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4 - Cost Analysis For Decision Making

This document discusses cost analysis for decision making. It defines differential costs as costs that differ between alternatives and distinguishes variable costs from fixed and sunk costs. The document compares total and differential cost formats and discusses full product costs, the full cost fallacy, and criticisms of differential analysis. It also covers legal issues like predatory pricing, dumping, price discrimination, and price fixing. The theory of constraints is introduced as focusing on revenues, costs, and bottlenecks to maximize throughput contribution.

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201 views2 pages

4 - Cost Analysis For Decision Making

This document discusses cost analysis for decision making. It defines differential costs as costs that differ between alternatives and distinguishes variable costs from fixed and sunk costs. The document compares total and differential cost formats and discusses full product costs, the full cost fallacy, and criticisms of differential analysis. It also covers legal issues like predatory pricing, dumping, price discrimination, and price fixing. The theory of constraints is introduced as focusing on revenues, costs, and bottlenecks to maximize throughput contribution.

Uploaded by

Pattranite
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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CHAPTER FOUR: COST ANALYSIS FOR DECISION MAKING

 Differential analysis the process of estimating revenues and costs of alternative actions available to decision makers
and of comparing these estimates to the status quo.
 One important distinction between short-run and long-run decisions is whether the timing of cash receipts and
disbursements is important; that is whether the time value of money is a significant factor.
 Differential costs are costs that differ among or between alternatives.
o Variable costs are differential when a decision involves possible changes in volume.
o Both fixed and variable costs can be differential.
 Sunk costs are costs incurred in the past and cannot be changed by present or future decisions. These cannot be
differential because they will be the same for all decisions.
 The total format has information readily available for easy derivation of the differences. Also, it provides information
on the total resources required if one alternative is chosen. On the other hand, the differential format highlights the
differences between alternatives.
 The full cost/ full product cost describe a product’s cost that includes both variable cost of producing and selling the
product and a share of the organization’s fixed costs.
 The full cost fallacy in setting prices involves adding fixed and variable costs and dividing by the total volume to
arrive with the cost per unit, which is wrong because fixed costs are not dependent on volume.
 Criticism on differential analysis are:
1. Leads to underpricing in the long run because the contribution to covering fixed costs and generating profits will
be inadequate
2. May be difficult to sell a product to a customer at a reduced price on a particular day when capacity utilization is
low if that customer might return on another day when capacity utilization becomes high
 Full product costs to make and/or sell a product are often used to estimate long-run differential costs.
 The product life cycle covers the time from initial R and D to the time at which support to the customer is withdrawn.
 A target price is the estimated price for a product or service that potential customers will be willing to pay. A target
cost is the estimated long-run cost of a product or service whose sales enables the company to achieve targeted profit.
 Cost-plus pricing is when the accounting department provides the marketing department with the cost reports, and
they add appropriate mark ups to determine benchmark or target prices.

Legal issues relating to costs and sales price

 Predatory pricing is the practice of setting the selling price of a product at a low price with the intent of driving
competitors out of the market or creating a barrier to entry for new competitors.
 Dumping occurs when a company exports its product to consumers in another country at an export price below the
domestic price.
o Remedies to domestic producers are usually tariffs on the dumped products that bring their prices up to the level
of prices charged by domestic companies.
 Price discrimination is the practice of selling identical goods or services to different customers at different prices.
 Peak-load pricing is the practice of setting price highest when the quantity demanded for the product approaches the
physical capacity to produce it.
 Price fixing is the agreement between business competitors to set prices at a particular level.

 A make-or-buy decision is any decision by a company to acquire goods or services internally or externally.
 Constraints include activities, resources, or policies that limit or bound the attainment of an objective.
 By concentrating on products that yield a higher contribution per unit of scarce resource, an organization can
maximize its profit.

Theory of Constraints
 This theory focuses on revenues and cost management when faced with bottlenecks.
 In the face of constraints, the optimal product mix is the that which maximizes contribution margin per unit of scarce
resource.
 Maximizing the output of a constrained resource is the best route to increased marginal revenues. The objective of this
theory is to maximize throughput contribution given investments and operating costs.
 A bottleneck is an operation where the work required limits production, thus the bottleneck is the constraining
resource.
 The theory of constraints focuses on three factors:
o The rate of throughput contribution; where throughput contribution equals sales dollars minus direct materials
costs and other variable costs
o Minimizing investments
o Minimizing other operating costs

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