Chapter 6
Relevant Information for Decision Making with a Focus on Operational
Decisions
Joint Product Costs: Sell or Process Further Decisions
Split off
point
Joint processing costs (xy)
Joint Products: are not separately identifiable as individual products until their splitoff point.
Split-Off Point - time in manufacturing where the joint products become
individually identifiable.
Joint Costs - costs of manufacturing joint products before the split-off point.
Separable Costs - any costs beyond the split-off point.
The joint costs do not play a role in determining whether or not to process a joint
product further as its irrelevant sunk (historical) cost.
Sunk cost (past, historical): a cost that has already been incurred and it's irrelevant
to decision making process.
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6-37 (10 min.)
Product M should not have been processed further.
The only valid approach is to concentrate on the separable
costs and revenues beyond split-off:
Sell at
Process
Split-off Further as
as M
Revenues, 2,500,000 gallons @30¢ & 38¢
$750,000 $950,000 $200,000
Separable costs beyond split-off
--
Income effects for April
Super M Difference
210,000
210,000
$750,000 $740,000 $ (10,000)
The joint costs do not differ between alternatives and are
irrelevant to the question of whether to sell or process
further.
6-55
1.
(15 min.)
Incremental Revenue, $10 x 4,000
$40,000
Incremental Cost
30,000
Incremental Profit
$10,000
Therefore, Western should process further.
2. a. The joint costs can increase by any amount, since they
are sunk and irrelevant. Western should always choose to
process further.
2
b. Total Revenue, $160,000 + $120,000
$280,000
Total Costs:
Separable costs: $80,000 + $50,000 + $30,000
160,000
Joint costs
60,000
Net Profit
$ 60,000
Therefore, joint costs can increase by $60,000 before it is
better to not be in the business of processing tobacco
leaves.
Keeping or Replacing Equipment
You have old equipment and comparing between two alternatives, whether to keep
the old equipment or replace it for a new one!
Relevant data are:
keep
replace
Cost of new equipment
@
Disposal value of old equipment
#
Operating expenses
@
@
#--- future inflow that differ among alternative
@---future outflows that differ among alternative
Irrelevant data are:
1. Book Value of old equipment - the original cost less accumulated
depreciation, because it is a past, not a future cost.
2. The gain or loss on disposal :



The difference between book value and disposal value.
So it's a combination of irrelevant ( BV) and relevant (disposal value)
items
A gain or loss on disposal is irrelevant to keep or replace decisions.
3
6-59 (15-30 min.)
1.Cost Comparison--Replacement of Equipment
 Relevant Items Only
Three Years Together
Keep
Replace
Difference
$30,000
$18,000
$12,000
Disposal value of old equipment
-2,000
2,000
Acquisition cost--new equipment
12,000
-12,000
$28,000
$ 2,000
Cash operating costs
Total relevant costs
$30,000
The advantage of replacement is $2,000 for the three
years together.
2. Cost Comparison--Replacement of Equipment
 Including Relevant and Irrelevant Items
Three Years
Keep
Cash operating costs
$30,000
Replace Difference
$18,000
$12,000
Old equipment (book value):
Periodic write-off as depreciation
or
9,000
---
4
Lump-sum write-off
9,000*
Disposal value
---
-2,000*
New equipment, acquisition cost
---
12,000** -12,000
Total costs
$39,000
$37,000
2,000
$ 2,000
* In a formal income statement, these two items would be
combined as "loss on disposal" of $9,000 - $2,000 = $7,000.
** In a formal income statement, written off as straight-line
depreciation of $12,000 ÷ 3 = $4,000 for each of the three
years.
3.
Keep
Replace
Cash operating costs
$10,000
$ 6,000
Depreciation expense
3,000
4,000
---
7,000
$13,000
$17,000
Loss on disposal ($9,000 - $2,000)
Total charges against revenue
Assuming the manager is evaluated on the basis of the
division’s profitability, the performance evaluation
model for the first year indicates a difference in favor
of keeping: $17,000 - $13,000 = $4,000. As indicated
earlier in this solution, such a decision would result in
$2,000 less income over the next three years together.
However, some managers would adhere to the shortrun view and not replace the equipment.
And this we call conflict between decision making and performance evaluation.
5
6-B5 (15-20 min.)
1.
Three Years Together
Keep
Cash operating costs
Replace Difference
$42,000
$24,000
15,000
-
-
15,000*
$18,000
Old equipment, book value:
Periodic write-off as
depreciation
or lump-sum write-off
Disposal value
-7,000*
New equipment, acquisition cost
15,000**
Total costs
$57,000
$47,000
7,000
- 15,000
$ 10,000
*In a formal income statement, these two items would be
combined as "loss on disposal" of $15,000 - $7,000 = $8,000.
**In a formal income statement, written off as straight-line
depreciation of $15,000 ÷ 3 = $5,000 for each of three years.
2.
Three Years Together
Cash operating costs
Keep
Replace
Difference
$42,000
$24,000
$18,000
Disposal value of old equipment
-
-7,000
7,000
New equipment, acquisition cost
-
15,000
- 15,000
$42,000
$32,000
$ 10,000
Total relevant costs
This tabulation is clearer because it focuses on only those
items that affect the decision.
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3. The prospective benefits of the replacement alternative:
3 x ($14,000 - $8,000) =
$18,000
Deduct initial net cash outlay required,
$15,000 - $7,000 =
8,000
Difference in favor of replacement
$ 10,000
Also, the new equipment is likely to be faster, thus saving
operator time. The latter is important, but it is not
quantified in this problem.
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