Using Accounting
for Decision-Making
27
Equipment Replacement Decision
Estimated life
Original cost
Accum. deprec
Disposal value now
Disposal value in 4 yrs
Operating exp / year
Old Equip
New Equip
4 yrs
4 yrs
$60,000
$20,000
36,000
N/A
2,500
N/A
0
0
7,000
2,000
Should the old equipment be replaced?
Consider future cash-in and cash-out…
… for all years affected.
difference
Dropping a Product Line
First Class
Business
(16 seats)
(150 seats)
$10,000
$ 5,600
$36,000
300
320
300
Contrib Margin
$ 9,700
$ 5,280
$35,700
Avoidable fixed
750
500
500
Unavoidable fixed
2,500
4,000
37,500
Operating Income
$ 6,450
$ 780
$(2,300)
(10 seats)
Sales
Variable
Coach .
Should the airline discontinue coach service?
difference
 Watch for unavoidable costs that do not change
even when you drop a product line.
 Beware: some of these costs might be allocated!
Special Sales Orders
Gizmo Incorporated
Sales (8400 units)
$294,000
$35
Cost of Goods Sold
268,800
32
Gross Margin
$ 25,200
$3
16,800
2
$ 8,400
$1
Selling and Admin
Operating Income
Should Gizmo accept a special sales order of
1,000 units at $28 per unit?
 Unit costs can be misleading.
 Distinguish between fixed and variable costs.
 How will total costs change?
difference
Sales ($35/unit or $28/unit) $294,000
Make-or-Buy Decisions
DM
$ 6,400
Gizmo Incorporated
DL
320,000
MOH
Super salary
$ 40,000
Utilities
11,000
Rent
25,000
Depreciation
564,000
Total MOH
640,000
Total cost
$966,400
$0.10
5.00
10.00
$15.10
Should BMI continue to make microprocessors
or buy them externally for $12.00?
difference
 Buying a service that was previously performed
within the firm.
 Buying a component part that was previously
made by the firm.
Opportunity Cost
Potential benefit that may be obtained by
following an alternative course of action.
What is the opportunity cost?
You cut your own hair.
A company just had a very profitable year and
is considering paying-off all its loans.
The Winona Products example.
General Guidelines
Beware of unit costs
 Analyze total revenues and costs.
Recognize costs that will not change
 Many fixed costs are unavoidable.
 Historical costs are sunk.
Beware of allocated costs
 Many shared costs are unavoidable.
Be aware of limited resources
 Analyze CM per limited resource.