garch13 relevant cost

7/26/2019 Garch13 Relevant Cost

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Relevant Costs forDecision Making

5/10/04

Chapter 13


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The McGraw-Hill Companies, IncMcGraw-Hill/Irwin

Cost Concepts for DecisionMaking

A relevant costis a cost thatdiffers between alternatives.

12


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dentif!ing Relevant Costs

Costs that can be eli"inated #in whole or inCosts that can be eli"inated #in whole or in

part$ b! choosing one alternative overpart$ b! choosing one alternative over

another areanother are avoidableavoidablecosts. Avoidable costscosts. Avoidable costsare relevant costs.are relevant costs.

%navoidable costs are never relevant and%navoidable costs are never relevant and

incl&de'incl&de' (&nk costs.(&nk costs.

)&t&re costs that)&t&re costs thatdo not differdo not differbetween thebetween the

alternatives.alternatives.

Costs that can be eli"inated #in whole or inCosts that can be eli"inated #in whole or in

part$ b! choosing one alternative overpart$ b! choosing one alternative over

another areanother are avoidableavoidablecosts. Avoidable costscosts. Avoidable costsare relevant costs.are relevant costs.

%navoidable costs are never relevant and%navoidable costs are never relevant and

incl&de'incl&de' (&nk costs.(&nk costs.

)&t&re costs that)&t&re costs thatdo not differdo not differbetween thebetween the

alternatives.alternatives.


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Annual Cost

of Fixed Items

Cost per

Mile

1 Annual straight-line depreciation on car 2,800 0!280

2 Cost of gasoline 0!0"0

# Annual cost of auto insurance and license 1,#80 0!1#8

$ Maintenance and repairs 0!0%"

" &ar'ing fees at school #%0 0!0#%% (otal average cost 0!"%)

Automo*ile Costs +*ased on 10,000 miles driven per ear

C!nthia* a +oston st&dent* is considering visiting her friend in ,ew -ork.C!nthia* a +oston st&dent* is considering visiting her friend in ,ew -ork.(he can drive or take the train. +! car it is 0 "iles to her friends(he can drive or take the train. +! car it is 0 "iles to her friends

apart"ent. (he is tr!ing to decide which alternative is less epensiveapart"ent. (he is tr!ing to decide which alternative is less epensiveand has gathered the following infor"ation'and has gathered the following infor"ation'

C!nthia* a +oston st&dent* is considering visiting her friend in ,ew -ork.C!nthia* a +oston st&dent* is considering visiting her friend in ,ew -ork.(he can drive or take the train. +! car it is 0 "iles to her friends(he can drive or take the train. +! car it is 0 "iles to her friends

apart"ent. (he is tr!ing to decide which alternative is less epensiveapart"ent. (he is tr!ing to decide which alternative is less epensiveand has gathered the following infor"ation'and has gathered the following infor"ation'

245 per "onth245 per "onth 3 "onths3 "onths

245 per "onth245 per "onth 3 "onths3 "onths 21.0 per gallon21.0 per gallon 6 M786 M78

21.0 per gallon21.0 per gallon 6 M786 M78

21*000 cost21*000 cost9924*000 salvage val&e24*000 salvage val&e 6 5 !ears6 5 !ears

21*000 cost21*000 cost

99

24*000 salvage val&e24*000 salvage val&e

6 5 !ears6 5 !ears


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. /eduction in resale value of car per mile of ear 0!02%

8 /ound-tip train fare 10$

) enefits of relaxing on train trip 10 Cost of putting dog in 'ennel hile gone $0

11 enefit of having car in 3e 4or'

12 5assle of par'ing car in 3e 4or'

1# &er da cost of par'ing car in 3e 4or' 2"

6ome Additional Information

Annual Cost

of Fixed Items

Cost per

Mile

1 Annual straight-line depreciation on car 2,800 0!280

2 Cost of gasoline 0!0"0

# Annual cost of auto insurance and license 1,#80 0!1#8

$ Maintenance and repairs 0!0%"

" &ar'ing fees at school #%0 0!0#%

% (otal average cost 0!"%)

Automo*ile Costs +*ased on 10,000 miles driven per ear


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Which costs and benefits are relevant in Cynthias decision?Which costs and benefits are relevant in Cynthias decision?

Which costs and benefits are relevant in Cynthias decision?Which costs and benefits are relevant in Cynthias decision?

The cost of the car isThe cost of the car is

a sunk cost and isa sunk cost and is

not relevant to thenot relevant to the

current decision.current decision.

The cost of the car isThe cost of the car is

a sunk cost and isa sunk cost and is

not relevant to thenot relevant to the

current decision.current decision.

However, the cost of gasoline is clearly relevant if sheHowever, the cost of gasoline is clearly relevant if she

decides to drive. If she takes the drive the cost woulddecides to drive. If she takes the drive the cost would

now be incurred, so it varies depending on the decision.now be incurred, so it varies depending on the decision.

However, the cost of gasoline is clearly relevant if sheHowever, the cost of gasoline is clearly relevant if she

decides to drive. If she takes the drive the cost woulddecides to drive. If she takes the drive the cost would

now be incurred, so it varies depending on the decision.now be incurred, so it varies depending on the decision.

The annual cost ofThe annual cost of

insurance is notinsurance is not

relevant. It willrelevant. It will

reain the sae ifreain the sae if

she drives or takesshe drives or takes

the train.the train.

The annual cost ofThe annual cost of

insurance is notinsurance is not

relevant. It willrelevant. It will

reain the sae ifreain the sae if

she drives or takesshe drives or takes

the train.the train.


7/46 The McGraw-Hill Companies, IncMcGraw-Hill/Irwin


Which costs and benefits are relevant in Cynthias decision?Which costs and benefits are relevant in Cynthias decision?Which costs and benefits are relevant in Cynthias decision?Which costs and benefits are relevant in Cynthias decision?

The cost of aintenanceThe cost of aintenance

and repairs is relevant. Inand repairs is relevant. Inthe long!run these coststhe long!run these costs

depend upon iles driven.depend upon iles driven.

The cost of aintenanceThe cost of aintenance

and repairs is relevant. Inand repairs is relevant. Inthe long!run these coststhe long!run these costs

depend upon iles driven.depend upon iles driven.

The onthly schoolThe onthly school

parking fee is notparking fee is notrelevant because itrelevant because it

ust be paid ifust be paid if

Cynthia drives orCynthia drives or

takes the train.takes the train.

The onthly schoolThe onthly school

parking fee is notparking fee is notrelevant because itrelevant because it

ust be paid ifust be paid if

Cynthia drives orCynthia drives or

takes the train.takes the train.

"t this point, we can see that soe of the average cost of"t this point, we can see that soe of the average cost of

#$.%&' per ile are relevant and others are not.#$.%&' per ile are relevant and others are not.

"t this point, we can see that soe of the average cost of"t this point, we can see that soe of the average cost of

#$.%&' per ile are relevant and others are not.#$.%&' per ile are relevant and others are not.





The decline in resale valueThe decline in resale value

due to additional iles is adue to additional iles is arelevant cost.relevant cost.

The decline in resale valueThe decline in resale value

due to additional iles is adue to additional iles is arelevant cost.relevant cost.

The round!trip train fare isThe round!trip train fare is

clearly relevant. If sheclearly relevant. If shedrives the cost can bedrives the cost can be

avoided.avoided.

The round!trip train fare isThe round!trip train fare is

clearly relevant. If sheclearly relevant. If shedrives the cost can bedrives the cost can be

avoided.avoided.

(ela)ing on the train is(ela)ing on the train isrelevant even though it isrelevant even though it is

difficult to assign a dollardifficult to assign a dollar

value to the benefit.value to the benefit.

(ela)ing on the train is(ela)ing on the train isrelevant even though it isrelevant even though it is

difficult to assign a dollardifficult to assign a dollar

value to the benefit.value to the benefit.

The kennel cost is notThe kennel cost is notrelevant because Cynthiarelevant because Cynthia

will incur the cost if shewill incur the cost if she

drives or takes the train.drives or takes the train.

The kennel cost is notThe kennel cost is notrelevant because Cynthiarelevant because Cynthia

will incur the cost if shewill incur the cost if she

drives or takes the train.drives or takes the train.





The cost of parking isThe cost of parking is

relevant because it can berelevant because it can beavoided if she takes theavoided if she takes the

train.train.

The cost of parking isThe cost of parking is

relevant because it can berelevant because it can beavoided if she takes theavoided if she takes the

train.train.

The benefits of having a car in *ew +ork and theThe benefits of having a car in *ew +ork and the

probles of finding a parking space are both relevantprobles of finding a parking space are both relevant

but are difficult to assign a dollar aount.but are difficult to assign a dollar aount.

The benefits of having a car in *ew +ork and theThe benefits of having a car in *ew +ork and the

probles of finding a parking space are both relevantprobles of finding a parking space are both relevant

but are difficult to assign a dollar aount.but are difficult to assign a dollar aount.




ro a financial standpoint, Cynthia would be better offro a financial standpoint, Cynthia would be better off

taking the train to visit her friend. -oe of the non!financialtaking the train to visit her friend. -oe of the non!financial

factors ay influence her final decision.factors ay influence her final decision.

ro a financial standpoint, Cynthia would be better offro a financial standpoint, Cynthia would be better off

taking the train to visit her friend. -oe of the non!financialtaking the train to visit her friend. -oe of the non!financial

factors ay influence her final decision.factors ay influence her final decision.

7asoline +$%0 0!0"0 per mile 2#!00

Maintenance +$%0 0!0%" per mile 2)!)0

/eduction in resale +$%0 0!02% per mile 11!)%

&ar'ing in 3e 4or' +2 das 2" per da "0!00

(otal 11$!8%

/elevant Financial Cost of 9riving

/ound-trip tic'et 10$!00

/elevant Financial Cost of (a'ing the (rain



,ote

Do not &nderesti"ate the i"portance andDo not &nderesti"ate the i"portance and

power of the relevant cost idea.power of the relevant cost idea.

Most costs #and benefits$ do not differMost costs #and benefits$ do not differbetween alternatives. :his allows !o& to foc&sbetween alternatives. :his allows !o& to foc&s

on the few things that "atter.on the few things that "atter.

:his principle also helps avoid "istakes.:his principle also helps avoid "istakes.



;ld Machine vs ,ew Machine

;ld Machine 9 book val&e 2140*000

;riginal Cost 210*000

(alvage val&e 2pected life for both is 4 !ears

(ho&ld new "achine be p&rchased?



Relevant Costs 9 ;ld vs. ,ew

Relevant costs/+enefits

(alvage =al&e ;ld "ach 2



(ho&ld ,ew Machine +e 7&rchased

+enefits

Costs



:otal and Differential Cost Approaches

:he "anage"ent of a co"pan! is considering a new labor@saving"achine that rents for 2*000 per !ear. Data abo&t the co"pan!s

ann&al sales and costs with and witho&t the new "achine are'

Current

6ituation

6ituation

:ith 3e

Machine

9ifferential

Costs and

enefits6ales +",000 units $0 per unit 200,000 200,000 -

;ess varia*le expensesC(;, R%>

ovell sho&ld drop the digital watch seg"ent onl!

if its profit wo&ld increase. :his wo&ld onl!happen if the fied cost savings exceedthe lostcontrib&tion "argin.

ets look at this sol&tion.

D>C(;, R%>

ovell sho&ld drop the digital watch seg"ent onl!

if its profit wo&ld increase. :his wo&ld onl!happen if the fied cost savings exceedthe lostcontrib&tion "argin.

ets look at this sol&tion.


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A Contrib&tion Margin Approach

Contri*ution Margin6olution

Contri*ution margin lost if digital

atches are dropped +#00,000

;ess fixed costs that can *e avoided

6alar of the line manager )0,000Advertising - direct 100,000

/ent - factor space .0,000 2%0,000

3et disadvantage +$0,000

C ti


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Co"parative nco"eApproach

:he ovell sol&tion can also be obtainedb! preparing co"parative inco"e

state"ents showing res&lts with andwitho&t the digital watch seg"ent.

ets look at this second approach.ets look at this second approach.

:he ovell sol&tion can also be obtainedb! preparing co"parative inco"e

state"ents showing res&lts with andwitho&t the digital watch seg"ent.

ets look at this second approach.ets look at this second approach.


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Comparative Income Approach

6olution

eep

9igital

:atches

9rop

9igital

:atches 9ifference6ales "00,000 - +"00,000

;ess varia*le expenses< -

Manufacturing expenses 120,000 - 120,000

6hipping ",000 - ",000

Commissions .",000 - .",000

(otal varia*le expenses 200,000 - 200,000Contri*ution margin #00,000 - +#00,000

;ess fixed expensesutside purchase price 2" "00,000

9irect materials ) 180,000

9irect la*or " 100,000

=aria*le overhead 1 20,000

9epreciation of e@uip! # -

6upervisorBs salar 2 $0,000

7eneral factor overhead 10 -

(otal cost #0 #$0,000 "00,000

:he Make or +&! Decision

:he special e&ip"ent has no resale:he special e&ip"ent has no resaleval&e and is a s&nk cost.val&e and is a s&nk cost.

:he special e&ip"ent has no resale:he special e&ip"ent has no resaleval&e and is a s&nk cost.val&e and is a s&nk cost.


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Cost

&er nit Cost of 20,000 nitsMa'e u

>utside purchase price 2" "00,000







(otal cost #0 #$0,000 "00,000


,ot avoidableH irrelevant. f the prod&ct is dropped* it,ot avoidableH irrelevant. f the prod&ct is dropped* itwill be reallocated to other prod&cts.will be reallocated to other prod&cts.

,ot avoidableH irrelevant. f the prod&ct is dropped* it,ot avoidableH irrelevant. f the prod&ct is dropped* itwill be reallocated to other prod&cts.will be reallocated to other prod&cts.


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6hould e ma'e or *u part $A6hould e ma'e or *u part $A

Anser< Ma'eDAnser< Ma'eD

Cost

&er nit Cost of 20,000 nitsMa'e u

>utside purchase price 2" "00,000







(otal cost #0 #$0,000 "00,000


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9ECI6I>3 /;E

n deciding whether to accept the o&tside

s&ppliers offer* >sse isolated the relevantcosts of "aking the part b! eli"inatingeli"inating':he s&nk costs #depreciation$:he f&t&re costs that will not differ between

"aking or b&!ing the parts #co""on costs$

9ECI6I>3 /;E

n deciding whether to accept the o&tside

s&ppliers offer* >sse isolated the relevantcosts of "aking the part b! eli"inatingeli"inating':he s&nk costs #depreciation$:he f&t&re costs that will not differ between

"aking or b&!ing the parts #co""on costs$


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(pecial ;rders

Iet* nc. "akes a single prod&ct whose nor"alIet* nc. "akes a single prod&ct whose nor"al

selling price is 20 per &nit.selling price is 20 per &nit.

A foreign distrib&tor offers to p&rchase *000 &nitsA foreign distrib&tor offers to p&rchase *000 &nits

for 210 per &nit.for 210 per &nit. :his is a one@ti"e order that wo&ld not affect the:his is a one@ti"e order that wo&ld not affect the

co"pan!s reg&lar b&siness.co"pan!s reg&lar b&siness.

Ann&al capacit! is 10*000 &nits* b&t Iet* nc. isAnn&al capacit! is 10*000 &nits* b&t Iet* nc. is

c&rrentl! prod&cing and selling onl! 5*000 &nits.c&rrentl! prod&cing and selling onl! 5*000 &nits.

Iet* nc. "akes a single prod&ct whose nor"alIet* nc. "akes a single prod&ct whose nor"al

selling price is 20 per &nit.selling price is 20 per &nit.

A foreign distrib&tor offers to p&rchase *000 &nitsA foreign distrib&tor offers to p&rchase *000 &nits

for 210 per &nit.for 210 per &nit. :his is a one@ti"e order that wo&ld not affect the:his is a one@ti"e order that wo&ld not affect the

co"pan!s reg&lar b&siness.co"pan!s reg&lar b&siness.

Ann&al capacit! is 10*000 &nits* b&t Iet* nc. isAnn&al capacit! is 10*000 &nits* b&t Iet* nc. is

c&rrentl! prod&cing and selling onl! 5*000 &nits.c&rrentl! prod&cing and selling onl! 5*000 &nits.

6hould et accept the offer6hould et accept the offer


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(pecial ;rders

2 variable cost2 variable cost2 variable cost2 variable cost


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(pecial ;rders

f Iet accepts the offer* net operating inco"ewill increase b! 2*000.

Increase in revenue +#,000 G 10 #0,000

Increase in costs +#,000 G 8 varia*le cost 2$,000

Increase in net income %,000

Increase in revenue +#,000 G 10 #0,000

Increase in costs +#,000 G 8 varia*le cost 2$,000

Increase in net income %,000

,ote' :his answer ass&"es that fied costs are&naffected b! the order and that variable "arketingcosts "&st be inc&rred on the special order.


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J&ick Check

,orthern ;ptical ordinaril! sells the K@lens for250. :he variable prod&ction cost is 210* thefied prod&ction cost is 21 per &nit* and the

variable selling cost is 21. A c&sto"er hasre&ested a special order for 10*000 &nits of theK@lens to be i"printed with the c&sto"ers logo.:his special order wo&ld not involve an! selling

costs* b&t ,orthern ;ptical wo&ld have top&rchase an i"printing "achine for 250*000.

#see the net page$

,orthern ;ptical ordinaril! sells the K@lens for250. :he variable prod&ction cost is 210* thefied prod&ction cost is 21 per &nit* and the

variable selling cost is 21. A c&sto"er hasre&ested a special order for 10*000 &nits of theK@lens to be i"printed with the c&sto"ers logo.:his special order wo&ld not involve an! selling

costs* b&t ,orthern ;ptical wo&ld have top&rchase an i"printing "achine for 250*000.

#see the net page$


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J&ick Check

hat is the rock botto" "ini"&" price belowwhich ,orthern ;ptical sho&ld not go in itsnegotiations with the c&sto"er? n other words*below what price wo&ld ,orthern ;pticalact&all! be losing "one! on the sale? :here isa"ple idle capacit! to f&lfill the order.

a. 250

b. 210c. 215

d. 2

garch13 relevant cost

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