Professional Documents
Culture Documents
Decision Making:
Relevant Costs
and Benefits
McGraw-Hill/Irwin
Learning
Objective
1
McGraw-Hill/Irwin
Cross-functional
Cross-functional
management
management teams
teams
who
who make
make
production,
production, marketing,
marketing,
and
and finance
finance decisions
decisions
Make
Make substantive
substantive
economic
economic decisions
decisions
affecting
affecting operations
operations
14-3
Quantitative
Analysis
3.
3. Identify
Identify the
the Alternatives
Alternatives
4.
4. Develop
Develop aa Decision
Decision Model
Model
5.
5. Collect
Collect the
the Data
Data
6.
6. Make
Make aa Decision
Decision
14-4
Learning
Objective
2
McGraw-Hill/Irwin
Primarily the
responsibility of the
managerial
accountant.
Information
Information should
should be:
be:
1.
1. Relevant
Relevant
2.
2. Accurate
Accurate
3.
3. Timely
Timely
6. Make a Decision
14-6
Qualitative
Qualitative
Considerations
Considerations
Accurate
Accurate
Information
Information must
must
be
be precise.
precise.
Timely
Timely
Available
Available in
in time
time
for
for aa decision
decision
6. Make a Decision
14-8
Learning
Objective
3
McGraw-Hill/Irwin
Relevant Information
Information is relevant to a decision
problem when . . .
1.
1. It
It has
has aa bearing
bearing on
on the
the future,
future,
2.
2. It
It differs
differs among
among competing
competing alternatives.
alternatives.
14-10
Learning
Objective
4
McGraw-Hill/Irwin
Identifying Relevant
Costs and Benefits
Sunk costs
Costs that have already been incurred.
They do not affect any future cost and
cannot be changed by any current or future
action.
Relevant Costs
Worldwide Airways is thinking about replacing a three
year old loader with a new, more efficient loader.
New
New loader
loader
List
List price
price
Annual
Annual operating
operating expenses
expenses
Expected
Expected life
life in
in years
years
Old
Old loader
loader
Original
Original cost
cost
Remaining
Remaining book
book value
value
Disposal
Disposal value
value now
now
Annual
Annual variable
variable expenses
expenses
Remaining
Remaining life
life in
in years
years
$$ 15,000
15,000
45,000
45,000
11
$$100,000
100,000
25,000
25,000
5,000
5,000
80,000
80,000
11
14-13
Relevant Costs
IfIf we
we keep
keep the
the old
old loader,
loader, we
we will
will have
have depreciation
depreciation
costs
costs of
of $25,000.
$25,000. IfIf we
we replace
replace the
the old
old loader,
loader,
we
we will
will write-off
write-off the
the $25,000
$25,000 when
when sold.
sold. There
There is
is
no
no difference
difference in
in the
the cost,
cost, so
so itit is
is not
not relevant
relevant..
We
We will
will only
only have
have depreciation
depreciation on
on the
the new
new loader
loader
ifif we
we replace
replace the
the old
old loader.
loader. This
This cost
cost is
is relevant
relevant..
The
The $5,000
$5,000 proceeds
proceeds will
will only
only be
be realized
realized ifif we
we
replace
replace the
the old
old loader.
loader. This
This amount
amount is
is relevant
relevant..
The new loader will be depreciated in one year.
14-14
Relevant Costs
The
The difference
difference in
in operating
operating costs
costs is
is relevant
relevant
to
to the
the immediate
immediate decision.
decision.
14-15
Relevant Costs
Here is an analysis that includes only relevant
costs:
14-16
Learning
Objective
5
McGraw-Hill/Irwin
14-18
Since
Since the
the charter
charter will
will contribute
contribute to
to fixed
fixed costs
costs and
and
Worldwide
Worldwide has
has idle
idle capacity,
capacity, the
the company
company should
should
accept
accept the
the flight.
flight.
14-21
14-22
14-25
14-26
14-27
14-28
$200,000
(135,000)
65,000
( 75,000)
$ ( 10,000)
14-31
14-32
ELIMINATE DIFFERENTIAL
0
$200,000
A
0
(70,000)
V
0
(40,000)
O
0
(25,000)
I
0
65,000
(30,000) D
0
0
(20,000)
A
(10,000) B
0
0
( 5,000)
L
(10,000) E
0
(50,000)
40,000
The positive $40,000 differential amount reflects the fact that the
company is $40,000 better off by keeping the club.
14-33
14-34
Conclusion
KEEP THE CLUB OPEN!
Contribution margin from
general airline operations
that will be forgone if club
is eliminated . . . . . . . . . . . $ 60,000
Profit/Loss
$ 40,000
Monthly profit of
KEEPING the club open
0
0
$ 60,000
$ 40,000
$100,000
=======
Learning
Objective
6
McGraw-Hill/Irwin
Special Decisions in
Manufacturing Firms
Joint
Joint Products:
Products:
Sell
Sell or
or Process
Process Further
Further
A
A joint
joint production
production process
process resulting
resulting in
in two
two
or
or more
more products.
products. The
The point
point in
in the
the
production
production process
process where
where the
the joint
joint
products
products are
are identifiable
identifiable as
as separate
separate
products
products is
is called
called the
the split-off
split-off point.
point.
14-37
Joint Processing
of Cocoa Bean
Cocoa beans
costing $500
per ton
Joint Production
process costing
$600 per ton
Cocoa butter
sales value
$750 for
1,500 pounds
Split-off point
Cocoa powder
sales value
$500 for
500 pounds
Separable
process
costing
$800
Instant cocoa
mix sales value
$2,000 for
500 pounds
14-38
Joint Products
Relative Sales Value Method
$750
$750 $1,250
$1,250 == 60%
60%
60%
60% $1,100
$1,100 == $660
$660
14-39
Joint Products
Cocoa butter is sold at the end of the joint
processing.
Cocoa powder may be sold now or processed
into instant cocoa mix. Further processing
costs of $800 will be incurred if the company
elects to make instant cocoa mix.
14-40
Joint Products
(
Limited Resources
Martin, Inc. produces two products and
selected data is shown below:
14-43
Limited Resources
The
The lathe
lathe is
is the
the scarce
scarce resource
resource because
because there
there is
is
excess
excess capacity
capacity on
on other
other machines.
machines. The
The lathe
lathe is
is being
being
used
used at
at 100%
100% of
of its
its capacity.
capacity.
The
The lathe
lathe capacity
capacity is
is 2,400
2,400 minutes
minutes per
per week.
week.
Should
Should Martin
Martin focus
focus its
its efforts
efforts
on
on Webs
Webs or
or Highs?
Highs?
14-44
Limited Resources
Lets calculate the contribution margin per unit
of the scarce resource, the lathe.
Highs
Highs should
should be
be emphasized.
emphasized. ItIt is
is the
the more
more valuable
valuable
use
use of
of the
the scarce
scarce resource
resource the
the lathe,
lathe, yielding
yielding aa
contribution
contribution margin
margin of
of $30
$30 per
per minute
minute as
as opposed
opposed to
to
$24
$24 per
per minute
minute for
for the
the Webs.
Webs.
If there are no other considerations, the best plan would be to produce to meet current
demand for Highs and then use remaining capacity to make Webs.
14-45
Limited Resources
Lets see how this plan would work.
Allotting the Scarce Resource The Lathe
Weekly demand for Highs
2,200 units
Time required per unit
x .50 minutes
Time required to make Highs 1,100 minutes
Total lathe time available
Time used to produce Highs
Time available for Webs
Time required per unit
Production of Webs
2,400 minutes
1,100 minutes
1,300 minutes
x 1.00 minute
1,300 units
14-46
Limited Resources
According to the plan, Martin will produce
2,200 Highs and 1,300 Webs. Martins
contribution margin looks like this.
The
The total
total contribution
contribution margin
margin for
for Martin,
Martin, Inc.
Inc. is
is $64,200.
$64,200.
Any
Any other
other combination
combination would
would result
result in
in less
less contribution.
contribution.
14-47
Theory of Constraints
Binding constraints can limit a companys
profitability.
To relax constraints management can . . .
Outsource
Retrain employees
Work overtime
14-48
Uncertainty
One
One common
common technique
technique for
for addressing
addressing the
the
impact
impact of
of uncertainty
uncertainty is
is
sensitivity
sensitivity analysis
analysis -- aa way
way to
to determine
determine
what
what would
would happen
happen in
in aa decision
decision analysis
analysis ifif
aa key
key prediction
prediction or
or assumption
assumption proved
proved to
to be
be
wrong.
wrong.
14-49
Expected Values
From the last example, recall the the contribution
margin for Webs was $24 and $15 for Highs.
Due to uncertainty, assume Martin has the following
probable contribution margins for the two products.
Webs
Highs
Martin
Martin would
would use
use the
the expected
expected value
value
contribution
contribution margins
margins in
in its
its decision
decision about
about
utilizing its limited resource - the lathe.
14-50
Learning
Objective
7
McGraw-Hill/Irwin
Incentives
Incentives for
for
Decision
Decision Makers
Makers
Short-Run
Short-Run
Versus
Versus
Long-Run
Long-Run
Decisions
Decisions
14-52
Allocated
fixed costs.
Unitized
fixed costs.
Opportunity
costs.
14-53
End of Chapter 14
14-54