approach
(i) A second approach is to calculate the total profit under each
alternative.
(ii) The alternative with the highest profit is preferred.
(This approach requires more information than the first approach since
costs and revenues that don’t differ between the alternatives must be
included in the analysis when the profits are compared.)
Define Make or Buy Decision
A decision concerning whether an item should be produced
internally or purchased from an outside supplier
LOOK AT EXAMPLES OF LECTURE SLIDES
Yes
Define Special Orders
One-time orders that do not affect a
company’s normal sales.
▪Idle capacity can be used to earn extra money.
▪If there is no idle capacity, opportunity costs should be included
as part of the incremental costs.
Should you accept the offer of: Incremental revenue > Incremental costs
Yes it = Net Profit
True or False. Managers must at times give more weight to qualitative or
non-financial quantitative factors.
True
Define Constrained Resource
a limited resource that limits
organizational ability to fulfill the sales demand
When a multiple-product plant operates at full capacity,
managers must often make decisions which products
to emphasize
Examples of Constrained Resources
▪ Any special machine
▪ Availability of skilled labour/ material
▪ Fluctuations in material costs/ demand
If Good A has a lower CM than Good B, BUT a higher CM per limited resources, which one should be prioritised
Good A
Should you promote products that have the highest unit CM or products that have the highest CM, relative to the
constraining resource
products that have the highest CM, relative to the
constraining resource
Define Joint Products
a number of products are produced from a
single raw material input
Define Split off point
The point in the manufacturing process where each joint product can be recognized as a separate product
Are Joint Costs Relevant or Irrelevant Costs
Joint costs are irrelevant in decisions
regarding what to do with a product from the split-off point forward.
Therefore, these costs should not be
allocated to end products for decision-making purposes
Incremental Revenue equation
Final sales value – Sales value at split-off
Define Incremental processing costs
Costs incurred after the split-off
Incremental profit/loss equation
Incremental revenue – Incremental processing costs
True or False. It will always be profitable to continue processing a joint product after the split-off point so long as the incremental revenue exceeds the incremental
processing costs incurred after the split-off point.
True
True or False. With respect to sell or process further
decisions, it is profitable to continue processing a joint product after the split-off point so long as:
the incremental revenue from processing
>
the incremental processing costs for processing
True
What are the five steps which managers might undertake in a decision process
1) Obtain Info.
2) Make Predictions
3) Choose alternative courses of action
4) Implement decisions
5) Evaluate Performance
What is the relevant cost criteria
(a) it must be an expected future revenue or cost
(b) it must differ among alternative courses of action.
What are the 2 types of consequences from alternative actions
Qualitative and Quantitative
Describe Qualitative Factors
employee morale, organisational culture or political fallout as they cannot be measured in numerical terms
Describe Quantitative Factors
outcomes that are measured in numerical terms. Some quantitative factors can be easily expressed in financial terms, others cannot
What are two common problems in relevant-cost analysis
(a) assuming all variable costs are relevant, (b) assuming all fixed costs are irrelevant