Week 7 Everything

Question 1

Relevant costs and relevant revenues

Answer 1

Relevant costs (revenues) are expected future costs (revenues) that differ among the alternative courses of action being considered.

Question 2

To be relevant a cost (revenue) item must meet the following two criteria:

Answer 2

It must be an expected future cost (revenue) – it must occur in the future
Decision should be about selecting a course of action based on its expected future results

It must differ among alternative courses of action
If they do not differ, then they will not matter and will have no bearing on the decision making

Question 3

Irrelevant costs

Answer 3

If costs and revenues are not relevant then they are said to be irrelevant. Irrelevant costs and revenues will not be affected by decisions. They are the same irrespective of which decision is made.

Question 4

Types of irrelevant costs:

Answer 4

Historic (past or sunk) costs

Unavoidable (committed or common) costs

Non-cash costs (such as depreciation)

Question 5

Historic (sunk) costs

Answer 5

Historic (sunk) costs are past costs (i.e. have been incurred prior to a decision point) and therefore unavoidable and cannot be changed no matter what action is taken. They are only useful to estimate the trend of future costs. an example is the book value of an equipment.

Question 6

Qualitative factors are

Answer 6

Difficult to measure accurately in numerical terms

Are just as important as quantitative factors even though they are difficult to measure.

Question 7

The concept of relevant costs and relevant revenues are used for special studies such as:

Answer 7

Special selling price decisions.

Product-mix decisions when capacity constraints exist

Decisions on replacement of equipment.

Outsourcing (Make or buy) decisions.

Discontinuation decisions.

Question 8

The main question related with special pricing

Answer 8

Special pricing decisions involve one-time only orders and/or orders below the contemporary market prices. As special orders are only one-time orders, they cannot be priced using market prices. In this context, the main question that is related with decision making is:

When an offer price is below the total cost of manufacturing, should the company accept or reject it?

Question 9

Decision making regarding special orders

Answer 9

Decisions on special orders should be made based on relevant costs. Irrelevant costs should be excluded from decision making, as their effect will be same under both accept and reject options. For example, fixed costs would not be affected by the order, so they should not be taken into consideration during the decision making.

Question 10

In the special pricing context:

opportunity cost should also be taken into consideration

Answer 10

Opportunity cost should also be taken into consideration because it represents the best alternative way in which an organisation may have used its resources had it not made the decision it did.

Question 11

Limiting factor

Answer 11

In the short term, sales demand may be in excess of production capacity. For e.g., Output may be restricted by shortage of skilled labour, materials, equipment or space.
The resources responsible for limiting the output are known as limiting factors. Within a short time period, it may be unlikely to acquire additional resources of the limiting factors.

Question 12

The main question regarding allocation of scare resources

Answer 12

When there is a limiting production factor, how should managers choose which of the multiple products to produce?

Question 13

When there is a limiting production factor, how should managers choose which of the multiple products to produce?

Answer 13

Objective is to maximise contribution margin for the firm.

Question 14

Objective is to maximise contribution margin for the firm.

Therefore, the decision rule is:

Answer 14

Select the products/services that yield the highest contribution margin per unit of the constraining or limiting resource. When multiple constraints exist, optimisation techniques such as linear programming can be used in making decisions.

In this process we also need to take into consideration the sales demand for each product.

Question 15

The irrelevance of past costs

Answer 15

Another area in decision making where relevant costs should be taken into consideration is making decisions of equipment replacement. In this case, making decisions based on written-down value may lead to inaccurate outcomes. Some costs, such as the original purchase cost of the old machine, its written down value and depreciation are irrelevant for decision-making.

Question 16

The main issue related with equipment replacement decisions

In equipment replacement decisions managers need to consider the following two questions:

Answer 16

Is book-value of existing equipment relevant in such decisions?

What would be savings from purchasing a new equipment?

Question 17

Is book-value of existing equipment relevant in such decisions?

Answer 17

irrelevant, as it is a past (historical or sunk) cost

Question 18

What would be savings from purchasing a new equipment?

Answer 18

need to compare future costs of using old and new equipment and revenues from their use.

Question 19

Equipment replacement

Relevant costs:

Answer 19

operating costs of old and new equipment,

disposal of old equipment

the cost of the new equipment

Expected revenues from using old and new equipment

Question 20

Equipment replacement

Irrelevant costs:

Answer 20

original cost of the equipment

its depreciation charge

Question 21

Outsourcing

Answer 21

Outsourcing is purchasing goods or services from outside producers rather than producing the same goods or providing the same services within the organisation. Decisions about whether to outsource goods (services) or to produce (provide) within the organisation are called make-or-buy decisions.

Question 22

The main issue related with outsourcing

The main decision-related questions are:

Answer 22

Whether obtaining components from outside suppliers is cheaper than producing them within the firm?

Whether unit cost of the components being outsourced include any costs that will be unchanged under both alternatives (outsourcing and making)?

What are the alternative use for the released capacity if the components are outsourced?

Question 23

Outsourcing decision should not be undertaken by simply comparing the purchase price of the components with their total manufacturing cost:

Answer 23

Unit cost may include some costs that will not change whether or not the components are outsourced. There may not be alternative use for the released capacity if the components are outsourced.

Question 24

Product profitability analysis

Occasionally it is necessary to analyse the performance of cost objects, such as:

Answer 24

products

services

customers

locations

Question 25

Unprofitable cost objects may be analysed

Answer 25

Periodic profitability analysis by cost objects provides attention-directing information that highlights those potential unprofitable activities that require more detailed.

Question 26

The main issue related with the discontinuation decisions

Answer 26

In this context, managers should consider what cost items will be eliminated and what cost items will not be eliminated by discontinuing a product or operation. Those cost items that will not be eliminated by discontinuing decisions are irrelevant for decision making therefore, managers should consider, whether the product / operation is unprofitable or not after excluding irrelevant costs?