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Chapter 12.docx

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Rotman Commerce
Stojanovic Dragan

Chapter 12: relevant costs for decision-making Cost concepts for decision-making Identifying relevant costs and benefits  Avoidable cost: Any cost that can be eliminated (in whole or in part) by choosing one alternative over another in decision-making situation. In managerial accounting, this term is synonymous with relevant cost and differential cost  2 categories of cost that can never be relevant in decisions: 1. Sunk cost: is the cost that has already been incurred and that cannot be avoided, regardless of the alternatives being considered, and they are therefore always irrelevant and should be ignored 2. Future cost that do not differ between the alternative: feature cost that are the same under each alternative being considered are also irrelevant since they cannot affect the decision  To identify the costs and benefits that are relevant in a particular decision of situation, the stats can be followed: 1. Eliminate cost and benefits that do not differ between alternatives. These irrelevance cost consist of sunk cost and future cost and benefits that do not differ between alternatives 2. Use the remaining costs and benefits that do differently to the alternatives in making the decisions. The costs of that remain are the differential, or avoidable, costs Different costs for different purposes  The manager needs different costs for different purposes, this means that a particular group of costs may be relevant; for another purpose, an entirely different group of costs may be relevant. Thus, in each decision situation the manager must examine the data at hand and isolate the relevant cost. An example of identifying relevant cost and benefits - READ THE EXAMPLE UNDER THIS SECTION*** VERY IMPORTANT Reconciling the total and differential approaches  **** see the example under this section and exhibit12.1 total and differential costs***  A positive number in the differential cost and benefits column indicates that the difference between the alternatives beavers the new situation; a negative number indicates that the difference between the alternative favors the current situation  If zero in the column simply means that the total amount of the item is exactly the same for both situations  This for the difference in the operating income is equal to the sum of the differences for the individual items, any cost for benefits that is the same for both alternatives will have no impact on which alternative is preferred  That is why costs and benefits that do not differ between alternatives are irrelevant and can be ignored  *** read the example under this section*** Why isolates the relevant costs?  Isolating relevant cost is desirable for two reasons: 1. Only rarely well enough information be available to prepare a detailed income statement for both alternatives for example, you are called to make a decision relating to a single product of a multi departmental, multi product firm. Under these circumstances, it will be virtually impossible to prepare an income statement of intent. You would have to rely on your ability to recognize these costs are relevance and which are not in order to assemble the data necessary to make a decision. 2. Combining irrelevant cost with relevant cost may cause confusion and distract attention from the matters that are really crucial and the danger always exist that an irrelevant piece of data may be used improperly, resulting in an incorrect decision Analysis of various decision situations  For each situation, the relevant cost and benefits must be quantified, and the alternative with the most favorable impact on operating income selected. In some situations, the analysis will consist only of a comparison of relevant cost while in others, both relevant benefits and relevant cost will be involved Adding and dropping product lines and other segments  Decisions relating to whether existing product lines or other segments other company should be dropped and me what’s added a run of the most difficult than a manager’s trust me therefore it needs many qualitative and quantitative factors into consideration and this decision greatly impacts the operating income.  *** read the example under this section... This is very important and exhibit 12.2 AFM electronics product lines *** A comparative format  *** read the example under this section and exhibit 12.3: the comparative format four product line analysis and exhibits 12.4 AFM electronics produce lines—recast in contribution format*** Relevant cost and benefits 1. Contribution margin (CM ) lost if dropped 2. Fixed cost avoided if dropped 3. Cm lost /gained on other products/segments Irrelevant costs: 1. Allocated common costs 2. Sunk cost Decision rule: 1. Keep if  CM lost (all products/segments) > fixed costs avoided + CM gained (other products/segments) 2. Drop if  CM lost (all products/segments) < fixed costs avoided + CM gained (other products/segments) The make or buy decision  Vertical integration: the involvement by a single company in more than one of the steps of the value chain from production of basic raw materials to the manufacture and distribution of a finished product  Make or buy decision: the decision as to whether an item should be produced internally or purchased from an outside supplier. Strategic aspect of the make or buy decision  An integrated firm is less dependent on its suppliers and may be able to endure a smoother flow of parts and materials for production than a non-integrated firm.  Positive aspect of using external suppliers is that by pooling demand from a number of firms, suppliers may be able to realize economies of scale in research and development and in manufacturing. These economies of scale can result in higher quality a
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