Chapter 23

Relevant Costing for Managerial Decisions

Short-Run Decision Making• Managers are asked to make lots

of decisions that affect the current operating period only

Common decision types outsourcing decisions (make or buy) special orders, product mix, profitability of a segment (just to name a few)

Short-Run Decision Making

Five steps for short-run decisions1. Define task & goal2. Identify alternatives3. Collect relevant information4. Select course of action5. Analyze and assess decision

Short Run Decision (Incremental) Analysis

• _______ analysis is a tool that we use to make decisions about competing alternatives.

• In evaluating alternatives, focus on the additional revenues and costs for each alternative. These are relevant (costs or revenues) to the decision.

• Revenues and costs that remain the same are _______!

• _______ costs are never relevant. Sunk costs are costs that were

incurred in the past and can’t be changed. They are irrelevant!

Other Considerations• _______ costs require a future outlay of

cash and are relevant to current and future decision making.

• _______ costs may exist! Consider them! Opportunity cost is a measure of revenue

that is lost by choosing one alternative over another.

• Use the contribution margin approach to analyze alternatives.

• _______ information may be relevant when choosing between alternatives.

Special Order

• Should a special order be accepted? Calculate revenue from order. Calculate _______ costs of accepting

order.• Variable costs will increase.• Fixed costs may or may not increase.

Accept the order if it is _______ Assuming

• Sales of other products will not be affected.

• Full capacity has not been reached.

Outsourcing Decisions(Make or Buy?)

• Outsourcing - the acquisition of products or services from an entity outside our own. Often, companies outsource non-value

added activities such as payroll processing.

• Outsourcing may save money and allow companies to focus on what they are good at.

• Problems can exist as well, so must make sure that the benefits outweigh all the costs.

Outsourcing: Make or Buy• Is it cheaper to buy a part or to make it

ourselves?• Compare the cost to make and the cost

to purchase it. Consider that not all fixed costs go

away when purchasing not making. Cost to _______ = VC of buying +

remaining fixed costs + opportunity cost of making

Cost to ____ = VC + FC to produce.

Sell or Process Further?

• Should an item be processed further or sold?

Process further if the incremental revenues ______ the incremental costs of processing.

Costs incurred to date areirrelevant (sunk costs).

Fixed costs may/may not change. Only include in analysis if they increase or decrease.

Allocation of Limited Resources: Product Sales Mix• When deciding which items to produce,

consider the relative sales mix of items. • Maximize the contribution margin of

products sold.• Consider when one product consumes more

of a limited resource than another. Calculate the CM per unit of limited

resource to decide which products to emphasize.

• If all products require same facilities and market for products is unlimited, produce the product with the highest contribution margin.

Eliminate Unprofitable Segments

Sometimes company segments appear to be losing money.

If those segments are eliminated, will the company be better off?

It depends! If the fixed costs allocated to the

eliminated segment are unavoidable (they continue to exist), those costs must be reallocated to other departments.

Decision rule Segment is candidate for elimination if

revenues are less than its avoidable expenses.

Also consider the impact on other segments.

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