Decision Making and
Relevant Information
Chapter 11
2009 Foster School of Business
Cost Accounting
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Overview
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Decisions
Relevant information
Examples of common decisions
Opportunity costs
Capacity constraints
Replace equipment
Comprehensive example
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Cost Accounting
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Information and the
Decision Process
A decision model is a formal method
for making a choice, often involving
quantitative and qualitative analysis.
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Feedback
Five-Step Decision Process
Step 1.
Gather Information
Historical Costs
Other Information
Step 2.
Make Predictions
Specific Predictions
Step 3.
Choose an Alternative
Step 4. Implement the Decision
Step 5. Evaluate Performance
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Cost Accounting
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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 that
differ among alternative courses of action.
Historical costs
Sunk costs
Differential income
Differential costs
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Cost Accounting
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Quantitative and Qualitative
Relevant Information
Quantitative factors
Financial
Nonfinancial
Qualitative factors
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Cost Accounting
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One-Time-Only
Special Order Example
Profit is made if the incremental revenue exceeds
incremental costs.
If excess capacity exists, then relevant cost generally equals
variable cost to make special order.
Will marketing costs change?
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Cost Accounting
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Two Potential Problems in
Relevant-Cost Analysis
1
Incorrect general
assumptions:
All variable costs
are relevant.
All fixed costs
are irrelevant.
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Cost Accounting
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Misleading
unit-cost data:
Include
irrelevant costs.
Use same unit
costs at different
output levels.
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Outsourcing versus Insourcing
Outsourcing is
purchasing goods
and services from
outside vendors.
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Cost Accounting
Insourcing is
producing goods
or providing services
within the organization.
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Make-or-Buy Decisions
This is a very common (frequent) decision made
by most organizations.
Purchase managers report three important factors:
(1) Quality
(2) Supplier dependability
(3) Cost
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Cost Accounting
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Make-or-Buy Decisions
In making a “make-or-buy” decision
it is often times useful and quick to
compare the cost to outsource versus
the costs saved if you outsource.
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Cost Accounting
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Opportunity Costs and
Outsourcing
Opportunity cost is the contribution to income
that is forgone (rejected) by not using a
limited resource in its next-best alternative use.
Generally, opportunity cost is the benefit
foregone by not choosing the next best
alternative.
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Cost Accounting
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Opportunity Costs and
Outsourcing
Many decisions have an opportunity cost.
What is the opportunity cost for making the
decision to come to class today?
Give an example of a decision that had no
or zero opportunity cost.
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Cost Accounting
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Capacity Constraints
Deciding which
products to produce when there
are capacity constraints.
Answer: Produce/sell product(s) with the
highest CM/unit of constraint!
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Product-Mix Decisions
Under Capacity Constraints
Per unit
Product #2 Product #3
Sales price
$2.11
$14.50
Variable 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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Cost Accounting
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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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From a company economic
Perspective, the book value
of equipment is irrelevant in
equipment-replacement decisions.
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Conflicts can arise
between the decision model
used 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
$14,000
Accumulated Depreciation 50,000
Loss on Disposal
16,000
Machine
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$80,000
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Decisions and
Performance Evaluation
In the real world would the manager
replace the machine?
An important factor in replacement decisions
is the manager’s perceptions of whether the
decision model is consistent with how the
manager’s performance is judged.
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Decisions and
Performance Evaluation
Top management faces a challenge – that is,
making sure that the performance-evaluation
model of subordinate managers is consistent
with the decision model.
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Anatomy of a Decision:
Buy a used versus lease a new car
• Example of decision--See spread sheet
analysis.
• Quantitative and qualitative analysis—you
are only part way done with analysis after
the quantitative analysis. Use this as a
benchmark against the qualitative factors.
• What qualitative factors have I missed (left
out of) in my quantitative analysis?
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Cost Accounting
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End of Chapter 11
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