Chapter 19

Information for decisions:

relevant costs and benefits

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-1
 Outline
Decision making
Characteristics of relevant information
Identifying relevant costs and benefits
Accept or reject a special order
Make or buy a product
Add or delete a product or department
Joint products
Implications of ABC analysis
Incentives and pitfalls
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-2
The management accountants
role in decision making
To provide relevant information to managers
and teams who make the decisions
Tactical decisions
Resource commitments
Quickly changed or reversed

Long-term decisions
More strategic
Movements in capacity-related resources
More difficult to reverse
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-3
 A model of the decision-
making process
The seven steps involved are:
1. Clarify the problem
2. Specify the decision criterion
3. Identify alternative courses of action
4. Collect information about relevant costs and
benefits
5. Compare the costs and benefits of each
alternative course of action
6. Select a course of action
7. Evaluate the effectiveness of the decision(cont.)
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-4
A model of the decision-making
process (cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-5
 Characteristics of
relevant information
Different under competing courses of
action
Costs and benefits that are the same
Relates to the future
Consequences of decisions
Sunk costs are ignored
Prediction of future costs may be based
on past data (cont.)
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-6
 Characteristics of
relevant information (cont.)
Timeliness versus accuracy
Valuable if available for the decision-making
process
Trade-off between the accuracy and
timeliness of information
Quantitative or qualitative
Quantitative information can be expressed in
numeric terms
Qualitative information cannot be expressed
effectively in numerical terms
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-7
 The importance of providing
only relevant information
Generating information is a costly
process
Supplying irrelevant data to managers
can lead to managers reading and
processing the information, which is a
waste of managerial resources
Information overload decreases the
effectiveness of decision making
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-8
Information for unique versus
repetitive decisions
Unique decisions
Arise infrequently or only once
Relevant information will often be found both
inside and outside the organisation
Relevant information is harder to generate

Repetitive decisions
Made at regular or irregular intervals
May draw on a large amount of historical data
Relevant information should be readily available
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-9
 Identifying relevant costs and
benefits: terminology
Incremental revenue
Results from choosing one course of action over
another
Incremental costs
Costs that arise from choosing one course of action
over another
Out-of-pocket costs
incurred if a particular course of action is selected
Sunk costs
Already incurred and irrelevant for future decisions
(cont.)
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-10
 Identifying relevant costs and
benefits: terminology (cont.)
Opportunity costs
The potential benefit given up when the choice of
one action precludes a different action
Avoidable costs
Costs that will not be incurred in the future if a
particular decision is made
Unavoidable costs
Costs that will continue to be incurred no matter
which decision alternative is chosen
Irrelevant to the decision

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-11
Accept or reject a special order
Whether or not to supply a customer with
a single, one-off order
Spare capacity occurs where inputs to
production are available for other
purposes
In situations of spare capacity
If there is no spare capacity
If the decision is not a one-off decision
Strategic issues (cont.)
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-12
Accept or reject a special order
(cont.)

(cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-13
Accept or reject a special order
(cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-14
 Make or buy a product
An organisation chooses to produce or
purchase the product from a supplier
Avoidable versus unavoidable costs
Opportunity costs are often relevant
Strategic issues may include
Quality of the purchased product
Delivery responsiveness, technical capabilities,
labour relations and financial stability of the
supplier
Ability of the supplier to respect confidential
information (cont.)
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 Make or buy a product (cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-16
 Outsourcing decisions
Outsourcing occurs when part of a
manufacturing process, or another
function normally undertaken within an
organisation, is contracted to an
outside business
Tends to be a long-term decision rather
than a tactical make-or-buy decision
Difficult and costly to reverse

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-17
 Add or delete a product,
service or department
Consider which costs and benefits will
change if the decision is taken
Has long-term implications
Traditional accounting data that contains
cost allocations should be treated with care
Strategic issues
If we delete a product
If we delete a department
(cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-18
Add or delete a product, service or department (cont.)

(cont.)
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 Add or delete a product,
service or department (cont.)

(cont.)
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-20
Add or delete a product, service or department (cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-21
 Joint products: sell or
process further
Joint products

By-product

Split-off point

Joint cost

Relative sales method (cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-22
 Joint products: sell or
process further (cont.)

(cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-23
 Joint products: sell or
process further (cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-24
 Implications of activity-based
cost analysis for decisions
Relevant costs, incremental costs,
opportunity costs, sunk costs and
avoidable costs still need to be identified
Costs may be more accurately assigned
to products or departments, based on a
better understanding of cost drivers
Leads to the identification of precise
cost implications of various decision
alternatives (cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-25
 Implications of activity-based
cost analysis for decisions (cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-26
 Incentives for decision makers
Managers typically make decisions that
will maximise their reported performance
and rewards
Cost systems may be designed to
explicitly encourage certain biases in
decision making
To encourage managers and employees
to make certain decisions, systems must
be designed with this in mind
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-27
 Pitfalls to avoid in using
accounting data for decisions
Ignore sunk costs
Beware of using unitised fixed costs in
decision making
Beware of allocated fixed costs, but focus
on identifying the avoidable costs
Pay special attention to identifying and
including opportunity costs in a decision
analysis
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-28
 Summary
Tactical decisions do not require significant
changes in capacity and can be changed if better
opportunities arise
Relevant information will include quantitative and
qualitative information, as well as consideration of
strategic issues
In decision analysis, incremental revenues and
costs are usually the focus, and in some cases
avoidable costs
In special order and make-or-buy decisions,
opportunity costs become relevant where there is
no or limited spare capacity (cont.)
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-29
 Summary (cont.)
Adding or deleting a product/department involves
consideration of avoidable and unavoidable costs
Processing joint products further requires
consideration of incremental revenue and costs
ABC systems may provide more accurate
information for decisions than costs generated
from traditional costing systems
Management incentives can sometimes distort the
collection and analysis of information in decisions
Accounting data should be used carefully in
decision analysis as it can be problematic
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 19-30