Slide Set 7

Question 1

Describe management’s decision process

Answer 1

1. Identify the problem and assign responsibility
2. Determine and evaluate possible courses of action
3. Make a decision
4. Review results of the decision

Question 2

making business decisions, involve financial and non-financial information. What are financial and non- financial informations?

Answer 2

Financial information
► Revenues and costs, and
► Effect on overall profitability.
Non-financial information
► Effect on employee turnover 
► The environment
► Overall company image.

Question 3

Incremental Analysis Approach

Answer 3

Also differential analysis
Process used to identify the financial data that change under alternative courses of action.
►Both costs and revenues may vary or 
►Only revenues may vary or
►Only costs may vary

Question 4

Important concepts used in incremental analysis:

Answer 4

• Relevant cost.
• Opportunity cost.
• Sunk cost.

Question 5

Common types of decisions involving incremental analysis:

Answer 5

1. Accept an order at a special price.
2. Make or buy component parts or finished products.
3. Sell or process further them further
4. Repair, retain, or replace equipment.
5. Eliminate an unprofitable business segment or product.

Question 6

Decision Rule for Sell or Process Further

Answer 6

Process further as long as the incremental revenue from such processing exceeds the incremental processing costs.

Question 7

Does book value affect the decision of Repair, Retain, or Replace Equipment?

Answer 7

The book value of old machine does not affect the decision.
► Book value is a sunk cost.
► Costs which cannot be changed by future decisions (sunk cost) are not relevant in incremental analysis.
However, any trade-in allowance or cash disposal value of the existing asset is relevant.

Question 8

Decision Rule to eliminate segments or products

Answer 8

Retain the segment unless fixed costs eliminated exceed contribution margin lost.

Question 9

Analyze the relevant costs in deciding whether to eliminate an unprofitable segment or product.
What is relevant?

Answer 9

• Consider effect on related product lines
• Fixed costs allocated to the unprofitable segment must be absorbed by the other segments.
• Net income may decrease when an unprofitable segment is eliminated.