Relevant Cost & Info

8/3/2019 Relevant Cost & Info

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11 - 12003 Prentice Hall Business Publishing, Cost Accounting11/e, Horngren/Datar/Foster

Decision Making and

Relevant Information


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Learning Objective 1

Use the five-step decision

process to makedecisions.


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Information and the

Decision Process

A decision model is a formal method

for making a choice, often involvingquantitative and qualitative analysis.


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Five-Step Decision ProcessGather Information

Make Predictions

Choose an Alternative

Implement the Decision

Evaluate Performance

Step 1.

Step 2.

Step 3.

Step 4.

Step 5.

Historical Costs

Other Information

Specific Predictions

Feedback


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Differentiate relevant

from irrelevant

costs and revenues in

decision situations.


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The Meaning of Relevance

Relevant costs and relevant revenues are

expected future costs and revenues thatdiffer among alternative courses of action.

Historical costs Sunk costs

Differential income Differential costs


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Distinguish between quantitative

and qualitative factors in decisions.


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Quantitative and Qualitative

Relevant Information

Quantitative factors

Financial Nonfinancial

Qualitative factors


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One-Time-Only

Special Order Example

The Bismark Co. manufacturing plant has a

production capacity of 44,000 towels each month.Current monthly production is 30,000 towels.

Costs can be classified as either variable or fixed

with respect to units of output.


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One-Time-Only


Variable Fixed

Costs CostsPer Unit Per Unit

Direct materials $6.50 $ -0-

Direct labor .50 1.50

Manufacturing costs 1.50 3.50

Total $8.50 $5.00


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One-Time-Only


Total fixed direct manufacturing labor is $45,000.

Total fixed overhead is $105,000.

Marketing costs per unit are $7

($5 of which is variable).

What is the full cost per towel?


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One-Time-Only


A hotel in San Juan has offered to buy

5,000 towels from Bismark Co. at$11.50/towel for a total of $57,500.

No marketing costs will be incurred.

Variable ($8.50 + $5.00): $13.50

Fixed: 7.00Total $20.50


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One-Time-Only


$8.50 5,000 = $42,500 incremental costs

What are the incremental revenues ?

What are the relevant costs of making the towels ?

$57,500 $42,500 = $15,000


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Beware of two potential

problems in

relevant-cost analysis.


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Two Potential Problems in

Relevant-Cost Analysis

Incorrect general

assumptions:

All variable costs

are relevant.

All fixed costsare irrelevant.

1 2Misleading

unit-cost data:

Include

irrelevant costs.

Use same unitcosts at different

output levels.


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Outsourcing versus Insourcing

Outsourcing is

purchasing goodsand services from

outside vendors.

Insourcing is

producing goodsor providing services

within the organization.


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Make-or-Buy Decisions Example

Bismark Co. also manufactures bath accessories.

Management is considering producing a part itneeds (#2) or buying a part produced

by Towson Co. for $0.55.


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Make-or-Buy Decisions ExampleBismark Co. has the following costs

for 150,000 units of Part #2:

Direct materials $ 28,000

Direct labor 18,500

Mixed overhead 29,000

Variable overhead 15,000Fixed overhead 30,000

Total $120,500


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Make-or-Buy Decisions ExampleMixed overhead consists of material

handling and setup costs.

Bismark Co. produces the 150,000 units

in 100 batches of 1,500 units each.

Total material handling and setup costsequal fixed costs of $9,000 plus variable

costs of $200 per batch.


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What is the cost per unit for Part #2?

$120,500 150,000 units = $0.8033/unit

Should Bismark Co. manufacture the part

or buy it from Towson Co.?


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Bismark Co. anticipates that next year the

150,000 units of Part #2 expected to besold will be manufactured in 150

batches of 1,000 units each.


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Variable costs per batch are expected to

decrease to $100.Bismark Co. plans to continue to produce

150,000 next year at the same variable

manufacturing costs per unit as this year.Fixed costs are expected to remain the

same as this year.


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What is the variable manufacturing cost per unit?

$61,500 150,000 = $0.41 per unit

Direct material $28,000Direct labor 18,500

Variable overhead 15,000

Total $61,500


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Expected relevant cost to make Part #2:

Cost to buy: (150,000 $0.55) $82,500

Manufacturing $61,500Material handling and setups 15,000*

Total relevant cost to make $76,500

*150 $100 = $15,000

Bismark Co. will save $6,000 by making the part.


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Now assume that the $9,000 in fixed clerical

salaries to support material handling andsetup will not be incurred if Part #2 is

purchased from Towson Co..

Should Bismark Co. buy the part or make the part?


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Relevant cost to make:

Variable $76,500Fixed 9,000

Total $85,500

Cost to buy: $82,500Bismark would save $3,000 by buying the part.


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Explain the opportunity-cost

concept and why it is

used in decision making.


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Opportunity Costs,

Outsourcing, and Constraints

Assume that if Bismark buys the part from

Towson, it can use the facilities previously

used to manufacture Part #2 to produce

Part #3 for Krysta Company.

The expected additional future operating

income is $18,000.

What should Bismark Co. do?


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Opportunity Costs,


Bismark Co. has three options regarding Krysta:

1. Make Part #2 and do not make Part #3.

2. Buy Part #2 and do not make Part #3.

3. Buy the part and use the facilities to produce

Part #3.


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Opportunity Costs,


Expected cost of obtaining 150,000 parts:

Buy Part #2 and do not make Part #3: $82,500

Buy Part #2 and make Part #3:

$82,500 $18,000 = $64,500

Make Part #2: $76,500


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Opportunity Costs,


Opportunity cost is the contribution to income

that is forgone (rejected) by not using alimited resource in its next-best alternative use.


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Opportunity Costs,


Assume that annual estimated Part #2

requirements for next year is 150,000.

Cost per purchase order is $40.

Cost per unit when each purchase is

1,500 units = $0.55.Cost per unit when each purchase is equal

to or greater than 150,000 = $0.54.


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Opportunity Costs,


Average investment in inventory is either:

(1,500 .55) 2 = $412.50 or

(150,000 $0.54) = $40,500

Annual interest rate for investment in

government bonds is 6%.$412.50 .06 = $24.75

$40,500 .06 = $2,430


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Opportunity Costs,


Option A: Make 100 purchases of 1,500 units:

Purchase order costs: (100 $40) $ 4,000.00

Purchase costs: (150,000 $0.55) $82,500.00

Annual interest income: $ 24.75

Relevant costs: $86,524.75


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Opportunity Costs,


Option B: Make 1 purchase of 150,000 units:

Purchase order costs: (1 $40) $ 40

Purchase costs: (150,000 $0.54) $81,000

Annual interest income: $ 2,430

Relevant costs: $83,470


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Know how to choose which

products to produce when there

are capacity constraints.


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Product-Mix Decisions

Under Capacity Constraints

Per unit Product #2 Product #3

Sales price $2.11 $14.50Variable expenses 0.41 13.90

Contribution margin $1.70 $ 0.60

Contribution margin ratio 81% 4%

Bismark Co. has 3,000 machine-hours available.


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Product-Mix Decisions

Under Capacity Constraints

One unit of Prod. #2 requires 7 machine-hours.

One unit of Prod. #3 requires 2 machine-hours.

What is the contribution of each product

per machine-hour?

Product #2: $1.70 7 = $0.24

Product #3: $0.60 2 = $0.30


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Discuss what managers

must consider when

adding or discontinuing

customers and segments.


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Profitability, Activity-Based

Costing, and Relevant Costs

Mountain View Furniture supplies furniture

to two local retailers Stevens and Cohen.The company has a monthly capacity

of 3,000 machine-hours.

Fixed costs are allocated on the basis of revenues.


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Stevens Cohen

Revenues $200,000 $100,000Variable costs 70,000 60,000

Fixed costs 100,000 50,000

Total operating costs $170,000 $110,000

Operating income $ 30,000 $(10,000)

Machine-hours required 2,000 1,000


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Total

Revenues $300,000Variable costs 130,000

Fixed costs 150,000

Total operating costs $280,000

Operating income $ 20,000

Machine-hours required 3,000


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Should Mountain View Furniture drop the Cohen

business, assuming that dropping Cohen woulddecrease its total fixed costs by 10%?

New fixed costs would be:

$150,000 $15,000 = $135,000


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Cohens business is providing a

contribution margin of $40,000.$40,000 decrease in contribution margin

$15,000 decrease in fixed costs

= $25,000 decrease in operating income.


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Assume that if Mountain View Furniture drops

Cohens business it can lease the excess capacityto the Perez Corporation for $70,000.

Fixed costs would not decrease.

Should Mountain View Furniture lease to Perez?


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Explain why the book value

of equipment is irrelevant in

equipment-replacement decisions.


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Equipment-Replacement

Decisions Example

Existing Replacement

Machine Machine

Original cost $80,000 $105,000Useful life 4 years 4 years

Accumulated depreciation $50,000

Book value $30,000Disposal price $14,000

Annual costs $46,000 $ 10,000


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Equipment-Replacement

Decisions Example

Ignoring the time value of money and

income taxes, should the company

replace the existing machine?The cost savings over a 4-year period will be

$36,000 4 = $144,000.

Investment = $105,000 $14,000 = $91,000

$144,000 $91,000 = $53,000

advantage of the replacement machine.


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Explain how conflicts can arise

between the decision modelused by a manager and the

performance evaluation model

used to evaluate the manager.


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Decisions and

Performance Evaluation

What is the journal entry to sell the existing machine?

Cash 14,000Accumulated Depreciation 50,000

Loss on Disposal 16,000

Machine 80,000


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Decisions and


In the real world would the manager

replace the machine?An important factor in replacement decisions

is the managers perceptions of whether the

decision model is consistent with how themanagers performance is judged.


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Decisions and


Top management faces a challenge that is,

making sure that the performance-evaluationmodel of subordinate managers is consistent

with the decision model.


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Thanks

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Relevant Cost & Info