Upload
meryl-flora-shaw
View
221
Download
2
Embed Size (px)
Citation preview
Relevant Information
Two primary characteristics distinguish relevant from useless information:
1. Relevant information differs among the alternatives under consideration.
2. Relevant information is future oriented.
Two primary characteristics distinguish relevant from useless information:
1. Relevant information differs among the alternatives under consideration.
2. Relevant information is future oriented.
13-2
Sunk Cost
A sunk cost has been incurred in a past transaction and cannot be changed. It is
not relevant for making current decisions.
I wish I hadn’t bought that stock. Cost me
$25,000, and now it’s worth only $15,000. I really need a car but don’t have the cash!
I wish I hadn’t bought that stock. Cost me
$25,000, and now it’s worth only $15,000. I really need a car but don’t have the cash!
Just sell the stock and buy the car!
Just sell the stock and buy the car!
You’ve already taken the loss. The $25,000 is a sunk
cost. Like I said, sell the stock and buy the car you need.
You’ve already taken the loss. The $25,000 is a sunk
cost. Like I said, sell the stock and buy the car you need.
I don’t want to take the loss!
I don’t want to take the loss!
13-3
Opportunity Costs
An opportunity cost is the sacrifice that is incurred in order to obtain an alternative
opportunity.
I think I am beginning to see what you mean.
I think I am beginning to see what you mean.
The opportunity cost of owning the stock is $15,000.
That is the amount you could receive if you decide to sell.
The opportunity cost of owning the stock is $15,000.
That is the amount you could receive if you decide to sell.
13-4
Relevance is an Independent Concept
Management at Better Bakery Products is debating whether to add a new product, either cakes or pies, to the company’s product line. Projected costs are
shown:Materials (per unit) 1.50$ Materials (per unit) 2.00$ Direct labor (per unit) 1.00 Direct labor (per unit) 1.00 Supervisor's salary 25,000.00 Supervisor's salary 25,000.00 Franchise fee 50,000.00 Advertising 40,000.00
Cost of Cakes Cost of Pies
Under either alternative, a new production supervisor must be hired at a cost of $25,000 per
year. Cakes are distributed under a nationally advertised label. Pies are marketed under the
company’s own name and will require new advertising. 13-5
Relevance is an Independent Concept
Which costs are relevant?
Materials (per unit) 1.50$ Materials (per unit) 2.00$ Direct labor (per unit) 1.00 Direct labor (per unit) 1.00 Supervisor's salary 25,000.00 Supervisor's salary 25,000.00 Franchise fee 50,000.00 Advertising 40,000.00
Cost of Cakes Cost of Pies
Material costs are relevant because they differ. Fifty cents can be avoided by choosing cakes
instead of pies. Labor costs and the supervisor’s salary are not relevant because they do not
differ. The advertising costs can be avoided if the company elects to make cakes. The franchise fee can be avoided if the company elects to
make pies. Whether a cost is fixed or variable has no bearing on its relevance.
13-6
Relevance is Context-Sensitive
A particular cost that is relevant in one context may be irrelevant in another.
A department store sells men’s, women’s, and children’s
clothing. The store manager’s salary could not be eliminated if the store eliminated the line of children’s clothing. Is the store manager’s salary relevant to the
decision to stop selling children’s clothing?
A department store sells men’s, women’s, and children’s
clothing. The store manager’s salary could not be eliminated if the store eliminated the line of children’s clothing. Is the store manager’s salary relevant to the
decision to stop selling children’s clothing?
No, the store manager’s salary will be the same if children’s clothing is no
longer sold.
No, the store manager’s salary will be the same if children’s clothing is no
longer sold.
13-7
Relevance is Context-Sensitive
A particular cost that is relevant in one context may be irrelevant in another.
Would the store manager’s salary be a relevant cost, if the company was thinking about closing the store completely?
Would the store manager’s salary be a relevant cost, if the company was thinking about closing the store completely?
Yes, it is a relevant cost. If the store remains open, the company will incur the manager’s salary. If the store is closed,
the cost will be eliminated.
Yes, it is a relevant cost. If the store remains open, the company will incur the manager’s salary. If the store is closed,
the cost will be eliminated.
13-8
Relationship BetweenRelevance and Accuracy
Information need not be exact to be relevant.
You may be considering the purchase of a laptop computer. You may decide to delay your decision because you think the price will decrease. You are not sure of the amount of the price drop, but you do believe part of the cost can be avoided by waiting.
13-9
A quantitative focus considers
the cost, increase in profits, or other numerical aspects of the
decision.
Quantitative Versus Qualitative Characteristics
Relevant information can have both quantitative and qualitative characteristics.
A qualitative focus considers
non-quantitative aspects such as the impact on people and
attractiveness of the products.
For example, suppose you are deciding which of two laptops to purchase. Computer A costs $300 more than Computer B. Both computers satisfy your technical requirements; however
Computer A has a more attractive appearance
Computer A Computer B
13-10
Differential Revenue and Avoidable Cost
Relevant revenues must (1) be future oriented and (2) differ for the alternatives
under consideration. Since relevant revenues differ between the alternatives,
they are sometimes called differential revenues.
Avoidable costs are the costs managers can eliminate by making specific choices.
13-11
Relevant (Avoidable) Costs
Unit-levelCosts
Batch-levelCosts
Product-levelCosts
Facility-levelCosts
Avoided by eliminating oneunit of product.
Avoided when a batch ofwork is eliminated.
Avoided if a product lineis eliminated.
Some costs may be avoidedif a business segment is
eliminated.
13-12
Relevant Information andSpecial Decisions
Occasionally, a company receives an offer to sell its product at a price significantly below its normal selling
price. The company must make a special order decision to accept or reject the offer.
Occasionally, a company receives an offer to sell its product at a price significantly below its normal selling
price. The company must make a special order decision to accept or reject the offer.
13-13
Outsourcing Decisions
Companies can sometimes purchase products needed in the manufacturing process for less than it
would cost to make them. Buying goods and services from other companies rather than producing them
internally is commonly called outsourcing.
That test was so easy. How did you
score so low?
That test was so easy. How did you
score so low?
I outsourced my homework!!
I outsourced my homework!!
13-14
Segment Elimination Decisions
A three step decision:
1. Determine the amount of relevant revenue that pertains to eliminating the segment.
2. Determine the amount of cost that can be avoided if the segment is eliminated.
3. If the relevant revenue is less than the avoidable cost, eliminate the segment. If not, continue to operate it.
A three step decision:
1. Determine the amount of relevant revenue that pertains to eliminating the segment.
2. Determine the amount of cost that can be avoided if the segment is eliminated.
3. If the relevant revenue is less than the avoidable cost, eliminate the segment. If not, continue to operate it.
13-15
Qualitative Considerations1. Employee lives will be disrupted.
2. Sales of different product lines are frequently interdependent.
3. What will happen to the space freed by the eliminated segment?
4. Volume changes can affect elimination decisions.
1. Employee lives will be disrupted.
2. Sales of different product lines are frequently interdependent.
3. What will happen to the space freed by the eliminated segment?
4. Volume changes can affect elimination decisions.
13-16
Equipment Replacement Decisions
The equipment replacement decision should be based on profitability rather than physical deterioration. Consider
the following:
Original cost 90,000$ Accumulated depreciation (33,000) Book value 57,000$
Market value (now) 14,000$ Salvage value (in 5 years) 2,000 Annual depreciation expenses 11,000 Operating expenses ($9,000 × 5 years) 45,000
Cost 29,000$ Salvage value (in 5 years) 4,000 Operating expenses ($4,500 × 5 years) 22,500
Old Machine
New Machine
13-18
Equipment Replacement Decisions – Quantitative Analysis
1. The original cost, current book value, accumulated depreciation, and annual depreciation expense are measures of cost of the old machine relating to prior periods. They are irrelevant because they are sunk costs.
2. The $14,000 market value of the old machine is an opportunity cost and is relevant to the replacement decision.
3. The salvage value of the old machine reduces the opportunity cost. The opportunity cost of using the old machine for five more years is $12,000 ($14,000 – $2,000).
4. The $45,000 operating expenses of using the old machine can be avoided if it is replaced. It is a relevant cost.
1. The original cost, current book value, accumulated depreciation, and annual depreciation expense are measures of cost of the old machine relating to prior periods. They are irrelevant because they are sunk costs.
2. The $14,000 market value of the old machine is an opportunity cost and is relevant to the replacement decision.
3. The salvage value of the old machine reduces the opportunity cost. The opportunity cost of using the old machine for five more years is $12,000 ($14,000 – $2,000).
4. The $45,000 operating expenses of using the old machine can be avoided if it is replaced. It is a relevant cost.
13-19
What are the relevant costs if Premier purchases and uses the new machine?
1. The cost of the new machine can be avoided by keeping the old machine. It is a relevant cost.
2. The relevant cost of purchasing the new machine is $25,000 ($29,000 – $4,000).
3. The $22,500 of operating expenses can be avoided by keeping the old machine. The operating expenses are relevant costs.
Let’s summarize the relevant costs for the two machines.
13-20
Equipment Replacement Decisions
Opportunity cost 14,000$ Salvage value (2,000) Operating expenses 45,000 Total 57,000$
Cost 29,000$ Salvage value (4,000) Operating expenses 22,500 Total 47,500$
Old Machine
New Machine
Our analysis shows that
Premier should acquire the new machine. Over a five-year period the company will
save a total of $9,500
($57,000 – $47,500).
13-21