CHAPTER
23
Short-Run Decision Analysis
Financial and
Managerial
Accounting
10e
Needles
Powers
Crosson
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Concepts Underlying Decision Analysis
(slide 1 of 2)
 The concept of cost-benefit holds that the benefits
to be gained from a course of action or
alternative should be greater than the costs of
implementing it.
– Managers frequently take the following actions when
applying the cost-benefit concept:
 Step 1: Discover a problem or need.
 Step 2: Identify all reasonable courses of action that can solve
the problem or meet the need.
 Step 3: Prepare a thorough analysis of each possible solution,
identifying its total costs, savings, benefits, other financial
effects, and any qualitative factors.
 Step 4: Select the best course of action.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Concepts Underlying Decision Analysis
(slide 2 of 2)
 Short-run decision analysis is the systematic
examination of any decision whose effects will be
felt over the course of the next year or less.
– In making such decisions, managers analyze not only
quantitative cost and benefit factors relating to
profitability and liquidity; they also analyze qualitative
factors.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Concepts Underlying Incremental Analysis
 Comparing alternatives by focusing on the
differences in their projected revenues and costs is
called incremental analysis.
– If incremental analysis excludes revenues or costs that
stay the same or that do not change between the
alternatives, it is called differential analysis.
– A cost that changes between alternatives is known as a
differential cost (or incremental cost).
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Incremental Analysis
 The first step in the incremental analysis is to eliminate any
irrelevant revenues and costs.
– Irrelevant revenues are those that will not differ
between the alternatives.
– Irrelevant costs include costs that will not differ between
the alternatives and sunk costs.
 A sunk cost is a cost that was incurred because of a previous
decision and cannot be recovered through the current decision.
 Once the irrelevant revenues and costs have been
identified, the incremental analysis can be prepared using
only the differential revenues and costs that will change
between the alternatives.
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Opportunity Costs
 Opportunity costs are the benefits that are
forfeited or lost when one alternative is chosen
over another and when the choice eliminates the
possibility of another course of action.
– Opportunity costs often come into play when a
company is operating at or near capacity and must
choose which products or services to offer.
– The income that might have been received from the
alternative that was not chosen is the opportunity cost
of the chosen alternative.
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Incremental Analysis for
Outsourcing Decisions
 Outsourcing is the use of suppliers outside the
company to perform services or produce goods
that could be performed or produced internally.
- Outsourcing can reduce a company’s investment in
physical assets and human resources, as well as
operating costs.
– Make-or-buy decisions, which are decisions about
whether to make a part internally or buy it from an
external supplier, may lead to outsourcing.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Incremental Analysis for
Special Order Decisions
 Managers are often faced with special order
decisions, which are decisions about whether to
accept or reject special orders at prices below the
normal market prices.
– Before a company accepts a special product order, it
must be sure that excess capacity exists to complete the
order and that the order will not reduce unit sales from
its full-priced regular product line.
– In addition, a special order should be accepted only if
it maximizes operating income.
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Special Order Analysis:
Price and Relevant Cost Comparison
 One approach to a special order decision is to
compare the price of the special order with the
relevant costs of producing, packaging, and
shipping the order.
- The relevant costs include the variable costs, variable
selling costs (if any), and other costs directly associated
with the special order.
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Special Order Analysis:
Minimum Bid Price for Special Order
 Another approach to this kind of decision is to
prepare a special order bid price by calculating
a minimum selling price for the special order.
– The bid price must cover the relevant costs and an
estimated profit.
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Incremental Analysis for
Segment Profitability Decisions
 Another type of operating decision that management must
make is whether to keep or drop unprofitable segments.
– A segment margin is a segment’s sales revenue minus its direct
costs.
 Such costs are assumed to be avoidable costs, which are costs that
could be eliminated if management were to drop the segment.
– An analysis of segment profitability includes the preparation of a
segmented income statement using variable costing to identify
variable and fixed costs.
 The fixed costs that are traceable to the segments are called direct
fixed costs.
 The remaining fixed costs are common costs and are not assigned to
segments.
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Incremental Analysis for Sales Mix Decisions
 Limits on resources like machine time or available labor
may restrict the types or quantities of products or services
that a company can provide.
 To satisfy customers’ demands and maximize operating
income, management must make a sales mix decision to
offer the most profitable combination of products and
services.
– To decide on the optimal sales mix, managers calculate the
contribution margin per constrained resource (such as labor or
machine hours) for each product or service.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Sales Mix Analysis
 The objective of a sales mix decision is to select the
alternative that maximizes the contribution margin per
constrained resource.
– The decision analysis consists of two steps:
 Step 1: Calculate the contribution margin per unit for each
product or service affected by the constrained resource as
follows:
 Step 2: Calculate the contribution margin per unit of the
constrained resource as follows:
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Incremental Analysis for
Sell-or-Process-Further Decisions
 Some companies offer products that can either be sold in a
basic form or be processed further and sold as a more
refined product.
– A sell-or-process-further decision is a decision about
whether to sell a joint product at the split-off point or
sell it after further processing.
 Joint products are two or more products made from a
common material or process that cannot be identified as
separate products during some or all of the processing.
 Only at a specific point, called the split-off point, do joint
products become separate and identifiable. At that point, a
company may choose to sell the product or process it further.
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Sell-or-Process-Further Analysis
 The objective of a sell-or-process-further decision is to select the
alternative that maximizes operating income.
– The decision analysis entails calculating the incremental revenue
as follows:
– The common costs shared by two or more products before they are
split off are called joint costs (or common costs).
 Joint costs are not relevant to a sell-or-process-further decision
because they are incurred before the split-off point.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Short-Run Decisions and
the Management Process
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.