Management Accounting & Decisions II N12401

Lecture 7

Relevant Costing For Decisions

by Hung Woan-Ting

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Learning Objectives

1. To understand the framework of decision-making

2. To understand the concept of relevant cost (revenue)

3. To be familiar with the different types of decisions and apply the concept of relevant cost (revenue) in arriving at a decision

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1.0 Decision-Making Model

1. Identify objectives

2. Search alternative courses of action

3. Gather data about alternatives

4. Select alternative courses of action

5. Implement the decisions

6. Compare actual & planned outcomes

7. Respond to divergences from plan

Pla

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pro

cess

Contr

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pro

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1.1 Decision Logic

Financial Accounting Logic Decision Logic

Perspective Historical

Verifiability

Average

Transaction

Profit

Future

Relevance

Decision

Cash Flow

Marginal

Objective

Unit

Prompt

Result

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2.0 Info Relevant for Decisions

Information considered for decision-making

Financials & non-financials

Underlying assumptions

profit maximization objectives

certainty of information

known cost behaviour pattern

Some familiar cost categorizations:

Relationship between cost item and cost object

Behaviour at different activity level

Issues faced:

Is unit cost data relevant for decision-making?

Are variable costs relevant? Always?

Are fixed costs always irrelevant? Always?

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2.1 Info Relevant for Decisions

In search of a cost categorization that support

decision making reflect cost relevance

Concept of RELEVANCE

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Costs (revenues) that will be incurred (earned)

in the future

Costs/revenues that would differ between alternative decisions

Costs/Revenues that are cash flows

Opportunity costs

Fly??

Cat sitter $20/day

Airfare & cab $600

7 days in Penang

Hotel stay 8nights@$90/night

Food 8days@ $30/day

Drive??

Cat sitter $20/day

Petrol & Toll $200; Car insurance $900/yr

6 days in Penang

Hotel stay 7nights@$90/night

Food 8days@ $30/day

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Example: You are planning to take a holiday after the MAD2 exam. Youd like to make a trip to Penang up north.

Analyse these info and decide on your vacation plan!?

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2.3 Info Relevant for Decisions

Possible categories of costs according to relevance

Future costs vs. Sunk costs

Incremental costs vs. Common costs

Avoidable costs vs. Unavoidable costs

Opportunity costs

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3.0 Typical Managerial Decisions

Capital investment decisions

Pricing decisions

Adding/dropping product/segment

Choice of Product

Accept special orders

Make or buy

Joint product to further process

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3.1 Add/Drop Product Line

Example 1:

Should the business discontinue with Central?

Southern Northern Central Total

000 000 000 000

Sales 900 1000 900 2800

Variable costs (466) (528) (598) (1592)

Fixed costs (266) (318) (358) (942)

Profit/(Loss) 168 154 (56) 266

If discontinued, 250 000 of fixed costs in Central and all of its variable costs are avoidable.

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Decision criteria:

Feasibility of the product line concerned

If continue with Central:

relevant revenues =______

relevant costs = _________

Contribution provided by Central = ______

Based solely on this, decision should be to _________

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3.2 Choice of Product

Example 2:

Should the business choose product X or Y?

$ Per unit

Product X Y

DM 10 20

DL 5 8

VOH 5 8

FOH 3 3

Selling Price 32 50

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Decision criteria:

Profitability of the products

$ Per unit

Product X Y

DM 10 20

DL 5 8

VO/h 5 8

FO/h 3 3

Selling Price 32 50

Contribution ___ ___

Based solely on this, decision should be to choose ____

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3.3 Choice of Product With Constraints

Example 3:

Machine capacity is limited. Should the business choose product X or Y?

$ Per unit

Product X Y

DM 10 20

DL 5 8

VO/h 5 8

FO/h 3 3

Selling Price 32 50

Contribution 12 14

Machine hr p.u. 3 4

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Decision criteria:

Profitability of the products in utilising the limited resources available

$ Per unit

Product X Y

DM 10 20

DL 5 8

VO/h 5 8

FO/h 3 3

Selling Price 32 50

Contribution 12 14

Machine hr p.u. 3 4

Contribution/MH ___ ___

Based solely on this, decision should be to choose Product ____

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3.4 Accept Special Orders

Example 5:

There is a one-time order for the Companys existing product. Should the order be accepted?

Company has capacity to produce 100,000 units p.a.

Total Per unit

Sales (at 100K units) 600K 6.0

Variable costs 150K 1.5

Fixed costs 250K 2.5

Net Profit 200K 2.0

The order involves 10,000 units at 3p.u, with no effect on fixed costs.

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Decision criterion:

Incremental revenue vs. Incremental cost of the order

Scenario 1: Regular sale level is 80K units. Incremental revenue = Incremental costs = Decision should be to ______ order Scenario 2: Regular sale level is 100K units. Incremental revenue = Incremental costs = Decision should be to ______ order

Make or Buy?

Decision-criteria:

_________ vs. __________

Joint product to further process?

Decision-criteria:

_________ vs. __________

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3.5 Other business decisions..

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Readings & Exe.

1.Read the following chapters in the prescribed textbooks

GNBCY Ch14

AHM Ch26

2.Attempt the Question Sets attached at the back of

this handout (indicative solutions in Moodle for self-checking)

End of Lecture