Chapter
13
Relevant Costs for
Decision Making
Is the cost of equipment
purchased in the past
relevant?
Are fixed costs
ever relevant?
The cost of new
equipment?
Future revenues or costs
that differ among alternatives.
Variable costs?
Cost Concepts for Decision Making
Avoidable cost
or
Differential cost
 important to consider when comparing one
alternative to another
Sunk cost
 a cost of the past that cannot be avoided
Opportunity cost
 a benefit (revenue or gain) of an alternative
that is not chosen
Replacing Equipment
 The cost of the old equipment is irrelevant.
 And the loss on the sale of the old
equipment is irrelevant.
 Don’t get trapped by past mistakes!
 Relevant factors
 current market value of the old
 cost & expected life of the new equipment
 future output
 future operating expenses

Old machine: $50,000 cost, $10,000 accum.
depreciation; $7,000 market value

New machine: $25,000 cost; 6 year life

New machine will decrease annual operating
costs from $10,000 to $6,000.
Keep Old
Oper. Costs (6 yrs)
Purchase of new
Sale of old
Net cash flow
Impact of buying new
Buy New
Adding and Dropping Segments
Review Problem, p. 601
Keep Rnd
Drop Rnd
Revenue
$1,000,000
Variable expenses
(410,000)
Advertising - traceable
(216,000)
Deprec – special equip
(95,000)
Supervisor salaries
(19,000)
General factory OH
(200,000)
Income
$ 60,000
Impact of dropping R.I.
Depreciation on equip is irrelevant!
Beware of allocated fixed costs!
Make or Buy Decisions
Exer. 13-9, p. 608
Make
Outside purchase
DM
DL
Variable MOH
Fixed MOH - traceable
Fixed MOH - common
Total
Impact of outsourcing
Some fixed costs cannot be avoided
Buy
Special Sales Order
 if regular sales are unaffected, it’s easiest to look
at the revenue and costs from special order only
Exer. 13-10, Part 1, p. 609
Revenue
DM
DL
Variable MOH
Variable selling & adm
Additional fixed costs
Total effect
Special
Order
Special Sales Order (cont.)
Information needed:
 Number of extra units
 Selling price per unit
 Variable cost per unit
 Changes in fixed costs
May need to
be calculated.
Utilization of a Constrained Resource
Exer. 13-5, p. 606
A
Sales
Variable: DL ($8/hr)
Other
$ 60.00
B
$ 90.00
C
$ 80.00
CM per unit
Decision based not on
CM per unit…
… but on CM per
constrained resource.
Managing Constraints
 “Bottleneck”: the machine or process that limits
overall output
 Managers should select product mix that
maximizes total contribution margin.
 Managers should try to increase capacity at the
bottleneck:
 working overtime
 subcontracting of bottleneck process
 additional investment
 reducing defects
Sell or Process Further
Exer. 13-6, p. 606
Sales value after
Less: Sales value before
Incremental rev / unit
A
B
C
$80,000
$150,000
$75,000
Sell or Process Further
 AgroCorp prepares fruit and vegetable products in a
large processing plant.
 Currently sells 28,000 bags of potatoes @ $2.10.
Cost of potatoes=$25,200; cost of package=$0.03;
DL=$9,000; MOH= DL x 1.2 = $10,800.
 Possibility: process the potatoes further to prepare
potato flakes.
 35,000 boxes of flakes @ $1.80; 14,000 pounds
of potato peels @ $0.02
 Cost of potato flake box = $0.05
 Direct labor cost will increase by $2,000
 New rental equipment = $3,200 / year
Bags
Sales ($2.10 / bag;
bag) $1.90 / box)
Raw materials
Packaging ($.03 / bag)
MOH allocated (DL x 1.2)
Profit before allocated costs
(10,800)
$ 12,960
Impact of switching to flakes
Beware of allocated fixed costs!
Flakes