Decision Making and Relevant Information

Topics: Costs, Variable cost, Management accounting Pages: 10 (1167 words) Published: August 19, 2013
Cost Accounting: A Managerial Emphasis

Chapter 11

Decision Making and Relevant Information

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Cost Accounting: A Managerial Emphasis

Decision Model
• The process of making a choice, often involving both quantitative and qualitative analyses • Quality of the choice depends upon the qualify of the information obtained – Perfect information is never available

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Cost Accounting: A Managerial Emphasis

Decision Model
• May involve more than one outcome
– Uncertainty refers to outcomes not contemplated during the decision-making process – Risk refers to outcomes that have been contemplated, and are quantified as probabilities

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Cost Accounting: A Managerial Emphasis

Relevance
• Relevant Information has two characteristics:
– It occurs in the future – It differs among the alternative courses of action

• Relevant Costs – expected future costs • Relevant Revenues – expected future revenues

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Cost Accounting: A Managerial Emphasis

Irrelevance
• Historical costs are past costs that are irrelevant to decision making – Also called Sunk Costs

• Information that does not change between alternative courses of action is irrelevant

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Cost Accounting: A Managerial Emphasis

Terminology
• Incremental Cost
– The additional total cost incurred for an activity

• Differential Cost
– The difference in total cost between two alternatives

• Incremental Revenue
– The additional total revenue from an activity

• Differential Revenue
– The difference in total revenue between two alternatives 1
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Cost Accounting: A Managerial Emphasis

Types of Information
• Quantitative factors that can be measured in numerical terms – Can be financial or non-financial

• Qualitative factors that cannot be measured in numerical terms, such as satisfaction – Important even though they are difficult to measure – Examples: employee morale, customer satisfaction 1
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Cost Accounting: A Managerial Emphasis

One-Time-Only Special Orders
• Compares relevant revenues and relevant costs to determine profitability • Accepting or rejecting special orders – When there is idle production capacity – And the special order has no long-term implications

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Cost Accounting: A Managerial Emphasis

One-Time-Only Special Orders
• Decision Rule:
– Does the special order generate additional operating income?

• Qualitative considerations - examples:
– Impact on regular customers? – Potential for future business from same customer?

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Cost Accounting: A Managerial Emphasis

One-Time-Only Special Orders
• Fixed costs are sunk costs and are therefore irrelevant: – Costs cannot be retrieved – Have been incurred already

• Absorption costing is not appropriate • Variable costing and contribution margin will provide impact of decision on operating income

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Cost Accounting: A Managerial Emphasis

Outsourcing – Make or Buy
• Insourcing
– Producing goods or services within an organization – May require an expansion to capacity – A strategy of vertical integration

• Outsourcing
– Purchasing goods or services from outside vendors

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Cost Accounting: A Managerial Emphasis

Outsourcing – Make or Buy
• Also called the “Make or Buy” decision • Decision Rule: – Select the option that will provide the firm with the lowest cost, and therefore the highest profit

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Cost Accounting: A Managerial Emphasis...
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