short term decision making: relevant costs and benefits
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8. Chapter Eight. Short term Decision Making: Relevant Costs and Benefits. The Managerial Accountant’s Role in Decision Making. Managerial Accountant. Cross-functional management teams who make production, marketing, and finance decisions. Designs and implements - PowerPoint PPT PresentationTRANSCRIPT
McGraw-Hill/Irwin
14-14-11
Short term Decision Making:Short term Decision Making: Relevant Costs and BenefitsRelevant Costs and Benefits
8 ChapterChapterEightEight
McGraw-Hill/Irwin
14-14-22
The Managerial Accountant’s Role in Decision Making
Designs and implementsaccounting information
system
Designs and implementsaccounting information
system
Cross-functional Cross-functional management teams management teams
who makewho makeproduction, marketing,production, marketing,and finance decisionsand finance decisions
Cross-functional Cross-functional management teams management teams
who makewho makeproduction, marketing,production, marketing,and finance decisionsand finance decisions
Make substantiveeconomic decisionsaffecting operations
Make substantiveeconomic decisionsaffecting operations
ManagerialManagerialAccountantAccountantManagerialManagerialAccountantAccountant
McGraw-Hill/Irwin
14-14-33
Relevant Information
Information is relevant to a decision Information is relevant to a decision problem when . . .problem when . . .
It has a bearing on the future, It has a bearing on the future, It differs among competing alternatives.It differs among competing alternatives.
Information is relevant to a decision Information is relevant to a decision problem when . . .problem when . . .
It has a bearing on the future, It has a bearing on the future, It differs among competing alternatives.It differs among competing alternatives.
McGraw-Hill/Irwin
14-14-44
Units
Co
sts
and
rev
enu
es
Fixed costs
Revenue
Total costs
Variable costs
Profit
Loss
Identifying RelevantCosts and Benefits
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14-14-55
Identifying RelevantCosts and Benefits
Sunk costsSunk costsCosts that have already been incurred. Costs that have already been incurred. They do not affect any future cost and They do not affect any future cost and cannot be changed by any current or cannot be changed by any current or
future action.future action.
Sunk costsSunk costsCosts that have already been incurred. Costs that have already been incurred. They do not affect any future cost and They do not affect any future cost and cannot be changed by any current or cannot be changed by any current or
future action.future action.
Sunk costs are irrelevant to decisions.Sunk costs are irrelevant to decisions.
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Relevant Costs: exampleYou live in King City. You come to class with the GO although you have a car. You live in King City. You come to class with the GO although you have a car. A classmate that also lives in King City is willing to come with you in your car A classmate that also lives in King City is willing to come with you in your car
and pay 1.25 times the GO fare.and pay 1.25 times the GO fare.
Current Situation:Costs: Go bus = 4.45
Alternative situation: Revenues: 1.25 times the GO bus fare = 5.55Costs: Gas 1 litre = 1.15 Insurance …………….? Lease payments ………?
Maximum total costs per trip: $10
Decision rule:YES if CMg > 0
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Distortions in Company Reporting
Accrual accounting (meaning of depreciation) Accrual accounting (meaning of depreciation) Full cost reporting Full cost reporting
See Exhibit 8.1 (page 177):Full costs $2.25Proposed selling price $2 Is the new customer offer worthwhile?
Calculate the variable costs and contribution margin
Decision rule:YES if CMg > 0
McGraw-Hill/Irwin
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Analysis of Special Decisions
Let’s take a close look at some special Let’s take a close look at some special decisions faced by many businesses.decisions faced by many businesses.
We just receivedWe just receiveda special order. Doa special order. Doyou think we shouldyou think we should
accept it?accept it?
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14-14-99
Accept or Reject a Special Order
A travel agency offers Worldwide Airways A travel agency offers Worldwide Airways $150,000 for a round-trip flight from Hawaii to $150,000 for a round-trip flight from Hawaii to Japan on a jumbo jet.Japan on a jumbo jet.
Worldwide usually gets $250,000 in revenue Worldwide usually gets $250,000 in revenue from this flight.from this flight.
The airlines is not currently planning to add The airlines is not currently planning to add any new routes and has two planes that are idle any new routes and has two planes that are idle and could be used to meet the needs of the and could be used to meet the needs of the agency.agency.
The next screen shows cost data developed by The next screen shows cost data developed by managerial accountants at Worldwide.managerial accountants at Worldwide.
A travel agency offers Worldwide Airways A travel agency offers Worldwide Airways $150,000 for a round-trip flight from Hawaii to $150,000 for a round-trip flight from Hawaii to Japan on a jumbo jet.Japan on a jumbo jet.
Worldwide usually gets $250,000 in revenue Worldwide usually gets $250,000 in revenue from this flight.from this flight.
The airlines is not currently planning to add The airlines is not currently planning to add any new routes and has two planes that are idle any new routes and has two planes that are idle and could be used to meet the needs of the and could be used to meet the needs of the agency.agency.
The next screen shows cost data developed by The next screen shows cost data developed by managerial accountants at Worldwide.managerial accountants at Worldwide.
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Accept or Reject a Special Order
Worldwide will save about $5,000 in reservationWorldwide will save about $5,000 in reservationand ticketing costs if the charter is accepted.and ticketing costs if the charter is accepted.
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14-14-1111
Accept or Reject a Special Order
Since the charter will contribute to fixed costs andSince the charter will contribute to fixed costs andWorldwide has idle capacity, the company shouldWorldwide has idle capacity, the company should
accept the flight.accept the flight.
Since the charter will contribute to fixed costs andSince the charter will contribute to fixed costs andWorldwide has idle capacity, the company shouldWorldwide has idle capacity, the company should
accept the flight.accept the flight.
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Accept or Reject a Special Order
What if Worldwide had What if Worldwide had no excess capacityno excess capacity? If ? If Worldwide adds the charter, it will have to cut Worldwide adds the charter, it will have to cut
its least profitable route that currently its least profitable route that currently contributes $80,000 to fixed costs and profits. contributes $80,000 to fixed costs and profits.
Should Worldwide still accept the charter?Should Worldwide still accept the charter?
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Accept or Reject a Special Order
Worldwide has no excess capacity, so it Worldwide has no excess capacity, so it should reject the special charter.should reject the special charter.
McGraw-Hill/Irwin
14-14-1414Decisions Involving Limited
ResourcesFirms often face the problem of deciding how Firms often face the problem of deciding how
limited resources are going to be used.limited resources are going to be used.Usually, fixed costs are not affected by this Usually, fixed costs are not affected by this
decision, so management can focus on decision, so management can focus on maximizing total contribution margin.maximizing total contribution margin.
Let’s look at the following example.Let’s look at the following example.
Firms often face the problem of deciding how Firms often face the problem of deciding how limited resources are going to be used.limited resources are going to be used.
Usually, fixed costs are not affected by this Usually, fixed costs are not affected by this decision, so management can focus on decision, so management can focus on maximizing total contribution margin.maximizing total contribution margin.
Let’s look at the following example.Let’s look at the following example.
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Limited ResourcesLet’s calculate the contribution margin per unit of Let’s calculate the contribution margin per unit of
the scarce resource.the scarce resource.
Highs should be emphasized. It is the more valuable use of the scarce resource the lathe, yielding a
contribution margin of $30 per minute as opposed to $24 per minute for the Webs.
Highs should be emphasized. It is the more valuable use of the scarce resource the lathe, yielding a
contribution margin of $30 per minute as opposed to $24 per minute for the Webs.
If there are no other considerations, the best plan would If there are no other considerations, the best plan would be to produce to meet current demand for Highs and be to produce to meet current demand for Highs and then use any capacity that remains to make Webs.then use any capacity that remains to make Webs.
If there are no other considerations, the best plan would If there are no other considerations, the best plan would be to produce to meet current demand for Highs and be to produce to meet current demand for Highs and then use any capacity that remains to make Webs.then use any capacity that remains to make Webs.
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Accept or Reject a Special Order
With excess capacity . . .With excess capacity . . . Relevant costs usually will be the variable Relevant costs usually will be the variable
costs associated with the special order.costs associated with the special order.
Without excess capacity . . .Without excess capacity . . . Same as above but opportunity cost of using Same as above but opportunity cost of using
the firm’s facilities for the special order are the firm’s facilities for the special order are also relevant.also relevant.
Decision rule: YES if CMg > 0
Decision rules: YES if CMg – Opportunity cost > 0 YES if not the worst CMg
McGraw-Hill/Irwin
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Outsource a Product or Service
A decision concerning whether an item A decision concerning whether an item should be produced internally or should be produced internally or
purchased from an outside supplier is purchased from an outside supplier is often called a “make or buy” decision.often called a “make or buy” decision.
Let’s look at another decision faced by the Let’s look at another decision faced by the management of Worldwide Airways.management of Worldwide Airways.
A decision concerning whether an item A decision concerning whether an item should be produced internally or should be produced internally or
purchased from an outside supplier is purchased from an outside supplier is often called a “make or buy” decision.often called a “make or buy” decision.
Let’s look at another decision faced by the Let’s look at another decision faced by the management of Worldwide Airways.management of Worldwide Airways.
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Outsource a Product or Service An Atlanta bakery has offered to supply the in-An Atlanta bakery has offered to supply the in-
flight desserts for 21¢ each.flight desserts for 21¢ each. Here are Worldwide’s current cost for desserts:Here are Worldwide’s current cost for desserts:
An Atlanta bakery has offered to supply the in-An Atlanta bakery has offered to supply the in-flight desserts for 21¢ each.flight desserts for 21¢ each.
Here are Worldwide’s current cost for desserts:Here are Worldwide’s current cost for desserts:
McGraw-Hill/Irwin
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Outsource a Product or ServiceNot all of the allocated fixed costs will be savedif Worldwide purchases from the outside bakery.Not all of the allocated fixed costs will be savedif Worldwide purchases from the outside bakery.
McGraw-Hill/Irwin
14-14-2020
Outsource a Product or Service
If Worldwide purchases the dessert for 21¢, it If Worldwide purchases the dessert for 21¢, it will only save 15¢ so Worldwide will have a will only save 15¢ so Worldwide will have a
lossloss of 6¢ per dessert purchased. of 6¢ per dessert purchased.
If Worldwide purchases the dessert for 21¢, it If Worldwide purchases the dessert for 21¢, it will only save 15¢ so Worldwide will have a will only save 15¢ so Worldwide will have a
lossloss of 6¢ per dessert purchased. of 6¢ per dessert purchased.
Wow, that’sno deal!
McGraw-Hill/Irwin
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Outsource a Product or Service
Beware of Unit-Cost DataBeware of Unit-Cost DataFor decision-making purposes, unitized fixed For decision-making purposes, unitized fixed
costs can be misleading.costs can be misleading.
Beware of Unit-Cost DataBeware of Unit-Cost DataFor decision-making purposes, unitized fixed For decision-making purposes, unitized fixed
costs can be misleading.costs can be misleading.
McGraw-Hill/Irwin
14-14-2222Add or Drop a Service,
Product, or Department
One of the most important decisions One of the most important decisions managers make is whether to add or drop managers make is whether to add or drop
a product, service or department.a product, service or department.
Let’s look at how the concept of relevant Let’s look at how the concept of relevant costs should be used in such a decision.costs should be used in such a decision.
One of the most important decisions One of the most important decisions managers make is whether to add or drop managers make is whether to add or drop
a product, service or department.a product, service or department.
Let’s look at how the concept of relevant Let’s look at how the concept of relevant costs should be used in such a decision.costs should be used in such a decision.
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Add or Drop a Product
Due to the declining popularity of digital Due to the declining popularity of digital watches, Swick Company’s digital watch line watches, Swick Company’s digital watch line
has not reported a profit for several years.has not reported a profit for several years.
If the digital watch line is dropped, If the digital watch line is dropped, the fixed general factory overhead the fixed general factory overhead
and general administrative expenses and general administrative expenses will be allocated to other product will be allocated to other product
lines because they are lines because they are not avoidablenot avoidable..
If the digital watch line is dropped, If the digital watch line is dropped, the fixed general factory overhead the fixed general factory overhead
and general administrative expenses and general administrative expenses will be allocated to other product will be allocated to other product
lines because they are lines because they are not avoidablenot avoidable..
The equipment used to manufacture digital The equipment used to manufacture digital watches has no resale value or alternative use.watches has no resale value or alternative use.
The equipment used to manufacture digital The equipment used to manufacture digital watches has no resale value or alternative use.watches has no resale value or alternative use.
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Add or Drop a Product
McGraw-Hill/Irwin
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Add or Drop a Product
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Summary
DECISION RULEDECISION RULE
Swick should drop the digital watch segment Swick should drop the digital watch segment only if its fixed cost savings exceed lost only if its fixed cost savings exceed lost
contribution margin.contribution margin.
McGraw-Hill/Irwin
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Short term Decision Making:Short term Decision Making: Relevant Costs and BenefitsRelevant Costs and Benefits
8
Chapter EightChapter Eight
Long term Long term decisions:decisions: All costs are variable, therefore all All costs are variable, therefore all costs are relevant.costs are relevant.
Next chapters
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Second mid term Second mid term examexamChapters 6, 7 and 8Chapters 6, 7 and 8Format: multiple Format: multiple choiceschoices
After the break:After the break:Discuss questions 2 & 10 + problem 10Discuss questions 2 & 10 + problem 10Discuss and solve problems 2, 4 and 5Discuss and solve problems 2, 4 and 5
Next class: