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Slide of Chapter 4

The document discusses concepts related to using relevant information in decision making. It defines relevant costs and revenues as future costs and revenues that differ among alternative courses of action under consideration. Both quantitative and qualitative factors should be considered. Decisions about accepting special orders, insourcing vs outsourcing, product mix, equipment replacement, and continuing or discontinuing customers involve analyzing relevant revenues and costs to determine the best option. Opportunity costs must also be accounted for when capacity is constrained.

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Uyen Thu
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37 views16 pages

Slide of Chapter 4

The document discusses concepts related to using relevant information in decision making. It defines relevant costs and revenues as future costs and revenues that differ among alternative courses of action under consideration. Both quantitative and qualitative factors should be considered. Decisions about accepting special orders, insourcing vs outsourcing, product mix, equipment replacement, and continuing or discontinuing customers involve analyzing relevant revenues and costs to determine the best option. Opportunity costs must also be accounted for when capacity is constrained.

Uploaded by

Uyen Thu
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 PDF, TXT or read online on Scribd
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CHAPTER 4: DECISION MAKING

USING RELEVANT INFORMATION


INFORMATION AND THE DECISION PROCESS
 A decision model is a formal method of making a
choice, and it often involves both quantitative and
qualitative analyses
 Management accountants work with managers by
analyzing + presenting relevant data to guide
decisions
THE CONCEPT OF RELEVANCE
 Relevant costs are expected future costs and
relevant revenues are expected future revenue that
differ among the alternative courses of action being
consider
 Relevant costs and relevant revenue must
 Occur in the future
 Differ among the alternative courses of action
 Qualitative and quantitative relevant information:
 Outcomes of decisions can be quantitative and/or
qualitative
 Quantitative factors: outcomes measured in
numerical terms (revenue, costs, number of units of
product…)
 Qualitative factors: outcomes that are difficult to
measure accurately in numerical terms (eg.
employee moral/loyalty, customer satisfaction,
company reputation/image)
ACCEPTING/REJECTING DECISION
 One-Time-Only Special Orders: refer to
accepting/rejecting special orders when there is idle
capacity + the orders have no long-run implications
 If the incremental costs of the order are smaller
than the revenue from the order, the order should
be accepted
 In case of full capacity, accepting the order will
generate benefits foregone, ie. opportunity costs of
the order. The order can be accepted if the revenue
of the order is greater than the sum of incremental
costs of the order and the opportunity costs of such
order
INSOURCING-VERSUS-OUTSOURCING AND
MAKE-VERSUS-BUY DECISIONS
 Outsourcing and Idle Capacity:
 Outsourcing is purchasing goods + services from
outside vendors rather than insourcing
 If incremental costs (additional cost incurred for
an activity) of insourcing is more than purchasing
price  buy/outsource
 Survey indicate that quality, dependability on
suppliers, and costs are the most important
factors in the make-or-buy decisions
 Sometimes, qualitative factors dominate
 Strategic and Qualitative Factors: affect outsourcing
decisions:
 Outsourcing decisions should be in line with
strategies of the company, should not be in
conflict with strategies
 Qualitative factors (quality of product, time of
delivery, dependency on suppliers, employee
moral…) are of concern
OPPORTUNITY COSTS AND OUTSOURCING
 Deciding to use a resource in a particular way
causes a manager to forgo the opportunity to use
the resource in alternative ways  this lost
opportunity is a cost
 OC is the contribution to operating income that is
forgone by not using a limited resources in its next-
best alternative
 When capacity is constrained, the relevant revenue
+ costs of any alternative equal the incremental
revenues and costs plus the OC
 To select an option from many (more than 2)
options, OC will be the highest value of benefits
forgone
 OC are not incorporated into formal financial
accounting records, because financial accounting
records actual transactions occurred, not
(transactions of) alternatives rejected
PRODUCT-MIX DECISIONS WITH CAPACITY
CONSTRAINTS
 Product-mix decisions are about which products to
sell + in what quantities
 Managers should choose the product with the
highest contribution margin per unit of the
constraint resource
 Constraint resource

 limits/restricts the company from maximizing its


profit
 can be machine, skilled labour, land, capital…
AC LTD. PRODUCES PRODUCTS A & B.
MACHINE HOURS ARE 5000 EACH MONTH
A B
Quantity 3000 units 2000 units
demanded/month
Selling price $20 $45
Variable cost/unit 12 25
Contribution 8 20
margin/unit
Machine hours/unit 1 2
CM/machine hours 8 10
Rank 2 1

Product mix is 1000 units of A + 2000 units of B


CONTINUE/DISCONTINUE A CUSTOMER
 Relevant-Revenue and Relevance costs analysis of
dropping a customer:
 If operating income will be lower because of dropping a
customer, then the customer should not be dropped
 Rent, general-administration, and corporate-office
costs are irrelevant as they do not change if dropping a
customer
 Depreciation is irrelevant as depreciation is past costs
 OC of having a customer is relevant
 Relevance-Revenue and Relevance- Costs Analysis of
adding a customer
 if incremental revenues > incremental costs, such
customer should be added
 Rent, general-administration and corporate-office
costs are irrelevant as they do not change
 Cost of new equipment for new customer is relevant
 Depreciation is irrelevant b/c of past costs
 Relevance-Revenue and Relevance - Costs
Analysis of Closing Branch Offices/Segments:
 If revenue loss exceeds cost saving leading to a
decrease in operating income, branch/segment
should not be closed
 Depreciation is a past cost hence irrelevant
 Corporate office costs are irrelevant as they do
not change
 Relevance-Revenue and Relevance - Costs
Analysis of Adding Branch Offices/Segments:
 If operating income increases, office/segment
should be added
 Cost of new equipment is relevant
 Corporate-office costs are irrelevant
EQUIPMENT REPLACEMENT DECISIONS
 Book value of existing old equipment is a past
cost hence irrelevant
 Current disposal value of old machine is
relevant as it is an expected future benefit that
will occur if the machine is replaced
 Loss on disposal = disposal value – book value,
so each will be considered separately
 Cost of new machine is relevant as it is future
expected cost that occur if the machine is
replaced

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