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(c) 2012 Pearson Prentice Hall. All rights reserved.

Chapter 11

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A. Objectives / Expected Learning Outcomes

(Course Outline)1. Chapter 11 !elevant "n#ormation $ecision %a&ing

'. A#ter studing this Chapter ou should be able to %aster the !elevant Costs Concepts and appl the

&no*ledge to manu#acturing merchandising andservice companies.

+se the in#ormation #rom management accountingsstems to improve the competitiveness o# thecompanies in operational excellence productleadership (product mix next slide) and customerservice.

$evelop s&ills and abilit to solve problems thatthe *ill need to succeed in a business

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$. Learning Activities1. Lecture (sharing o# &e concepts and ideas)

'. $iscussions (sharing b students)

6. Available -echnolog (visual presenter 7 - 7 Clic&er)

E. Assessment1. "n Class Exercise (Clic&er) %C 8ormat

'. 9: Assignment (in %C 8ormat Openended ;uestion8ormat and Essa 8ormat)

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1. +se the #ivestep decisionma&ing process

'. $istinguish relevant #rom irrelevantin#ormation in decision situations

6. Explain *h managers should consider thecosts *hen ma&ing insourcingversusoutsourcing decisions

3.

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. $iscuss the #actors managers must consider*hen adding or dropping customers orbusiness units

4. Explain *h boo& value o# e2uipment isirrelevant to managers ma&ing e2uipmentreplacement decisions

=. Explain ho* con#licts can arise bet*een the

decision model a manager uses and theper#ormanceevaluation model topmanagement uses to evaluate managers

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%anagers usuall #ollo* a decision model #orchoosing among di##erent courses o# action.

A decision model is a #ormal method o# ma&ing achoice that o#ten involves both 2uantitative and2ualitative analses.%anagement accountants anal>e and presentrelevant data to guide managers? decisions.%anagers use the #ivestep decisionma&ingprocess presented in Chapter 1 (slide 1) to ma&edecisions.

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!elevant in#ormation has t*o characteristics "t occurs in the #uture

"t di##ers among the alternative courses o#action.

!elevant costs (slide 11) are expected #uturecosts.

!elevant revenues (slide 11) are expected

#uture !evenues. ast costs (historical costs) are never

relevant and are also called sun& costs (slide16).

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;uantitative #actors are outcomes that canbe measured in numerical terms.

;ualitative #actors are outcomes that are

di##icult to measure accuratel in numericalterms such as satis#action.;ualitative #actors are just as important as

2uantitative #actors even though the aredi##icult to measure.

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ast (historical) costs ma be help#ul as a basis #or ma&ingpredictions. 9o*ever past costs themselves are al*asirrelevant *hen ma&ing decisions.

$i##erent alternatives can be compared b examiningdi##erences in expected total #uture revenues and

expected total #uture costs. @ot all expected #uture revenues and expected #uture

costs are relevant. Expected #uture revenues andexpected #uture costs that do not di##er among

alternatives are irrelevant and hence can be eliminated#rom the analsis (see next slide). -he &e 2uestion isal*as :hat di##erence *ill an action ma&e

;uantitative and 2ualitative #actors should be considered.

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Costs that have alread occurred and cannot bechanged are classi#ied as sun& costs.

0un& costs are excluded (slide 5) because thecannot be changed b #uture actions.

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"ncremental cost (slide 1=) B the additionaltotal cost incurred #or an activit.

$i##erential cost B the di##erence in totalcost bet*een t*o alternatives.

"ncremental revenue B the additional totalrevenue #rom an activit.

$i##erential revenue B the di##erence in totalrevenue bet*een t*o alternatives.

@ote that incremental cost and di##erentialcost are sometimes used interchangeabl inpractice.

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1. Onetimeonl special orders (slide 1415)

'. "nsourcing vs. Outsourcing (%a&eor,u)(slide ''3)

6. roductmix *ith capacit constraints (slide''D)

3. Customer ro#itabilit and !elevant Costs(slide '566)

. ,ranch / 0egment adding or discontinuing(slide 63)

4. E2uipment !eplacement (slide 631)

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Accepting or rejecting special orders *henthere is production capacit and thespecial orders have implications.

$ecision rule $oes the special ordergenerate additional operating incomeFesBaccept

@oBreject Compares relevant revenues and relevant

costs (slide 5) to determine pro#itabilit.

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,ac&ground "n#ormation A customer o##ers topurchase units at G11 per unit *hich is G5less than the usual selling price.

;uestion 0hould the special order be accepted -hings to note

1. $ecision !ule $oes the special ordergenerate additional operating income

"# es then accept the special order.'. -he onl incremental costs (slide 13) arethe manu#acturing costs.

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$iscussion / !esult$ecision !ule $oes the special order generateadditional operating income "# es then

accept the special order.

1. Column $ Operating "ncome G6.

'. Column 8 Operating "ncome G3= i# thespecial order is accepted.

6. Column 9. $i##erence G1=.3. Henerate operating income.

. the special order.

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"nsourcing means ou?ll produce the good (orprovide the service) *ithin the organi>ation.

Outsourcing is purchasing goods and services

#rom outside vendors. $ecisions about *hether to insource or

outsource are called %a&eor,u decisions.

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$ecision rule 0elect the option that *illprovide the #irm *ith the lo*est cost andthere#ore the highest pro#it.

0ame as special order choose thealternative that maximi>es operatingincome.

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,ac&ground "n#ormation A compan needs ' units o#a good produced in ' batches o# 1' units each.

-he compan could purchase the good #or G43 per unit.

;uestion 0hould the compan ma&e or bu the good

-hings to note

1. Consider the manu#acturing costs ($irect %aterials%anu#acturing Overhead Cost). (-otal Amount 1

million dollar) #or ma&ing the product.'. Consider 14 million dollar (' units x G43selling price) #or purchasing / buing.

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Total RelevantCosts

RelevantCost Per

Unit

Relevant Items Make Buy Make Buy

Outside purchase of parts ($64 * 250,000units)

$16,000,000 $64

Direct materials$9,000,00

0 $6

Direct manufacturin! la"or$2,500,00

0 $10

#aria"le manufacturin! oerhead$1,500,00

0 $6

%i&ed (aria"le and '&ed) materials handlin! and setup oerhead

$2,000,000 $

otal releant costs (a)$15,000,0

00$16,000,0

00 $60 $64

Di+erence in faor of main! D#D pla-ers $1,000,000 $4

(a) he $,000,000 of plantlease, plantinsurance, and plantadministrationcosts could "e included under "oth alternaties. /once tuall , the do not

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$iscussion / !esult

$ecision rule 0elect the option that *ill provide the #irm*ith lo*est cost and there#ore the highest ro#it.

1. :e see an analsis o# the relevant costs #or thisdecision (G1 million vs G14 million).

'. 0ince it costs to ma&e the item there#oreproduction should remain inhouse.

6. As *ith special order decision strategic and2ualitative #actors cannot be ignored.

3. Also regardless o# this #inancial outcome perhaps thecompan pre#ers to retain inhouse control over2ualit issue.

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roductmix decisions are decisions managersma&e about *hich product to sell and in *hat2uantities.

$ecision rule (*ith a constraint)Choose the product that produces the

highest contribution margin per unit o#the constraining resource (see exampleon next slide) (not the highestcontribution margin per unit o# theproduct).

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,ac&ground "n#ormation -*o products (roduct A and roduct ,).

%achine hour is limitedI there#ore machine hour is the resources.

;uestion :hich product (A or ,) ma maximi>e thecompan?s pro#it

-hings to note

1. Consider the contribution margin per unit o#

the constraining resource(i.e. )

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Product A Product B

0elling rice G1. G6.

Jariable Cost per unit G 4. G1.

Contribution %argin / +nit (Ch. 6) G 3. G1.

Contribution %argin ercentage (Ch. 1) 3K K

%achine 9ours re2uired per unit . 6.

Contribution %argin / %achine 9our G D. G .

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$iscussion / !esult$ecision rule Choose the product that produces thehighest contribution margin per unit o# theconstraining resource.

1. roduct A C% per unit G3

roduct , C% per unit G1

'. Constraining !esource is the %achine 9our.

6. %achine 9our re2uired per unit is . and 6 #orroduct A and , respectivel.

3. roduct A C% per machine hour G3/. GD

roduct , C% per machine hour G1/6 G

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:hen the cost object (Chapter ') is acustomer managers must decide aboutadding or dropping the customer.

$ecision rule $oes adding or dropping acustomer add operating income to the #irm

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,ac&ground "n#ormation

-he Compan #aces the 2uestion o# *hether ornot it should drop Customer C *ho appears tohave a negative impact on operating income

(see next slide).-he are also considering adding a Customer

$ *ho have the same revenues and costs asCustomer C plus the re2uirement o# additional

e2uipment *ith G5 depreciation (see slide6'). Also !ent Heneral Administration Costand Corporate O##ice Costs *ill not change (seeslide 6').

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/ustomer 3 / otal

eenues $500,000$00,0

00$400,00

0$1,200,0

00

/ost of !oods sold 0,000

220,00

0 0,000 920,000urniturehandlin! la"or 41,000 1,000 ,000 92,000

urniturehandlin! e7uipmentcost ritteno+ as depreciation 12,000 4,000 9,000 25,000

ent 14,000 ,000 14,000 6,000

%aretin! support 11,000 9,000 10,000 0,000

8alesorder and delier-processin! 1,000 ,000 12,000 2,000

eneral administration 20,000 12,000 16,000 4,000

llocated corporateo:ce costs 10,000 6,000 ,000 24,000

otal costs 491,00024,00

0 42,0001,20,00

0

$16,00 ($2,00

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(;ncremental

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$iscussion / !esult

1. Loo&ing at this relevant revenues / relevant costanalsis *e see that dropping the C account *ouldactuall operating income b G1.

'. Adding the $ account *ill operating income G4.

6. @ote that #or $ !ental Cost Heneral AdministrationCost and Corporate O##ice Cost are not relevantbecause the don?t change *hether or not $ is

added (bac&ground in#ormation slide 6). On theother hand the additional costis relevant #or $ since the G5 *ill onl occur i#that customer is added.

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$ecision rule $oes adding or discontinuing abranch or segment add operating income to the

#irm

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0ometimes di##icult due to amount o#in#ormation at hand that is irrelevantCost accumulated depreciation and boo& value

o# existing e2uipment

An potential gain or loss on the transaction B a#inancial accounting phenomenon onl.

$ecision rule 0elect the alternative that *illgenerate the highest operating income.

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Old machine >e machineOri!inal cost $1,000,000 $600,000

?seful life 5 -ears 2 -ears

/urrent a!e -ears 0 -ear

emainin! useful life 2 -ears 2 -ears

ccumulated depreciation $600,000 >ot ac7uired-et

3oo alue $400,000>ot ac7uired

-et

/urrent disposal alue (in cash) $40,000>ot ac7uired

-et

erminal disposal alue (in cash, 2 -earsfrom no) $0 $0

nnual operatin! costs (maintenance,ener!-, repairs, coolants, and so on) $00,000 $460,000

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,ac&ground "n#ormation-he Compan uses straight line

depreciation.-he Compan *ill ma&e a decision about

*hether or not to replace e2uipment.

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Two Years Together

@eep(1)

eplace(2)

Di+erence

()A(1)(2)

eenues $2,200,000 $2,200,000 0

Operatin! costs/ash operatin! costs ($00,000 B -ear *2 -earsC $460,000 B -ear * 2 -ears) 1,600,000 920,000 60,000

3oo alue of old machine

eriodic riteo+ as depreciation or 400,000 0 400,000

e machine cost, ritten o+periodicall- as depreciation 0 600,000

(600,000)

otal operatin! costs 2,000,000 1,0,000 120,000

Operatin! income $200,000 $20,000

($120,00

0)

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11-3

Mournal Entr

$iscussion / !esult$ecision rule 0elect the alternative that *illgenerate the highest operating income.

1. !eplacing the machine *ill operating income b G1'.

'. @o* let?s ta&e a loo& at the relevant cost onl(next slide) and see i# it gives the same decision.

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9ere *e see the analsis sho*ing relevantcosts (previous slide) onl.

$iscussion / !esult$ecision rule 0elect the alternative that *illgenerate the highest operating income.

1. !eplacing the machine *ill operating income b G1'.

'. "t gives us the decision even thoughjust loo&ing at the relevant costs.

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TERMS TO LEARN PAGE NUMBER REFERENCE

,oo& value age 33D

,usiness #unction costs age 3'5

Constraint age 3

$ecision model age 3'$i##erential cost age 366

$i##erential revenue age 363

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TERMS TO LEARN PAGE NUMBER REFERENCE

"nsourcing age 36'

%a&eorbu decisions age 36'

Onetimeonl special order age 3'D

Outsourcing age 36'roductmix decisions age 33

;ualitative #actors age 3'D

;uantitative #actors age 3'=

!elevant costs age 3'4

!elevant revenues age 3'4