Module 11

Question 1

What are relevant costs?

Answer 1

Future costs that will change as a result of a decision

Question 2

What are relevant revenues?

Answer 2

Future revenues that will change as a result of a decision

Question 3

Which group of costs can be eliminated from consideration?

Answer 3

1. No cost incurred prior to making the decision is relevant
2. Future costs that a business will incur for activities that are not necessary to carry out the decision are not relevant

Question 4

What is the three step process for identifying relevant costs?

Answer 4

1. First step, we removed all past costs.
2. In the second step, we removed any future costs not needed to carry out the decision.
3. In the third step, we eliminated those costs that would not differ from one decision alternative to another.

Question 5

What are incremental costs?

Answer 5

cost increases resulting from a higher volume of activity or from the performance of an additional activity

Question 6

When are incremental costs relevant?

Answer 6

They are always relevant when the higher volume of activity, or the additional activity, is not necessary for all the alternatives.

Question 7

What are avoidable costs?

Answer 7

costs that a business must incur to perform an activity at a given level, but that it can avoid if the business reduces or discontinues the activity

Question 8

What are opportunity costs?

Answer 8

the profits that a business forgoes by following a particular course of action.

Question 9

Why would a manager drop a product?

Answer 9

• because of changing technology and competition
• because it is no longer profitable
• because customers’ interest in the product has decreased
• because the product is becoming obsolete
• because the product has a poor safety record
• because new information indicates that the product may harm the environment
• any combination of these and other reasons.

Question 10

How do you evaluate the profit effects of dropping a product?

Answer 10

a. Determine the costs that it would not incur (the avoidable costs) and
b. The revenues that it would not earn if it discontinued production and sale of the product.

Question 11

When should a business drop a product?

Answer 11

Based on accounting information alone, a business should drop a product only if the total avoidable costs are more than the revenue it would lose if it dropped the product.

Question 12

What are other factors to consider when dropping a product?

Answer 12

a. If dropping an unprofitable product might affect sales of another related product.
b. Furthermore, managers should consider the effect on the business’s employees of dropping a product. What if dropping an unprofitable product necessitated making employees redundant?
c. if new research indicates that a product is hazardous

Question 13

What are factors to consider in determining whether to make or buy a part?

Answer 13

1. equipment to buy
2. whether to make it to get a short term cost advantage if they already have the equipment
3. damage to business relationships with suppliers
4. If the supplier of parts is unreliable and may cause product costs
5. if producing will lead to better quality and supplier reliability

Question 14

What are factors to consider when deciding on whether to sell or process a product further?

Answer 14

a. the difference in business profits between the two alternatives
b. whether the customers who like the product ‘as is’ will refuse to buy the product when it is processed further
c. whether the further processing will have a negative effect on the environment
d. whether the business has access to employees (either present or potential employees) with the skills necessary to do the further processing
e. whether the business will be able to continue to employ those factory employees who do not have those skills.

Question 15

How do you do an analysis on whether to process a product further?

Answer 15

This analysis involves subtracting the relevant costs (incremental costs and opportunity costs) from the relevant revenues under each alternative and selecting the alternative (sell or process further) that provides the higher ‘profit’.

Question 16

What are some non-financial issues in decision making?

Answer 16

1. Impact on workers if the order requires non-standard adjustments, both in terms of the learning curve of performing a non-routine task and the workers willingness to perform tasks differently.
2. Impact on the current customers, especially if the order is sold at a reduced price. You could lose current customers as they feel hard done by.
3. Also, they could expect you to then drop your prices in the future, having a long-term impact financially.

Question 17

What are some non-financial issues when dropping products?

Answer 17

1. Loss of customers to competitors because they cannot get the full range of products from your business anymore.
2. Drop in morale because of lay-off of other workers, people fear for their jobs and productivity drops.
3. Need to consider alternate uses for now unused machinery or space.

Question 18

What are some non-financial issues when making or buying?

Answer 18

1. If we stop making are there alternate uses for the equipment or machinery.
2. Morale of workers if other workers are laid-off due to the business now buying components.
3. Reliability, quality and reputation of the supplier, as the customer will be unhappy with you not the supplier is the reliability or quality is not up to standard.
4. What will you do if the supplier goes on strike, need to have multiple suppliers?

Question 19

What are some non-financial issues when deciding to sell or process further?

Answer 19

1. Environmental impact of processing further.
2. Skill level of employees to do the work in processing the product further and the learning curve involved.
3. If machines do the processing further, will there be loss of jobs leading to behavioural and morale issues?